Commercial real estate owners and operators are amid a complicated exercise to figure out how to factor climate risk within their portfolios.
Deciphering how much risk a property will face, now and in the future — and subsequently pricing in that risk — isn’t always clear-cut.
And while there are a number of analytical tools available to help figure out risk and potential exposure to extreme-weather events, the data can be inconsistent and produce wildly different outcomes, even for a single property.
“We were having multiple conversation with real estate investment managers trying to leverage climate risk software analysis to inform … their decision-making process,” said Billy Grayson, executive vice president at the Urban Land Institute. “Many of them were trying out multiple providers and were getting different scores … for the same assets. That was concerning for a lot of people.”
ULI and Chicago-based LaSalle Investment Management Inc., which manages about $82 billion in assets, including real estate, recently completed a study examining how the industry can better use climate-risk analytics.
Lindsay Brugger, ULI vice president of urban resilience, said the study found data itself is frequently different among providers, and the way it’s processed can also vary. For example, not all climate hazards are examined by all providers, and which global-warming scenario a group is operating under can provide more optimistic or pessimistic evaluations of a property.
Particularly in the U.S., commercial real estate companies are still in the early stages in figuring out how to implement climate-related changes to their portfolios. But there’s no denying most significant real estate investors have started to shift how they invest in real estate and what they invest in through the lens of climate.
Brugge said real estate companies ULI and LaSalle spoke with reported frustration over a lack of transparency from climate-risk providers, which, she said, are also trying to understand what the industry needs.
“At the end of day, we need increased transparency and collaboration,” Brugger said.
ULI and LaSalle also identified difficulties in translating complex climate science into economics as another concern among investment managers. Development of industry standards was identified by the study as necessary to make climate-risk evaluations more consistent.
Being closely watched by real estate executives and others: what the U.S. Securities and Exchange Commission will require for environmental, social and corporate governance, or ESG, reporting requirements.
Right now, defining whether a property or portfolio is following ESG standards is somewhat subjective. When such regulations are issued from the SEC, that’ll have a significant impact on how climate risk is measured, Grayson said.
“Anyone looking at global capital … (is) starting to get prepared for a regulatory approach to assessing climate risk,” he continued.
A February report by McKinsey & Co. Inc. said factoring climate-change risk in asset and portfolio valuations will be key for the real estate industry to stay ahead of the curve on climate change. Owners should build analytical capabilities to understand physical and transition risks, in addition to things like decarbonizing buildings.
Transition risk refers to actions needed to get a building in compliance with new regulations, or to respond to broader economic, social or technological changes. In the context of climate change, it’s the cost and actions required to ensure buildings emit fewer carbon emissions, for example.
For state and local governments that’ve already passed some legislation around ESG, that’s provided some predictability for owners in pricing their portfolios’ transition risk, Grayson said.
As an example, Local Law 97 passed by the New York City Council in 2019, requires most buildings that are more than 25,000 square feet to meet specific energy-efficiency and greenhouse-gas emissions limits by 2024, and even stricter limits must be met by 2030. Knowing, for example, how much the fine will be if standards aren’t met by those deadlines provides some predictability for owners and investors, Grayson said.
The Urban Green Council in 2019 found updating the 50,000 buildings covered by New York’s law would create up to $24.3 billion in retrofit demand through 2030. But, as McKinsey noted in its report, standard property valuation models don’t necessarily take into account costs required to decarbonize a building. That means investors and operators frequently face unexpected major expenses or taxes when embarking on climate-related changes to their buildings.
And while sustainability is frequently used as a marketing point for commercial assets today, it’s tough to disaggregate how much climate-resilient features are affecting real estate values, Grayson said.
“We know some U.S. and global investors are using climate risk in their due diligence for acquisition, which is affecting pricing for that asset,” he said. “That’s informing their decisions about whether they want to increase, stay the same or decrease their level of investment in high-risk climate regions.”
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