How Much Risk Does Climate Change Actually Pose To Real Estate?

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Increasingly, Americans are viewing climate change as a serious issue. A poll taken earlier this year by Morning Consult found that 50% of Americans say climate change is a “critical threat,” while 26% saw it as an “important” issue. Just 19% said climate change was not a threat.

Defining the true threats of climate change is a challenge. We’ve been hearing for a long time that the biggest issues we’re going to face—and are already facing—are the increased intensity and frequency of natural disasters, rising sea levels, and expanding flood zones.

The residual effects of climate change affect every area of life, especially housing. In a brand-new report released by the Mortgage Bankers Association (MBA), Dr. Sean Becketti, a veteran economist and former Chief Economist of Freddie Mac, highlights the risks facing the housing and mortgage industry in the wake of climate change.

Climate change’s main increase: Risk

If there’s anything to be noted in the report, it’s that the primary growth stemming from climate change is not sea levels or temperatures, it’s risk.

Becketti spends most of the report explaining the growing risks to every stakeholder in real estate, from homeowners, renters, investors, government officials, lenders, and more.

The warning: frequent and intense natural disasters will cause unparalleled damages like never before. This of course, naturally creates a great deal of risk. Homeowners could lose their homes or their lives, renters could lose their place of stay, investors can lose out on their hard-earned investments, government officials will be handed the burden of recovery, repair, and mitigation, and mortgage lenders will have to deal with increased defaults or complete losses.

Becketti also explains that climate change will force firms and institutions to change the way they assess and define risk in their financial disclosures. The Task Force on Climate-Related Financial Discloses (TFCD), headed by billionaire Michael Bloomberg, works to create more market transparency on the potentials of climate change that could adversely affect individual properties so that investors and buyers can make better decisions and better prepare.

The TFCD, in particular, recommends that disclosures begin highlighting changing precipitation and weather patterns, rising temperatures, and rising sea levels.

For real estate, Becketti says flooding poses the largest immediate threat.

Climate change places stress on the National Flood Insurance Program as flood zones will expand and bring more homes into the crosshairs of a natural disaster. In these flood zones designated by FEMA, homeowners are required to purchase flood insurance.

For investors, the added costs of insurance can throw off their cash flow calculations. For homeowners, it adds extra costs to their housing bill each month. This, along with an increase in destructive floods, can lead to mass defaults and put serious pressure on the US financial system.

Becketti notes that the current flood insurance system is inadequate and will only be ravaged by climate change. “Insurance is the classic risk management technique for property damage. However, as discussed above, the current U.S. flood insurance system incorporates significant deficiencies that are likely to be exacerbated by climate change.”

We’ve already seen the effects of a major natural disaster on our current system pan out. In August 2017, Hurricane Harvey struck Houston, Texas. Of the 100,000 homes that were flooded, 80% had no flood insurance because they were not designated in the federal flood zone. According to CoreLogic, mortgage delinquencies jumped 200%.

The burden of tighter regulations

The United States is facing a housing shortage of epic proportions. In June, the National Association of Realtors reported an underbuilding gap of 5.5 to 6.8 million housing units.

In states like California, the lack of housing supply is exacerbated most. California’s housing prices are not only some of the highest in the nation across the board, but also feature some of the strictest zoning and environmental regulatory laws in the country.

Regulations in the state have either pushed away developers entirely or bogged down the process of applications to such a slow crawl that critical time and money is lost. It also adds to the cost of development when builders must hurdle through the smallest of hoops just to remain in good standing.

While regulations in some respects are good, the solution to the housing crisis is more construction, not barriers to it. But with environmental impacts worsening in connection to climate change and stiff challenges facing lenders and developers, there’s a real concern over whether we’ll be able to strike a proper balance between green development and cost-effective development.

We can chalk it up as another critical challenge presented to us.

Conversely, there’s the possibility that home values in at-risk areas such as flood zones, could shed significant value. Becketti cites a study that found homes to be overvalued by about $44 billion due to flood zoning.

“[Several] researchers have presented evidence that real estate in regions of high climate-related risk may be significantly overvalued. To cite just one recent study, Hino and Burke (2021) examine two decades of sales data in floodplains and conclude there is little evidence that markets fully price information about flood risk. They note that homes drop roughly two percent in price when they are zoned into a floodplain. However, factoring in the cost of fully insuring against the higher flood risk in the floodplain implies a price drop of between 4.7 and 10.6 percent. According to their estimates, single-family homes in flood zones in the U.S. currently are overvalued by almost $44 billion dollars.”

The path toward mitigation

According to Becketti, if the agreements made in the Paris Climate Accord are fulfilled, by 2065, the world would have reduced the increase of global warming by 50% and by 73% in 2100. Similar progress can be made against sea level rises by the end of the century as well.

To mitigate the growth of climate change, the usual ideas are highlighted in the report. Reduce energy consumption, switch to alternative energies, retrofit buildings and dwellings to become more efficient, ween out natural gas, add more electric vehicles to the road, forestry management, etc.

But the challenge is getting everybody on the same page. One argument Becketti cites, for instance, is the policy of weening homeowners and renters off natural gas by forbidding new gas hookups. These types of regulations have occurred in cities like Denver, San Francisco, New York City, and Seattle.

In response, states like Arizona, Texas, Oklahoma, Kansas, Tennessee, and Louisiana have outlawed such regulations.

In essence, we have a clear divide between not only stakeholders (states like Texas and Oklahoma are major natural gas producers), but an ideological divide. The cities mentioned are more progressive or liberal, whereas the states tend to skew conservative.

But with a growing majority cohort of Americans addressing the importance of climate change mitigation, there’s reason to believe that the various factions within the country will be able to find some sort of common ground throughout the next few decades.

What’s an investor to do?

Overall, the MBA’s report offers bleak prospects for the future of real estate if nothing is done to combat the effects of climate change more purposefully.

As real estate stakeholders, our biggest concern is the growing risk our properties will face as flood zones expand, sea levels rise, and natural disasters strike more frequently with greater force.

From the greater economic perspective, there could be serious fallout if defaults and equity values are lost with rising risk. The strains on our financial system could become very hard to manage if left unprepared for too much longer.

Perhaps the greatest message the report proposes to investors: if not already, start assuming climate risks when purchasing a property.

 

Note: This article is based on the MBA report, not the author’s personal opinions. 

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.