Ignoring Climate Change Risk Could Hit Investments Hard

Climate change is altering the world around us; scientists are tying floods, heat waves, even pandemics back to climate change as a root cause. But how much is the real estate sector factoring climate change risk into investment decisions?

Not enough, according to EVORA Global Chief Strategy Officer Sonny Masero. The sector is “lagging behind” others in how climate change risk is factored into investment decisions. And the cost of ignoring not just climate change but countries’ increasing environmental legislation could come as a financial shock sooner than organisations anticipate. This message echoes the latest annual letter from BlackRock's Larry Fink.

Since the Paris Agreement was signed in 2015, pressure has been increasing around the world to reduce carbon emissions and mitigate the impact of climate change. Many countries are introducing legislation as a commitment to reaching net-zero carbon emissions by 2050, for example. At the same time, as the world forms a better understanding of climate science, public opinion on the need to act has increased, as well as recognition of the damage already done. The general scientific consensus is that we need to get more than halfway to net-zero carbon within the next 10 years.

“As a result, investor attitudes have changed,” Masero said. “When Mark Carney was head of the Bank of England, he had begun working behind the scenes on a quiet revolution to move the financial sector forward. His aim was to make climate risk a consideration in every investment decision. The result today is much greater investor pressure on real estate owners and managers.”

The adoption of environmental, social and governance, or ESG, investing is increasing. A 2020 survey by the Royal Bank of Canada found that 75% of respondents globally integrate ESG principles into their investment approach and decision-making, up from 70% in 2019.

The real estate sector might be slower than others, but change is happening. The Better Building Partnership members made their climate change commitment 18 months ago to reach net-zero by 2050 or sooner and this has gained traction. On an even bigger scale, the UN-convened Net-Zero Asset Owner Alliance is aiming to direct investment to align with a net-zero future. The Task Force on Climate-related Financial Disclosures is gaining momentum, with a framework that companies are starting to adopt.

Use Data To Make Investment Decisions

Key to meeting targets such as net-zero by 2050 is data. Companies need to be able to assess how close they are and whether they are moving in the right direction.

The problem according to Masero is that much sustainability reporting is historic, a report on how a company has performed in the past. What companies need in addition, he argued, is a way to assess the potential impact of climate change on the future value of their business and assets.

“A key part is having data to measure what the risks ahead are,” he said. “There are two types of climate risk. The first is physical risk; the likelihood of being impacted by flooding, storms, rising sea levels and so on. The second is transition risk, such as if the EU adopts a certain target such as net-zero carbon, we know that a policy regime and legislation will follow that could impact property management. Property owners need to be able to scenario plan and understand the cost of compliance.”

These risks can have significant financial implications on a property. The cost of facing a physical risk is obvious; an investor may have to prepare a property for potential future floods or heat waves. The cost of a transition risk is possibly harder to predict. For example, an investor might acquire a property in a country that hasn’t developed or enforced regulations aligned with the requirements of the Paris Agreement. The political situation might then alter to administer policies that are based on the science, are transparent and are enforced. Different amounts of investment will be required in each scenario for the property owner to comply.

EVORA has developed a specific net-zero module of its software to carry out scenario planning for organisations to help to find an optimal path.

“We can look at a portfolio to see where we are today and project a pathway to net-zero,” Masero said. “We can overlay this model for each property in a fund to see what could happen if no investment is made. If measures are implemented, we can see how much emissions could be reduced and aggregate that across the portfolio, including how this could contribute to regulatory compliance. This could impact management costs as well as an exit value.”

Consider Assets Now

Real estate lags behind other sectors in its adoption of climate change risk as an investment consideration, Masero said.

“There are some leading lights but there’s a long tail that are being forced to up their game either by investors or regulation,” he said. “The more forward-thinking investors are already making decisions on the impact of climate change over the next 10 years. They know that the speed of change could impact their next investment cycle. If you don’t factor it in now you might well acquire assets with higher costs than you can afford and a lower exit price.”

Those that are using EVORA’s sustainability software SIERA to factor climate change risk into investment decisions are currently doing so for two main reason, Masero said. The first is due diligence when acquiring a property; what risks might they inherit and what are the potential costs? The second is to assess how to transform an owned asset, and whether it is better to invest in improvements, rethink or dispose of it.

Of course, it is impossible to plan for every scenario. Legislation in 10 years could be even tighter than imagined today and political leadership changes quickly. However, any scenario planning at all might be better than waiting to discover the financial implications in years to come.  

This article was produced in collaboration between EVORA Global and Studio B. Bisnow news staff was not involved in the production of this content.

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