_Climate risk and resilience and the opportunity for commercial real estate

In recent years, climate risk and resilience have become increasingly relevant topics. The changing climate brings about extreme weather events and evolving environmental conditions that present significant hurdles for various sectors, including real estate. However, among these challenges lies an opportunity for real estate investors and stakeholders to proactively address climate risk and enhance the resilience of their assets.

1. Understanding the landscape

Climate risk refers to the potential negative impacts of changing climatic conditions on properties and investments. This includes physical threats, such as damage from extreme weather events, and transition risks, such as regulatory changes and market shifts. Climate risks will vary depending on the climate zone an asset (property) falls within, and advances in climate data and modelling has improved the capability of predicting the associated physical and transition risks.

Investors need to understand how climate change can impact various sectors and asset classes in order to adapt to a rapidly changing environment. Risks require short-, medium- and long-term considerations to be factored into assessments. This could involve evaluating vulnerabilities, understanding geographical and geopolitical factors, and determining how different properties might be affected.

Examples of specific climate risks include the increasing frequency of severe weather patterns that can be seen globally. From a UK perspective, flooding can lead to direct damage to properties. For example, properties in coastal areas might face risks related to sea-level rise and could also pose a risk of flooding. Additionally, increased heat stress from heat waves often puts pressure on air-con systems within buildings, sometimes causing IT systems to trip. As the frequency of heat waves increase along with the steady rise in average temperatures, the UK will require greater reliance on cooling, contributing to an expected increase in energy consumption.

2. Adapting to change

Investors can work to understand climate risk and devise strategies to adapt to a rapidly evolving environment.

Diversifying investments across different asset classes, sectors, and regions can help mitigate climate risks. For example, investing in climate-resilient infrastructure can provide growth opportunities whilst reducing exposure to physical climate risks. In the UK, one of the largest risks for our built environment is extreme wind. On the week commencing April 15th 2024, the UK was impacted by strong 55mph+ wind gusts, mostly impacting the south and east of England. Many homes were affected by the gusts of wind, with reports of damaged roofs and fences with debris scattered across residential streets. How we build resilience into our buildings and change the way we stress test in masterplan developments to reduce the impacts of wind microclimates is key. Recognising these risks and implementing measures to withstand or recover from such events is critical for protecting property value. 

3. Transition to low-carbon and net-zero

As we approach the UK government's Net Zero 2050 target, various regulations are being introduced to assist the economy in transition. For example, the MEES (Minimum Energy Efficiency Standard) regulation requires that all rented properties in the UK achieve a minimum Energy Performance Certificate (EPC) rating of B by 2030, effectively preventing the letting of buildings that fall below this energy efficiency standard. To stay in line with these regulations, it is essential to incorporate ESG factors into investment analysis and decision-making processes to identify and manage climate risks effectively.

4. Market perception

Investors and property owners share similar perspectives on climate risks. Their concerns consider properties in areas susceptible to risk, potentially resulting in decreased demand, devaluation of assets, and reduced rental engagement. Investors equipped with robust climate-resilient strategies are more appealing to both investors and stakeholders. This creates alignment with market perceptions. Demonstrating acknowledgement of the issue and showcasing strategies to address these concerns is crucial for maintaining attractiveness in the market.

5. Insurance considerations and climate risk  

Investors and stakeholders should focus on developing climate resilience strategies and due diligence, demonstrating their ability to navigate adverse climate-related impacts. This might involve retrofitting buildings with heat-resistant materials, elevating structures in flood-prone areas, or implementing sustainable urban drainage systems.

Insurance in real estate is increasingly considering climate risk as a significant factor in assessing property risks. Investment in advanced modelling and analytics is determining premiums and shaping coverage policies as a result of more frequent and severe climate events. Insurance premiums for properties located in high-risk areas are likely to rise to reflect the elevated risk of damage and loss, evident in flood-risk areas.

6. Long-term planning

Climate resilience strategies should take a long-term approach to protect investments, and an entire life cycle of an asset should be considered. Future-proofing buildings against climate risks requires a comprehensive approach that spans design, construction, maintenance, and renovation.

Demonstrating long-term planning is important for investors, shareholders, and other stakeholders to meet the increasing demand for action on climate-related issues. Proactively managing climate risks and responsible investment practices can build a strong reputation and credibility for investors, enhancing long-term value creation.

7. Collaboration and engagement

Climate risk and resilience demand collaboration among various stakeholders, including developers, investors, tenants, and government bodies. Recognising the interconnected nature of the real estate landscape can lead to more informed decisions that prioritise climate resilience.

A prime example of how working in partnership is vital in improving the sustainability of real estate is in building and construction practices and materials. By bringing together architects, engineers, builders, material scientists, policymakers, and industry partners, the industry can collectively address the challenges and opportunities posed by climate change and sustainability. Contributing towards advancing sustainable building materials is crucial for reducing environmental impact, enhancing energy efficiency and performance, conserving resources, promoting resilience and durability, sequestering carbon, meeting market demand and adding value to properties.

8. Regulatory changes in ESG

We expect the introduction of stricter regulatory changes that will increasingly encourage climate resilience and mitigation. For example, the TCFD (Task Force on Climate-related Financial Disclosures) and, more recently, the SFDR (Sustainable Finance Disclosures Regulation) have been set up with the aim of standardising reporting. As governments worldwide prioritise climate action, our role is to stay informed and maintain as much foresight as possible. To remain informed and achieve balance within our Team advisory to our clients, we keep close to market activity.  For example, by monitoring government announcements such as budget statements, growth strategies, and political party activity such as recent manifestos. We continue to track the progress made by the IFRS, which has developed sustainability standards that fully incorporate the TCFD recommendations, known as IFRS S1 and S2. IFRS S1 is for sustainability-related financial disclosures, and IFRS S2 is for climate-related disclosures. This means that organisations that comply with the requirements of IFRS S1 and S2 will also be meeting the requirements of TCFD.

9. Valuation and future-proofing

One significant opportunity in real estate lies in integrating climate risk and resilience considerations into property valuation methodologies. Currently, there is a lack of standardised approaches to price reflect the resilience of real estate assets. As an established governing body, RICS has as yet to provide a clear framework for outlining climate risk. By incorporating these factors into valuation, investors can better position their assets for long-term value.

What are the opportunities for commercial real estate?

As the impacts of climate change become more pronounced, real estate investors and stakeholders must proactively acknowledge and address climate risk. By focusing on climate resilience, adapting strategies, collaborating with stakeholders, and staying informed about regulatory changes, the real estate sector can transform climate challenges into opportunities for long-term value creation.

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