No oversight is affordable anymore - climate risks and real estate
Hurricane Ian which made landfall on Florida in September 2022 has caused more than 100 deaths and thousands of properties are reported damaged. As the emergency response team continues their effort in damage assessment, according to Bloomberg, estimates of Ian’s damage range from tens of billions to as much as 100 billion, making Ian one of the most expensive hurricanes in US history. According to McKenzie Intelligence Services, about 300 thousand buildings are severely damaged, and the total number of affected homes already reaches over one million. Due to repairs and reconstruction demands, the storm could cost insurers billions in claims, and many banks also suspended loans in the residential market around the affected area.
Apart from physical damage, climate shocks, such as hurricanes, would result in labor shortages and disruptions of the supply chain, causing catastrophic losses to the local economy. As residents are restoring power to their homes and the industry getting back to their business, we have no clue how long would it take for Florida to recover. While about 20% of the Florida area is assigned as a 100-year Flood Zone, still a very large portion of the damaged properties are located outside the flood zone area. Perhaps it is high time for residents and investors to update their perceptions about future climate risks, based on what they actually experienced in the past few years. A paper by Addoum et al. (2021) shows that real estate pricing effects can already be observed in areas that have not experienced floods. The same holds for the pricing and performance of commercial real estate loans (Holtermans et al., 2021).
In a recent study by Rogier Holtermans (University of Guelph), Dongxiao Niu (Maastricht University), and Siqi Zheng (MIT), researchers investigate the capitalization of climate shocks in commercial real estate owned and operated by sophisticated investors. They focus on Hurricanes Harvey and Sandy to quantify the price impacts of climate shocks on commercial buildings in the U.S. There is clear evidence of a decline in transaction prices in hurricane-damaged areas after the hurricane made landfall, compared to unaffected areas, by about 1.5%-3.5%, which corresponds to about $4.41-5.49/sq. ft.
Figure. Transaction price increment over time - Hurricane Harvey
Interestingly, the response of the commercial real estate market to hurricanes depends on whether the risks are perceived before real shocks. Assets in locations outside the FEMA floodplain (with less prior perception about climate risk), where the hurricanes act as new news, have experienced larger price discounts after the hurricanes. Investors could use realized flooding to learn about their flood risk, unfortunately, in a hard way. Flood maps used by FEMA are out of date and understate the risks to homes and businesses triggered by climate change. First Street Foundation, a non-profit research group, also found that federal maps underestimate the number of properties in danger by about 67%. Hurricanes and storms are getting more intense, leaving homeowners, investors, insurers, and lenders not much time to learn about the accurate flood risks or evacuate.
Moreover, the study creates a Green Index using Google search to rank investors with respect to their environmental awareness and document that more pro-environment investors are likely to claim a larger price discount for properties in areas that face higher climate risk. As commercial investors are believed to be more sophisticated than homeowners, it is not hard to imagine that the residential market is even less prepared for the upcoming risks. Low-income communities, where the infrastructure and house resilience are weak, do not have the awareness and/or resources to take mitigation measures. The research underlines the importance of information provision and environmental awareness in order to accurately capitalize on climate risk in commercial real estate as the cost of climate change becomes more salient.
When coastal areas attract people and industries, they also put more residents and buildings in danger. These beautiful, water-adjacent locations need no more wake-up calls from hurricanes or storms before actions are taken. Theories in economics, real estate, and migration need to integrate climate risks as an important part. No oversight is affordable anymore.
Addoum, J., P. Eichholtz, E. Steiner and E. Yönder (2021). Climate Change and Commercial Real Estate: Evidence from Hurricane Sandy, Cornell University working paper.
Holtermans, R., M. Kahn and N. Kok (2021). Commercial Mortgage Performance and Climate Shocks, Maastricht University working paper.
Holtermans, R., D. Niu and S. Zheng (2022). Quantifying the Impacts of Climate Shocks in Commercial Real Estate Market. Available at SSRN: https://ssrn.com/abstract=4276...