How to Assess Climate-Related Risks for Your Portfolio

The reality of today is that climate risk is investment risk. Climate change is the number one risk (and number one risk accelerant) facing commercial real estate portfolios. Investors are increasingly reckoning with questions like:

  • How will cities pay for their infrastructure needs as climate risk reshapes the market for municipal bonds?
  • What will happen to the 30-year mortgage if lenders can’t estimate the impact of climate risk over such a long timeline, and if there is no viable market for flood or fire insurance in impacted areas?
  • What happens to inflation, and in turn interest rates, if the cost of food climbs from drought and flooding? 
  • How can we model economic growth if emerging markets see their productivity decline due to extreme heat and other climate impacts?

Evaluating how your portfolio is preparing for potentially disruptive events and changing conditions, assessing long-term trends, and building resilience is now a critical piece of doing business. But where do you start? To get a grasp on the risks facing your portfolio, you’ll need to understand how the industry categorizes risk factors, what to assess, and how to use that information to plan for the future.

Physical risks have tangible, quantifiable impacts. Climate change can physically impact portfolio assets and surrounding infrastructure. You’ll need to assess building codes and operations, the physical site, structure, and system of each asset, and depending on location, the risk of earthquakes, flooding or sea level rise, wildfires, or mudslides. For sea level rise in particular, it is important to understand the regions where that risk applies, the number of properties that might be below water level under different sea level rise scenarios, and what percentage of your portfolio that accounts for. This information will be the basis of your plan to reduce disruption to building operations in the case of extreme weather events or long-term shifts in climate patterns. 

Transition risks are due to market and non-market shifts, including changing consumer preferences, and shifts in climate and environmental policy and associated technologies. Assessing these trends will allow you to reduce exposure to climate-related transition risks, such as changes in energy sources, shifts in energy costs, and enhanced energy and emissions reduction and reporting laws.

Social risks are all about the human side of things. Severe weather, rising temperatures, poor air quality, and natural resource scarcity will result in certain regions being unlivable. You’ll need to assess building safety and materials, contamination potential, health codes, emergency response plans, and occupant and community needs.This information will be the basis of your plan to invest in and operate buildings that are safe for occupants and the surrounding community. 

Tying it all together

Once you’ve explored the vulnerabilities facing your portfolio, you should have a good understanding of the shocks and stressors that your buildings are prone to and you’ll be able to begin estimating the potential costs of recovery. At this point it is worth considering the potential future losses of high risk investments and possible divestment from certain high risk assets. Going forward, you should invest in locations that are less prone to regional risks like sea level rise. Where that is not possible, it is important to investigate fortification strategies and public and private initiatives to protect the entire region.

For your existing assets, you should focus on optimizing your building operations. Operating practices have a significant impact on the resilience of a property and its energy systems. Be sure to regularly review standard practices and key systems to ensure they can endure the additional risk scenarios.