Impact of climate on the future of real estate investing

The ULI-Heitman report singles out the Netherlands (its capital Amsterdam is seen here) and Singapore as two countries with a robust framework of climate strategies in place.

SINGAPORE (EDGEPROP) – The real estate industry has made significant headway in recent years to account for the long-term effects of climate change. However, the real estate investment sector needs to adapt more quickly to incorporate a new dimension of climate change that will impact decision-making, according to a new research report published on Jan 27 by the Urban Land Institute (ULI), an international research institute, and Heitman, a global real estate investment firm.

The report, titled “Climate Migration and Real Estate Investment Decision-Making”, sheds light on the effects of climate migration. This refers to the relocation of people due to environmental change, and the social and economic disruptions it causes.

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Climate migration

According to the report, there are two main reasons why climate migration is directly relevant to future real estate investments.

Firstly, climate migration contributes to significant shifts in demand for real estate as individuals and communities respond to changing environmental conditions. Urban areas that are less able to manage the effects of climate change will likely see a decline in demand in their respective property markets.

But new real estate investment opportunities are likely to spring up in regions or neighbourhoods that are better poised to absorb climate shocks and stresses.

“[Since 2019,] industry awareness and engagement with climate change risk has clearly shifted. The industry has developed new approaches and physical risk assessment, revised investment underwriting criteria and asset management practices,” says ULI.

Other improvements include new forms of cross-sector and community-level collaboration efforts to enhance climate resilience within urban developments and areas.

Yet, extreme weather displaced close to 31 million people globally in 2020, says ULI, and about 14 million could be displaced each year on the sudden onset of natural disasters like hurricanes, earthquakes and floods. ULI also cites research by Christian Aid, a UK-based charity, that shows that last year, global insured catastrophe losses exceeded the US$100 billion ($135 billion) threshold for the fourth time in five years.

Flood in New Orleans. About 14 million people could be displaced each year from the sudden onset of natural disasters like hurricanes, earthquakes and floods.

“This illustrates the potential for profound shifts in where and why populations will locate or relocate in a climate-changed world,” says ULI.

Secondly, climate migration also raises the need for the industry to urgently adopt proactive real estate investment approaches that promote effective, efficient and equitable climate change adaptation at the market and asset level.

Sustained investment activity in areas that are more likely to experience population decline due to climate-related disruption poses a direct investment risk. “Climate change, and its effects and governance, are uncertain and geographically variable, particularly when analysed in the context of long-term investments in the built environment,” says ULI.

Thus, climate migration needs to be factored into real estate investment decision-making.

Financing climate risk

According to the ULI report, climate-risk assessment is increasingly becoming a standard practice in real estate investment decision-making. This could begin by screening a portfolio against a suite of climate risks such as flooding or wildfire. Risk assessments then examine evidence of existing or feasible asset and community risk management measures.

Many ULI members share that they have started the process of identifying how they can address and prioritise these challenges in relation to key investment markets with high physical risk exposures.

“Moving forward, they expect to systematise this research process, which may include a standardised output that acquisition and asset management teams can use to monitor climate risks in the most vulnerable markets they invest in,” says ULI.

The research institute weighs in to say that some of the initial questions investors can ask themselves are whether the asset is protected by local infrastructure and resilience measures, and whether there is sufficient market-level adoptive capacity.

Adoptive capacity refers to the ability of place-based institutions to mitigate climate risks and implement effective adaptation strategies. It could also relate to the fiscal capacity of a community to finance risks through property tax levies, government subsidies and transfers.

However, several local factors beyond fiscal capacity and access to capital add another layer of complexity that influences how communities navigate climate adaptation.

For example, community development projects and planning guidelines may enable a problematic development in vulnerable areas, heightening the long-term economic exposure to climate risks.

“I’m watching developers build in the floodplain, and they’re adding miles of roads that they won’t have to pay to elevate or to maintain. The state will have to pay to maintain it. They’re building in the floodplain and they’re building new assets that other people will have to pay to maintain and to adapt,” says an unnamed ULI member who shares his experience in the report.

Most ULI members when discussing adaptive capacity challenges faced by cities cite Singapore and the Netherlands as countries that they believe will be better positioned to absorb climate shocks and stresses. This is because there is a robust framework of climate strategies in place that offers comparatively safe investment opportunities in the future.

‘Oversized concern’ on downside risk

The report highlights that investor discussion about climate migration tends to focus on places that are likely to be adversely affected by climate stress and outward mobility flows, rather than areas and regions that may grow and further develop.

“We’re not placing a premium on higher-ground assets at the moment, so we’re probably focused more on the downside risk of climate,” says a senior executive at a major international investment firm.

ULI says the “oversized concern” with the downside of climate risk stems from several decision-making factors. These include the need to make near-term investment decisions about current or potential acquisitions in high-exposure markets, and the uncertainties associated with medium- to long-term climate science.

The Indonesian government passed a bill on Jan 18 that approved plans to relocate the capital from Jakarta (pictured) to a new capital city.

This contrasts with top-down strategies to develop regions that can absorb so-called climate refugees in the future. For example, the Netherlands has started to study ways to shift populations and investment from high-risk flood-prone areas to comparably safer higher-elevation ground.

Indonesia is also finalising plans to relocate the nation’s capital from Jakarta to a new city called Nusantara on Borneo, given the former’s chronic struggles with flooding, land subsistence, and other urban sprawl and environmental challenges. The Indonesian government passed a bill approving the relocation on Jan 18 this year.

Outdated models hinder new insights

Most investors that ULI spoke to for the report recognise the importance of climate risk and migration as important determinants of market performance and return on investment. But they are only beginning to integrate these issues into their decision-making process.

“For investors, it’s a challenging time because all of these traditional indicators and models are pointing to conclusions that may be different from a climate-centric way of thinking about migration,” says one unnamed respondent from a large international property investment firm.

Existing market dynamics also continue to drive investment in, and subsequently returns from, many of the most-climate-risk exposed regions, says ULI.

This is a systemic rather than sector-specific challenge, given the multiple factors that influence human migration and the overall rate of climate change and its effects. Thus, specific industry approaches may need to be complemented with research methodologies and performance indicators to make the right long-term trajectory for real estate investments.

Summing up, ULI and Heitman believe that this requires a shift in perspective from an asset-centric view to a market-level appraisal of risk and resilience drivers. Leadership from the real estate industry and real estate investment community will be key in the widespread adoption of effective and equitable societal approaches to climate action.

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