Natural disasters can have a severe impact on the real estate market, yet investors appear unaware of this looming risk. A correction in real estate stocks seems to be lurking.
Portfolio manager Lucas Vuurmans of Amsterdam-based investment bank Van Lanschot Kempen discussed this with InvestmentOfficer.nl. For the U.S. office market, a correction is anticipated due to climate risks averaging more than 3 percent. In riskier areas, the decline in value could even reach 10 to 12 percent.
Vuurmans acknowledged the challenges in assessing the impact of climate change on real estate, stating: «It’s a difficult subject. What is the effect of climate change on property? No one really knows the exact answer.»
According to Van Lanschot Kempen, it’s already necessary to include climate risks in real estate valuation models. Initially, the firm sought collaboration with non-profit organizations and tech companies, but the data they provided were either inadequate or too costly, Vuurmans explained.
Munich Re as partner
Van Lanschot has now partnered with Munich Re, a reinsurance company. «They’ve been collecting data on various disasters worldwide and the financial impact they’ve had for forty years. These data are incredibly useful for us. With them, we can get a much clearer picture of the anticipated impact of natural disasters on property.»
In evaluating real estate, Van Lanschot Kempen considers location, property quality, and tenants› creditworthiness. In recent years, climate risks have also been included, now weighing 20 percent in the total valuation. Vuurmans added, «If we see in five years that climate changes are developing faster than expected, our valuation model allows us to give climate risks a heavier weighting overall.»
One point of concern, according to Vuurmans, is that all natural disasters are still lumped together in the model. Earthquakes don’t weigh more than floods, even though the impact might not be the same. «We haven’t found a solution to this yet. Maybe in the next five years, it will become clear that one risk plays a bigger role in the valuation of property than the other. We’ll then need to adjust our valuation methodology, but we can’t do that right now due to a lack of data.»
While Van Lanschot Kempen has found a way to make climate risks transparent, many other parties are still struggling. «Everyone is searching,» Vuurmans said. «There’s no standard in assessing climate risks.»
More pressure needed
He urged regulators and stock exchange operators to put more pressure on publicly listed real estate companies to report the impact of climate change on their portfolios. «Companies really don’t report on climate risks.» According to Vuurmans, real estate companies usually only intervene when disasters have already occurred.
Significant devaluations are in sight, Vuurmans explained, providing two examples based on different Representative Concentration Pathway-scenarios (RCP) that describe the development of greenhouse gases up to 2300. Under the RCP4.5 scenario, the value of an office building in Texas could drop by 7 percent, while a similar building in Massachusetts might only see a 2 percent decline.
If considering an RCP8.5 scenario, the Texas property could lose up to 16 percent in value, and the Massachusetts property nearly 10 percent.
Potential declines not sufficiently priced in
Investors are not sufficiently pricing in these potential declines. «Climate risks are not adequately priced in by the market,» Vuurmans warned. This means that a correction of real estate stocks is on the horizon, especially in the U.S. office market, where the expected correction due to climate risks averages 3.3 percent. In riskier areas, the decline could be 10 to 12 percent.
In Europe, the risks from natural disasters appear to be less significant. Vuurmans expects smaller write-offs due to climate risks in Europe, noting that European real estate is currently cheaper than American or Asian properties, but this is mainly due to other factors, including the energy crisis and the war in Ukraine.
Interestingly, Vuurmans observed an increase in demand for real estate in high-risk areas, especially in the United States, partly due to a more favorable tax climate and warmer weather. «Because of the high costs in cities like New York and San Francisco, people are moving to the warm south, but we think this is a short-term phenomenon. The climate risks in the south are so much greater than elsewhere, that people will eventually leave that area again,» Vuurmans concluded.
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