SectoralRiskBriefings:

InsightsforFinancial

Institutions

ClimateRisksinthe

RealEstateSector

March2023

SectoralRiskBriefings:InsightsforFinancialInstitutions|ClimateRisksintheRealEstateSector2

Contents

|

Acknowledgments

Authors

UNEPFI

DavidCarlin

HeadofClimateRiskandTCFD(

david.carlin@

)

MaheenArshad

ClimateRiskManager(

mahaeen.arshad@

)

KatyBaker

ClimateRiskAssociate

(

katy.baker@

)

Theauthorswouldspecificallyliketoacknowledgethecontributions,inputs,andsupportingresearchthathaveenabledthecompletionofthisreport:

HinaMajid,UNEPFI

JoanaPedro,UNEPFI

Inaddition,theauthorsaregratefultothebanksandinvestorswhoparticipatedinthesectorexercisesofthepilotprojectandprovidedfeedbackonthisreport.

Projectmanagement

Theprojectwassetup,managed,andcoordinatedbytheUNEnvironmentProgrammeFinanceInitiative,specifically:RemcoFischer(

kai.fischer@

)andDavidCarlin(

david.carlin@

)

SectoralRiskBriefings:InsightsforFinancialInstitutions|ClimateRisksintheRealEstateSector3

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ThepilotprojectwasledbyaWorkingGroupofthefollowingbanksandinvestorsconvenedbytheUNEnvironmentProgrammeFinanceInitiative:

ABN-AMRO

DanskeBank

Mizuho

AccessBank

Desjardins

MUFG

AIB

DNB

NAB

BankofAmerica

EBRD

NatWest

BankofIreland

FarmCreditCanada

NIB

Banorte

FirstRand

Rabobank

Barclays

ForbrightBank

RBC

BBVA

FTF

Santander

BMO

GoldmanSachs

ScotiaBank

Bradesco

HSBC

SovcomBank

CaixaBank

INGIntesaSanpaolo

StandardBank

CDL

Investa

Storebrand

CIB

Itau

TDAssetManagement

CIBC

KBFG

TDBank

Citibanamex

KBC

TSKB

COE

Linkreit

UBS

CreditSuisse

Manulife

WellsFargo

SectoralRiskBriefings:InsightsforFinancialInstitutions|ClimateRisksintheRealEstateSector4

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Contents

Acknowledgments 2

Introduction 6

Realestatesectoroverview 7

Transitionrisks 10

1.Increasingregulationandpolicypressure 12

2.Costofindirectemissions 16

3.Shiftingmarketpreferences 17

4.Changeininvestorsentiment 19

5.Reputationalrisks 20

6.Transitionriskguidance 23

SECTION2: 26

Physicalrisks 26

1.Sealevelriseandcoastalflooding 28

2.Inlandflooding 30

3.Extremestormsandwind 32

4.Wildfires 34

5.Subsidence 37

6.Heatandwaterstress 38

7.Physicalriskguidance 42

References 45

SectoralRiskBriefings:InsightsforFinancialInstitutions|ClimateRisksintheRealEstateSector5

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Listoffigures,tablesandcasestudies

Figure1:ProjectedtransitionandphysicalriskinMSCI’sGlobalAnnualPropertyIndex 7

Figure2:PriceofEPCratedpropertiesovertime 13

Figure3:AggregateimpairmentratesbycurrentandestimatedEPCratings

undertheearlyactionscenario 14

Figure4:Correlationbetweenenergy-efficientbuildingsandhigherrentsfound

intheliterature,shownasrentalpremiums 19

Figure5:Exampleofanenergyperformancecertificate(EPC)forabuilding 22

Figure6:Citiesatriskfromsealevelriseof0.5metresbythe2050s 28

Figure7:Globalinsuredlossesfromfloodingfrom1991to2021 31

Figure8:Cumulativevaluechangeofrealestateforquartersafterhurricanes,

bypropertytype 32

Figure9:Likelihoodofwildfiresamongpropertiesatrisktodayandin30years 35

Figure10:Areasexpectedtoexperiencesignificantincreaseinsusceptibilityto

subsidenceby2030and2070 37

Table1:Keyclimaterisksfortherealestatesector 8

Table2:Overviewofclimate-relatedriskstostakeholdersinhousing 9

Table3:Examplesoftransitionrisksfortherealestatesector 11

Table4:EffectofclimatechangeonenergydemandforresidentialbuildingsinEurope 38

Casestudy1:Operationalandmarketpreferencerisk 11

Casestudy2:Technologicalandconstructionrisk 15

Casestudy3:Shiftingmarketpreferencesrisk 18

Casestudy4:Extremeweatherrisk(i) 27

Casestudy5:Extremeweatherrisk(ii) 33

Casestudy6:Heatstressandwildfirerisk 39

SectoralRiskBriefings:InsightsforFinancialInstitutions|ClimateRisksintheRealEstateSector6

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|Introduction

Introduction

Inthepastfewyears,theglobaleconomyhasbeenlashedbytheCOVID-19pandemic,geopoliticalconflict,supplychaindisruptions,anenergycrisis,andhighinflation.Thesechallengesareoccurringagainstthebackdropofthemountingplanetaryemergencyofclimatechange.Climatechangecanexacerbateallotherchallenges;increasinggeopo-liticalconflictsoverresources,cripplinginfrastructureandsupplychains,extendingtherangeofdangerouspathogens,andcausingthecollapseofthenaturalsystemsuponwhichwedepend.AstheUSPentagonprescientlystated:“climatechangeisathreatmultiplier”.Whilethetransitiontoasustainable,net-zerofutureiscritical,itdemandsfundamentalshiftsinnearlyalleconomicsectors.Theseshiftsarenotwithoutriskforcompaniesandthecommunitiesimpactedbythem.

Financialinstitutionsfaceanarrayofrisksfromthisrapidlychanging,andoftenchaotic,globalcontext.Theirclientsareexposedtophysicalhazardsaswellastransitionrisks.Thesecanhavemajorcredit,market,andoperationalimplications.Theprudentfinancialinstitutionwillexploretheseclimate-relatedrisksandpreparestrategiestomeetthem.Ensuringresiliencyandsuccessinthefuturedependsonmakinggooddecisionsandthoughtfulplanstoday.

UNEPFIhasbeenworkingattheintersectionofsustainabilityandfinanceforover30years.Itsprogrammesforfinancialinstitutionsdevelopthetoolsandpracticesneces-sarytopositivelyaddressthemostpressingenvironmentalchallengesofourtime.UNEPFI’sClimateRiskandTCFDprogrammehasnowworkedwithover100financialinstitutionstoexplorephysicalandtransitionrisksposedbyclimatechange.Throughthiswork,aneedhasbeenidentifiedtoprovidefinancialinstitutionswithabaselineunderstandingofclimate-relatedrisksandtheirmanifestationsacrossdifferentsectors.

Thisbriefispartofaseriesofnotesthatcovermajoreconomicsectorsandtheirasso-ciatedclimaterisks.UNEPFIintendsfortheresourcesandperspectivesincludedwithinthesenotestoempowerfinancialcolleaguestocommunicatetheserisksthroughouttheirinstitutionsandacrossthefinancialsectormoregenerally.Thehopeisthatthecommunicationprocesswillnotonlyenhanceawarenessofclimaterisks,butalsobeginconversationsthatwillleadtotangiblechangesinstrategyandoperations.Theextenttowhichtheseinsightsareintegratedwillbethetruesttestofthisseries’effectiveness.Thisparticularbriefcoversthephysicalandtransitionrisksfacingtherealestatesector.

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|Realestatesectoroverview

Realestatesectoroverview

Climaterisksarealreadymaterialisingfortherealestatesector,andtheirfrequencyandseverityareexpectedtoincreaseinthecomingyears.Physicalandtransitionrisksthreatenrealestateassetcashflowsaswellasthefuturevalueoftheassetsthemselves.Extremeweatherandphysicalhazards,suchashurricanes,floods,andwildfires,cancausesubstantialdamagetorealestatelocatedinvulnerableareas.Thesector(directlyandindirectly)isresponsibleforabout40%ofallgreenhousegas(GHG)emissionsglob-ally(

UNEPFI,2022

).Asaresult,actionstakentodecarbonisetheglobaleconomytomeetclimategoalswillhavestrongcostimplicationsforthesector.ThefigurebelowshowstheprojectedphysicalandtransitionriskforrealestatefromMSCI’sGlobalProp-ertyIndexusingitsrealestateClimateValue-at-RiskModel(Figure1)(

MSCI,2022

).

Figure1:ProjectedtransitionandphysicalriskinMSCI’sGlobalAnnualPropertyIndex(

MSCI,2022

)

Below,weexploreindepththekeyphysicalandtransitionrisksfacedbytherealestatesector(Table1).

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|Realestatesectoroverview

Table1:Keyclimaterisksfortherealestatesector

Risk

Summary

Transition

Risks

Increasing

regulationand

policypressure

Thesectorwillbeimpactedbyincreasingregulationandnewpolicies,suchasstricterbuildingstandards,carbonpricing,andadditionalreportingstandards.

Costofindirect

emissions

Activitieslikeconstruction,refurbishment,anddemolitioncontributesignificantlytoindirectemissions.Althougharealestatecompanymaynothavedirectcontrolovertheseemissions,itcouldexertinfluenceovertheirmagnitude.Ascarbon-intensivebuildingmaterialsbecomemorecostlyinthecomingyears,constructioncostswillrise.

Shiftingmarket

preferences

Asawarenessofclimatechangegrows,tenantsandpoten-tialbuyersarebeginningtoexpectmorefromtherealestatesectorregardingemissionsreductions.Thesectorfacesnewrisksaspreferencesshifttowardshigh-efficiencybuildingswithrenewableenergysources.

Changein

investor

sentiment

Toalignportfoliostoclimategoals,investorscouldattempttooffsetemissionselsewhereintheirportfoliotocounterhigh-emittingbuildingsorfavourlow-emittingrealestateassets.

Reputationalrisk

Inactiontodecarbonisecouldresultintherealestatesectorfacingpublicpressuretoreduceitsshareofemissions.

PhysicalRisks

Sealevelriseandcoastalflooding

Sealevelriseandcoastalfloodingwillbecomemorefrequentandsevere,increasingpropertydamageandcausinghigherrepairandmaintenancecosts.

Inlandflooding

Inlandfloodingduetothegreaterfrequencyandseverityofcoastalstormsorextremeprecipitationeventscanincreasepropertydamage.Drivenbyrapidurbanisation,itcanalsocausethecostsofrepairingandmaintainingpropertiestorise.

Extremestormsandwind

Greaterseverityandfrequencyofextremestorms,suchashurricanes,cancausedamageworthbillionsofdollars.Extremestormscannegativelyimpactthevalueofcommer-cialrealestateinthenearterm.

Wildfires

Millionsofresidentialandcommercialbuildingshavebeenbuiltinareaspronetowildfires.Withtheintensityandsever-ityofsuchfiresincreasing,thelikelihoodofthesepropertiesbeingdestroyedbyawildfirerises.

Subsidence

Anincreasingnumberofrealestateassetsarelikelytobeatriskofsubsidenceinthecomingyears,potentiallycausingseriousstructuraldamagetobuildings.

Heatandwater

stress

Risingheatwillcreatenewcoolingneedsforbuildings,increasingoperatingcosts.Waterstresswillalsoleadtohigheroperatingcostsduetoincreasedwaterprices,theneedtoimprovewaterefficiency,andtheregulationofwateruse.

SectoralRiskBriefings:InsightsforFinancialInstitutions|ClimateRisksintheRealEstateSector9

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|Realestatesectoroverview

Table2belowhighlightshowthesekeyphysicalandtransitionriskscanimpactstakeholdersintherealestatesector,especiallyinhous-ing.

Table2:Overviewofclimate-relatedriskstostakeholdersinhousing(adaptedfrom

MortgageBankersAssociation,2021

)

Risk

Owners

Buyers

Renters

Lenders

Servicers

GovernmentSponsoredEnterprises

Investors

Insurers

Government

Property

damage

x

x

x

x

x

Mortgagedefaultrisk

x

x

x

x

x

Mortgageprepaymentrisk

x

x

x

Adverse

selectionofloanssold

x

x

x

x

Moral

hazard

x

x

Housepricerisk

x

x

x

x

x

Climate

migration

x

x

x

x

x

SECTION1:

Transitionrisks

Theroleoftherealestatesector inconstructingandoperatingbuildingsaroundtheworldmakes itresponsibleforaround40%ofglobalGHGemissions.Asaresult, theambitiontoachievenetzero demandsmajorchangestothesectorandpresentsitwithvarious transitionrisks,suchasdecliningmarketattractiveness,increasingregulation,andreputation

risk.Table3belowhighlightskeytransitionrisksfortherealestatesector.

Thetransitionrisksfacingtherealestatesectoralsoposeariskforworkersandcommunitiesthat

relyonthethesectorforjobsand income.Itisthereforeimportanttoalignfinancingwithajusttransitionapproachthatconsiderstheimpactofthetransitionongroupsatrisktooperationsintherealestatesector, includingworkers,IndigenousPeoplesandlocalcommunities.

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|Transitionrisks

Casestudy1:Operationalandmarketpreferencerisk

LandsecAnnualReport,2021

TheUK’slargestcommercialpropertydevelopmentand

investmentcompany

Climatescenarioanalysis:>2°Cpathway(until2030)

Hightransitionrisksassociatedwithaggressivemitigationactionstoreduceemissions

?MinimumEnergyEfficiencyStandards(MEES)raiserequirementsforall

non-domesticrentedpropertiestomeetaminimumEPCB,potentiallyimpact-ingnearly80%offloorarea

?IncreasedpricingofcarbonemissionsexpectedtoreachGBP87/tCO2

(US$100/tCO2),impactingoperationalcosts

?Changeincustomerexpectationsregardingoffices,asmorecompanies

committedtobecomingnetzeroandsetscience-basedtargets

Table3:Examplesoftransitionrisksfortherealestatesector(

UNEPFI,2022

)

TransitionRisk

Impactonrealestate

Decliningmarketattractiveness

Decliningattractivenessofsubmarketsduetoincreasedvulnerabilityandexposuretohighercosts

?Lowerdemand(investorandtenants)?Lowercompetitiveadvantagebyincreasing

energycostsforpropertieswithhigh-energyintensities

?Reducedassetvaluesmayleadtoa

depressedmarketenvironment

?Decreasingmarketvalues

Increasingregulation

Legislationfocusedonclimatechange—e.g.disclosureofclimaterisks,stricterbuildingstan-dards,carbonpricing,carboncredits,etc.

?Taxincreases,e.g.carbontax

?Decreaseinsubsidiesforcertaintechnologies?Extracostsfromreportingrequirements?Additionalinvestmentcoststobringthereal

estateportfolioinlinewithnationallaws

?Enforcedrulesthatpropertiescanonlybe

rentediftheymeetacertainenergystandard

Riskstoreputationandmarketpositioning

Stakeholderdemandforrealestatecompanieswhereclimaterisksareincludedintheinvest-mentcalculation

?Lossofreputationifactionistoolateorifno

actionistaken

?Reputationalrisksforcompaniesthatdo

notsufficientlyconsiderESGtopicsintheirstrategy

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|Transitionrisks

1.Increasingregulationandpolicypressure

Therealestatesectorcouldfaceincreasingregulationandtheimplementationofnewpolicies,suchasstricterbuildingstandards,carbonpricing,andadditionalreportingstandards.Forexample,somejurisdictionsareconsideringnewefficiencyrequirementstoimproveenergyefficiencyandtheelectrificationofbuildings,suchasbyimprovingthermalinsulationandabanoffuel-andgas-basedheatingsystems(

UNEPFI,2022

).ThiscanbeseeninHongKong’sClimateActionPlan2050,whichincludesmeasuresemphasisingtheimportanceofenergysavingandgreenbuildings.Thecity’sgoalistoreducetheelectricityconsumptionofcommercialbuildingsby30to40%andresiden-tialbuildingsby20to30%by2050,comparedto2015levels.HongKongalsoplanstoexpandthescopeofitsenergyefficiencyregulationtocoverallbuildingswithhighenergyconsumption,includingdatacentres.Othermeasurescomprise:promotingretro-commission;mandatingtheimplementationofenergymanagementopportunities;conductingregularenergyaudits;tighteningstandardsrelatedtoair-conditionelectric-ityincommercialbuildings;andacceptingaccreditedcertificationschemesforenergyefficiency(

HongKongGovernment,2021

).

Thoughsuchregulationsarelikelytobeaccompaniedbygovernmentalsubsidies,house-holdsandbusinessesmayincurhighretrofittingcostsorrisktheirassetsbeingpricedoutofthemarket.A2021reporttotheUKParliamentestimatedthatinvestmentsworthbetweenGBP35billionandGBP65billionareneededtobringallhomesuptoEnergyPerformanceCertificate(EPC)Standardsby2035.However,costscouldbesignificantlyhigher,withsomeestimatesbeinguptofivetimeslarger(

UKParliament,2021

).In2018,theUKgovernmentimplementedtheMinimumEnergyEfficiencyStandard(MEES)inEnglandandWalestoencouragelandlordsandpropertyownerstoimprovetheirenergyefficiency.Thestandardsetsaminimumenergyefficiencylevelfordomesticprivaterentedproperties(

UKGovernment,2020

).Thepolicyrestrictsthecontinuationofexist-ingtenancieswherethepropertyisnotenergyefficient,basedonitsEPCrating.Alter-natively,landlordscouldfaceafineofuptoGBP5,000.AstudybytheBankofEnglandshowedpricesofpropertiesaffectedbythepolicydecreasedbyGBP5,000toGBP9,000comparedtounaffectedproperties.DespitepricesrisingforallEPC-ratedproperties,theyincreasemoreforpropertiesthatarelessenergyefficientinitially.However,prop-ertiesbecomemoreenergy-efficientovertimeduetohigherdemand(Figure2).ThestudyalsodeterminedthattheMEES2018policyonlyimpactedmortgagesagainsttheleastenergy-efficientpropertieswithEPCratingsof“F”and“G”.Theloan-to-valueratiooftheiroutstandingmortgageswasslightlylessthanthetotalsampleanalysed(

Bank

ofEngland,2021

).

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|Transitionrisks

Figure2:PriceofEPCratedpropertiesovertime(

BankofEngland,2021

)

TheBankofEngland’s2021ClimateBiennialExploratoryScenarioassessedtheimpactofanearlyaction(earlyandorderlytransitioningbeginningin2021)andlateaction(lateanddisorderlytransitionbeginningin2031)scenariosonmortgagelossesforbankstill2050.Theexerciseshowedthatimpairmentrateswillbehighforpropertieswhosepotentialenergyefficiencyratingsbelongtothelowestcategoriesof“F”and“G”,makingthesepropertiesunmarketableby2050.Delayedpolicyimplementationleadstohighermortgagelossesduetoamacroeconomicdownturn.This,inturn,leadstohigherunem-ploymentandfallinghouseprices.Inbothearlyactionandlateactionscenarios,house-holdsareassumedtobearthecostofimprovingtheenergyefficiencyofhomes,withtotalaggregatecostsofaroundGBP75billion(

BankofEngland,2022

).

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|Transitionrisks

Figure3:AggregateimpairmentratesbycurrentandestimatedEPCratingsundertheearlyactionscenario(

BankofEngland,2022

).

Newbuildingsarealsolikelytobecomesubjecttomoredemandingconstructionandenergyefficiencystandards,therebyincreasingcosts.InMay2022,theLosAngelesCityCouncilvotedtobanthemajorityofgasappliancesinnewconstructionprojectstoincreasetherateofelectrificationofbuildingsandtomakenewbuildingsreachzeroemissionsusingaphased-inapproach(

LosAngelesTimes,2022

).Itmaysubsequentlybecomeuneconomicaltoupgradeorretrofitsomeassets.Inaddition,buildingsthatdonotmeetcertainstandardsmaybecomeillegaltobuild,rent,orsell,thusresultinginprematureobsolescenceandsignificantwrite-downs.

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|Transitionrisks

Casestudy2:Technologicalandconstructionrisk

CityDevelopmentsLimited(CDL)IntegratedSustainabilityReport,2021

Singaporeanmultinationalrealestatecompany

Transitionrisks

Buildingstandards

StandardsthatmandatebuildingandenergyefficiencywoulddirectlyaffectCDL’scostsfromincreasedinvestmentintechnology.However,theremaybefutureopportunitiestoembracethetechnologytypesthatarecurrentlynotcost-effi-cientbutmaybecomesounderahighcarbonpricescenario.CDLmayalsoenjoyenergycostsavingsifallCDLhotelsareretrofittedtothehighestenergyeffi-ciencystandard.

Constructioncosts

Higherexpectationsonenergyefficiencywillresultinhigherconstructioncostsduetotheinclusionofgreenfeaturesinnewdevelopmentproperties.Potentialmandatesthatcallfortheuseofsustainableconstructionmaterialswillalsoraiseconstructioncosts

Mitigatingactions

Meetnet-zerocarboncommitmentthroughbuildingdesignandmaterialselec-tion:formulateclearstepstoachievenet-zerooperationalcarbon;offsetunavoid-ableemissionsusingemergingandinnovativetechnologies;mayincludegreenbuildingmaterials,districtcooling,incorporatingrenewablesthroughBIPVandleveragingAItechnologytoreducewaterandenergyuse.

Promoteconstructiondesignsforwastereductionandmanagement:embeddedicatedwastesegregationcapabilitieswithinbuildings;usematerialsandcomponentsthatcanbeeasilyreusedoradaptedtoreducewaste.

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|Transitionrisks

2.Costofindirectemissions

Keyemissionsourcesfrombuildingsarealsolinkedtotheirconstructionandtheirdemolition.Activitiesrelatedtoconstruction,refurbishment,anddemolitioncont