The warning that climate-related damage will be more difficult to insure is growing. A challenging time is coming for real estate investors, as their investment horizon becomes riskier.
It was painfully obvious this summer, with the deadly floods in Belgium, Germany and Limburg. The changing climate is causing extreme weather and enormous damage. The unpredictability of the impact of climate change makes it increasingly complicated to insure against damage, the AFM recently warned. According to the Dutch regulator, real estate investments will gradually become riskier.
Worldwide, the damage caused by natural disasters in 2020 was 190 billion dollars, 81 billion of which was insured. And flood damage in the EU averaged EUR 4 billion a year in the first decade of this century. That will rise to as much as 23 billion by 2050, according to estimates by the Dutch Association of Insurers.
Predicting the impact of climate change is also becoming increasingly difficult for insurers. As a result, climate-related damage, such as floods and house collapses due to drought, will gradually become more difficult to insure. As far as damage is covered, consumers may have to deal with large differences between insurers, complex policy conditions with limitations, exclusions, prevention requirements and changing policy conditions. The burden of claims will increase significantly in the coming years, warned regulator AFM.
Mismatch of investment horizon
According to senior portfolio manager Lucas Vuurmans of Van Lanschot Kempen, the danger lies in the short investment horizon of many property investors. This is often only ten years, while property valuations and climate change often have a horizon of more than forty years. This mismatch constitutes a risk, according to the investor. According to him, many property investors do not include the impact of climate change on their investments in their analyses.
Vuurmans emphasised that there is already real estate that is no longer insurable. Japanese real estate has in some cases been uninsurable for earthquakes since the 1980s. “The earthquake damage to real estate there is the responsibility of the owner and therefore ultimately of the investor.”
Vuurmans also poined to Florida, where the same development is taking place. “Three years ago the hurricane insurance premiums of the hotels in which we invested were less than one percent of the annual rental income. Now the amounts are going up fast and that makes some chains have to sell the hotels. These are inevitable changes that an investor needs to be aware of.”
According to Vuurmans, climate change and damage make it clear how necessary forward-looking analysis is. Together with the world’s largest reinsurer Munich Re, Van Lanschot Kempen is charting the risks of natural disasters. “On the basis of data analyses at building level, we estimate the qualities and risks. Where is the building located, how developed is the environment and is the condition of the building in order? To these estimates we add Munich Re’s climate risk analysis, which maps out what rising temperatures, increased precipitation and more frequent storms can do to real estate.”
The investment fund in listed property of which Vuurmans is portfolio manager has over 1 billion euro under management and invests in names such as Warehouse de Pauw, Vonovia and Merlin Properties. When the investment team wants to estimate the intrinsic value of companies, it looks at the sum of all the real estate owned by those companies. “Our climate risk analysis then determines whether we are willing to pay a premium if the risk is low, or demand a discount if the risk is high.”
PGGM remains calm
Maarten Jennen, senior director of private real estate at PGGM, sees no reason to panic yet. “We are trying to assess the physical and transition risks as well as possible, but there is no need to panic.” PGGM, which has been building its private markets platform since 2009, manages EUR 16 billion in real estate investments, spread across 4,500 properties worldwide.
According to Jennen, this development is not problematic for the global real estate investor with a long horizon. “We see here and there that insurance premiums can rise, but an insurer can adjust premiums annually. However, the long-term risks are surrounded by a lot of uncertainty. That may mean that extreme weather conditions will be priced in more in the future. In addition, certain areas will become more difficult to insure in due course, but we don’t encounter that at all in our portfolio now.?
All PGGM’s real estate investments are insured, Jennen said. “We see insurance premiums rising here and there, but for the time being a higher premium will not affect our investments negatively enough to warrant action. That effect is simply not visible in our returns.”
Where insurance premiums do have a significant impact on investment results, this will also be accompanied by undesirable changes in the risk profile, the investor continues. “We are then expected to have already parted with those locations through our analysis of physical risks.”
The change in the insurability of real estate as a result of climate change has PGGM’s attention, but it is not currently a decisive factor in the risk profile of a real estate investment.