Climate change and cities: adapting real estate investment decisions

It is becoming increasingly clear that some of the predicted impacts of climate change are now inevitable.

To date, global discussions and efforts have primarily focussed on climate mitigation and carbon emissions reduction. However, the need for rapid, considered, and collaborative efforts to appropriately assess and adapt to the impacts of a changing climate are also pressing.

Existing government and private sector commitments to greenhouse gas (GHG) emission reduction will not put the world on track to meet the essential target of keeping global temperature rise to below 1.5°C. This is despite the pledges and efforts already made across sectors - such as across large parts of the real estate market – to achieve net zero carbon by 2050 or sooner.

In fact, the latest predictions are that without rapid, large-scale change to systems and infrastructure, we could see a temperature rise of 2.8°C or greater by the end of the century. This poses a serious challenge for investors and asset owners, as the risks of losses and damages from climate change compound with every increment of global warming.

A new report by Schroders Capital’s real estate team looks at the complexities of modelling and understanding the risks posed by climate change to cities and real assets. Building resilience is a multi-faceted challenge.

The complexity of interconnected risks and opportunities in global cities will require insurers to re-evaluate premiums in risk-prone or resilient areas. It will require valuers to determine robust and standardised protocols for evaluating resilient buildings and cities. Asset owners will need to develop intricate and complex modelling and assessment tools to critically assess assets at all lifecycle stages to ensure physical and financial resilience.

To achieve this, a number of advancements across the sector will be necessary:

• Better, more complex tools and modelling techniques to overlay micro-economic trends, social needs, and potential secondary impacts onto physical risks.
• Focused and considered engagement with insurers and valuation professionals to understand how the adaptation at both building and city level will impact asset values, financial business plans, and exit cap rates.
• Improved integration of associated energy and carbon impacts of future climatic scenarios into existing net-zero strategies (i.e. increased cooling loads, ineffectual renewables on site, potential risk to energy demand capacity).
• Engagement with tenants and occupiers on perceived impact of potential risks and the ability for them to adapt to new practices/ expectations.
• Focused collaboration with local and regional public bodies involved in area-wide adaptation planning to understand potential exposure of, or opportunities for, assets and cities.
• Enhanced due diligence to require more climate risk analysis, and interplay between risk and adaptation measures – either existing or required – at both the asset and area level.
• Greater understanding of connectivity and reliance upon infrastructure that may be at risk.

In the medium-term, insurance providers and valuation professionals may begin to account for future scenarios in their assumptions, resulting in decreased property values and potential stranding of maladapted or poorly-located assets. However, in the short term, investors must begin to model expectations for increased premiums and reduced asset values in areas within, and in close proximity to, climate risks, and adapt their criteria for acquiring, managing and selling assets.

Ultimately, we believe that blending physical risk modelling with social, financial and regulatory information will be the difference between prepared real estate investors, and those failing to adapt to the inevitable threats of climate change.

To read the full report, please click here.