The U.S. real estate market, valued at $45.3 trillion, is experiencing a noticeable cooldown. National residential sales have plummeted by 23.2% compared to last year, and the inventory of available homes for sale is expected to remain in the near future.
On top of this, some $1.5 trillion in mortgages are forecasted to mature in the next 2 years, posing a potential threat as higher interest rates push down property values. Housing economists predict prices could fall further. While experts believe that this decline will not replicate the magnitude of the 2008 recession, the impact of climate change poses an additional risk to the already somewhat unstable U.S. housing market.
The mounting burden of climate-related hazards, such as inland flooding, wildfires, and extreme storms, has raised concerns that the housing market is not accurately assessing these risks, leaving real estate assets vulnerable to climate change.
Moreover, the direct consequences of climate change may force homeowners to migrate inland, potentially reshaping the U.S. real estate landscape gradually. The response to these challenges will determine the overall costs associated with climate-related risks and whether these costs will be primarily borne by American taxpayers or internalised by the parties directly exposed to physical climate impacts. This includes construction, insurance, and investment companies, which must assess and address these risks to mitigate their climate impact.
Wildfires ravage California, hurricanes relentlessly pummel Florida, and coastal regions across the U.S. are increasingly plagued by flooding. The physical risks of climate change spare no corner of the country, and the real estate industry is already witnessing early warning signs of its impact.
Shockingly, an estimated 2% of U.S. homes, with a collective value of $882 billion, face the looming threat of being inundated by 2100. Fifteen climate disasters in 2022 alone further highlight the severity of the situation, each resulting in losses exceeding $1 billion, shown in Figure 1below. These disasters included ten severe storms, two tropical cyclones, one flooding event, one drought and heat wave combination, and one regional wildfire event. Hurricane Ian emerged as a mega-disaster, ranking globally as the most financially devastating natural catastrophe. Its estimated insurance loss ranges between $50 billion and $65 billion, potentially exceeding $100 billion.
In the past five years (2017 to 2021), a staggering 89 events caused over $788 billion in damages, accounting for 35% of the total costs of billion-dollar disasters in the U.S. from 1980 to 2021, which amounted to $2.27 trillion. Furthermore, 2022 marked the eighth consecutive year with ten or more billion-dollar weather and climate-related disasters.
Major coastal markets, including Boston, Miami, and New York, face the constant threat of flooding and severe weather conditions. However, those residing in coastal settings encounter the most apparent physical risks. For instance, if sea levels rise by 6 feet, it is estimated that approximately 10% of homes in Hawaii and 12% of homes in Florida will be submerged underwater. Consequently, investors in commercial real estate are reassessing the value of coastal properties in vulnerable locations, particularly those at risk of flooding.
Sairah Burki, the managing director of regulatory affairs and sustainability at the CRE Finance Council, highlights that structures 5 to 10 years ago did not need flood protections, but “flooding is such a significant risk, and it’s not necessarily coming from an isolated event. Nonetheless, the ever-increasing risk of flooding due to rising sea levels has become an imminent and pervasive threat.
Understanding how to manage assets that are now exposed to climate risks is a critical question that needs to be addressed. Failure to do so may lead to a substantial decline in the value of these assets. Investors, construction companies, and insurance firms are grappling with this significant dilemma as they face an uncertain future amid our changing climate.
Botching The Problem
Climate risks can significantly impact U.S. real estate assets' value, viability, and prospects due to their close interconnection. This poses a considerable challenge for real estate companies as they need to understand the extent of climate-related risks to assess the market's long-term implications, evident by the overvaluation of real estate presenting a profound issue for the U.S. housing market.
It is estimated that approximately 14.6 million properties in the U.S. face a 1% annual likelihood of flooding, leading to projected annual damages of over $32 billion. In addition, assets located in counties along the U.S. coastline, where flood risk disclosure laws are absent, are overvalued by an estimated $121–$237 billion. This serves as a prime example of the urgent need for asset values to reflect climate-related risks accurately and highlights the current lack of understanding regarding climate risks across the nation.
Correctly pricing the costs of flood damage to residential properties is crucial for promoting climate adaptation and discouraging inappropriate development in flood-prone areas. Yet, this process may have negative financial implications for households, communities, and municipalities.
Real estate owners and developers must adapt their business strategies by incorporating climate risk assessments to mitigate climate risks. This includes mapping out the physical risks associated with their existing portfolios and potential acquisitions and implementing physical adaptation measures for assets at risk. Moreover, climate risks should be integrated into the due diligence processes of real estate transactions. By proactively addressing climate risks in the real estate sector, stakeholders can better protect their investments, promote sustainable development, and contribute to long-term climate resilience.
Insurance plays a crucial role in addressing the escalating climate risks faced by insurance companies across the U.S.. Still, the increasing pressure of climate change on the insurance industry has increasingly impacted their financial performance.
A recent example of this is State Farm, California's leading property insurance provider, valued at $131 billion, constituting 20% of California's bundled home insurance policies. State Farm decided to cease issuing new policies due to the rapid increase in construction costs that outpaced inflation, a challenging reinsurance market, and, most significantly, the growing exposure to climate risks. The situation becomes even more concerning as rising premiums in homeowners' insurance throughout the country indicate that insurers are starting to incorporate the costs associated with climate change.
Nationwide, the average cost of coverage has reached $1,900 per year, with exceptionally high premiums of approximately $4,000 per year in New Orleans and $5,000 per year in Miami, both prone to climate-related risks. From 2021 to 2022, premiums rose by 12.1% across the U.S., with higher rates in states where natural disasters occur more frequently, such as Arkansas, Washington, and Colorado.
The withdrawal of State Farm from California and the increasing premiums serve as a warning sign that the insurance market in the U.S. may become more challenging for homebuyers seeking mortgage financing. These surges in insurance premiums can ripple effect on property values, potentially leading to a domino effect whereby mortgage companies and banks may withdraw lending.
Consequently, the burden of managing the risks associated with climate change falls on governments and homeowners, creating a precarious situation that threatens the stability of the vulnerable U.S. housing market.
The Great Displacement
Migration patterns are expected to intensify as properties deemed vulnerable lose value while insurance costs surge for individuals unable to safeguard their assets. Despite no comprehensive data existing on the scale of America’s climate migration, Matthew Hauer, an assistant professor of sociology at Florida State University, projects that 13.1 million Americans will relocate because of sea-level rise alone by 2100, as evident in figure 2 below.
This movement will not unfold linearly as different locations experience varying instability and upheaval. Ironically, despite the inherent risks, there is a prevailing trend towards concentrated population growth in high-risk areas, driven by the allure of short-term advantages such as favourable weather conditions.
This trend has been exacerbated by the COVID-19 housing boom, as Americans, including retirees, gravitate towards climate-vulnerable regions in the southern parts of the United States, exacerbating the long-term predicament.
Dr. Cascade Tuholske, an Earth Institute Postdoctoral Research Scientist at Columbia University, emphasised this phenomenon: "People are relocating to areas with escalating climate hazards. Take wildfires, for instance—real estate prices are soaring across the Western regions, rather than diminishing, in areas afflicted by increased fire risk due to climate change. The same applies to the flourishing housing markets in coastal areas facing mounting flood risk due to climate change, such as Florida."
Consequently, the shifting migration patterns will alter population demographics and redefine market dynamics. However, as individuals relocate from high-risk areas, climate change also presents opportunities for regions less exposed to climate-related risks to fulfil the surging demand for housing and infrastructure from the migrating populations.
Embracing a Data Approach
To safeguard the real estate markets' financial stability against climate-related risks, real estate businesses must prioritise the resilience of their asset portfolios. This can be achieved by investing in climate intelligence through data analysis, enabling informed asset valuations and facilitating strategic planning for future asset utilisation.
Furthermore, with increasing regulations in the U.S., industry players face mounting pressure to disclose climate risks affecting real estate entities, necessitating consistent data collection and reporting. Alfonso Pating, climate finance manager with NRDC, reinstates the importance of data. "Data is data", "It doesn't lie. And without this data, we can't create concrete solutions for these problems."
The importance of data is echoed by international bodies such as the British Property Federation and the Investment Property Forum, which identify the lack of high-quality data as a hurdle to formulating and executing effective real estate climate change strategies.
We at Climate X address this challenge with our Spectra platform, which utilises detailed data to assess assets accurately. This empowers users to evaluate the impact on revenue, operating and capital costs, and capitalisation rate risks.
Real estate entities can enhance their resilience and comply with the increasing regulations related to climate risks across the U.S. by understanding and quantifying exposure and opportunities, prioritising risks, and modelling physical hazards and their projected changes. Neglecting climate risk could lead to complacency among real estate actors, which could trigger the sudden burst of the U.S. housing market bubble.
To gain a deeper understanding of how to protect your real estate assets from climate risk, book a demo with us to find out how.
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