Change in the Weather – Sept. 30, 2024

Natural disasters have been in the headlines worldwide all year, spanning the four basic elements. Here and abroad, we’ve seen the effects of earth (landslides and earthquakes), water (floods), air (hurricanes and tornadoes) and fire (wildfires). It stands to reason that increasing frequency, magnitude and duration of hazards in the physical environment can make an impact on real assets, and a new study from GIC and S&P Global Sustainable1 seeks to quantify this impact.  

Each of the four groups of disasters cited above may be exacerbated by ongoing climate change—possibly including seismic events, albeit indirectly. Under a medium-high warming scenario without adaptation investment, properties represented in the S&P Global REIT Index could incur US$110 billion in cumulative excess costs from climate hazard exposure by 2030, US$310 billion by 2040 and US$559 billion by 2050, according to the study. “This implies that by 2050, the cumulative costs (nominal prices) of physical climate risks could reach the equivalent of 28% of the total real estate asset value of the index constituents as of July 2024.” 

The report cites three important pathways through which climate hazards can create direct costs for asset owners and investors. They include the following: 

• Loss of revenue due to business interruption; 

• Excess operating expenses (opex) such as higher cooling costs and productivity impacts; 

• Higher capital expenditure (capex) associated with cleanup and repair, accelerated asset degradation, and asset replacement.  

Moving beyond the middle of this century, “future climate change scenarios diverge sharply, with climate physical risks becoming significantly more onerous in high warming scenarios compared to low warming scenarios,” the study says. “Regardless of the climate scenario used, the warming that is already embedded in the climate system means that physical risks are likely to increase over time, raising costs across the broader economy for customers, tenants, building operators, owners and investors.” 

Not all climate physical risks pose the same level of likelihood in a given region. “We estimate that 89% of S&P REIT Index constituent assets will be materially exposed to extreme heat by the 2050s, whereas only 1%, 9% and 13% of assets will be exposed to coastal flood, pluvial flood and fluvial flood, respectively,” according to the study.  

The GIC/S&P Global Sustainable1 study isn’t the first to attempt to quantify the costs of changing climate physical risk exposure. Yet the study’s authors point out that previous models have often overlooked the mitigating effects of adaptation. “This omission can lead to an incomplete view of the net costs of physical risks and create challenges for investors in prioritizing risk management efforts,” according to the GIC/S&P team. 

The study recommends numerous mitigation investments that investors can make at the property level. For water-related risks, these range from dry/wet floodproofing to rainwater harvesting as a hedge against prolonged drought. The dangers of wildfires could be mitigated with a non-combustible building envelope, while impact-resistant glass could help lessen damage from tropical cyclones.

However, the authors write, “A coordinated approach combining private sector investments in building-scale adaptation and public investments in large-scale adaptation projects (such as sea walls, levees and other adaptations) will be needed to maximize the protection of communities, assets and economies.” 

At the portfolio level, “Managing physical risks will require investors to take a bottom-up approach to account for the different exposures each property can have to different hazards,” according to the study. “Additionally, the skills required to implement the adaptation measures that address more widespread physical impacts may need to become core to real asset management.”