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The impact of climate risk on real estate valuation

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The global business community is now seeing the financial implications of climate change. From intensified wildfires, typhoons, and other natural disasters, to increased severity of flooding in Hong Kong, acute shocks are demonstrating the necessity for investors to mitigate underlying and emerging environmental and social risks.

In 2020s World Economic Forum’s Global Risks Report, it was stated that greater concern is being placed upon environmental degradation with climate action failure being a key issue highlighted by senior global leaders. Climate risk factors are now present in the top five spots ranking most likely to impact the world over the coming decade.

Using this as context, there has been a strong migration towards sustainable investment and a rise in environmental, social and governance (ESG) considerations. Hong Kong, as one of Asia’s leading financial centres, has taken significant steps to create a well-conceived Green and Sustainable Finance Cross-Agency Steering Group to drive sustainable finance policy with five key action points. Securities and Futures Commission, Mandatory Provident Fund Schemes Authority, Hong Kong Monetary Authority, and the Hong Kong Stock Exchange have also introduced initiatives and guidance to manage climate and environmental risks consistently.

These are positive steps, especially when you take note that Hong Kong has signed up to become carbon neutral by 2050. To achieve this, there will be a clear adoption of the Task Force on Climate-related Financial Disclosures (TCFD) which has a focus to “promote more informed investment, credit, and insurance underwriting decisions” that in turn “would enable stakeholders to understand better the concentrations of carbon-related assets in the financial sector and the financial system’s exposures to climate-related risks.”

Climate risk and the real estate market 

The real estate market has mirrored this direction with the adoption of ESG criteria to ensure resilience in investment activity. Private equity real estate investment managers are now more active in managing their portfolios against sustainability benchmarks such as the Global Real Estate Sustainability Benchmark (GRESB) and the United Nations Principles for Responsible Investment (UN PRI). This enables investors to understand, process and analyse large sums of data to ensure the financial implications of maintaining a green portfolio, transparently. 

In addition, there has also been a drive in Hong Kong by investors to appoint in-house ESG experts to help comply with these global ESG benchmarks. And, in the 2019 PERE ESG Investor Survey, it was reported that 35% of such real estate investors already expect their investment managers to implement ESG initiatives.

Increase in intensity and severity

Real estate investors and developers need to build climate risk factors into their decision-making process when buying land or a building. This involves looking beyond the individual asset by assessing the preparedness of cities, countries, and their governments by asking the question, how resilient are they in the face of climate related risks? 

Cities across the world have always had to contend with extreme weather events. However, increased frequency and their strength are creating new scales of damage, testing the resilience of major built environments. This isn’t new and was predicted by climate experts. What is new, is that the associated climate change risk is not being adequately priced into commercial real estate valuations with accurate modelling and metrics.

For a coastal city like Hong Kong, of all the associated risks, none is as prevalent as rising sea levels. While the risk of floods is not new, Hong Kong’s situation is precarious as buildable land is at a premium and developers are having to consider residential plots in locations that have been highlighted as high risk.

It won’t take too much of a rise in sea level to further intensify the risk for the SAR. The Hong Kong Observatory has forecasted a jump of about 0.2 meters by 2040, which won’t cause immediate large-scale flooding, but will lead to more intense storm surges triggered by more frequent and severe typhoons.

For real estate investors, the need to place climate change risk into the decision-making process, especially from a financial perspective is critical. As practitioners, there is a need to align more closely, collaborate and develop a standardised approach in relation to the investment process. The need to consider long- and short-term financial implications are important, such as increased insurance premiums, higher operational costs due to a building’s system working longer and what an assets neighborhood will look like in 25 years – will there be ongoing infrastructure repairs or a need for robust flood defenses? There must be a consideration for a regulated, widely adopted approach to climate risk, ensuring assets go through consistent, and accurate valuation.  

The work we are delivering at Colliers, on-the-ground in Hong Kong shows that environmental and social factors are having a stronger correlation to financial performance. And as a business, we are committed to supporting our clients and our people to find the right real estate solutions. Globally, we have just launched our Global Impact Report, a report highlighting our commitment to ESG best practices across the organisation. In the coming months, we will conduct a materiality assessment to understand the firm’s greatest opportunities to effect positive change and establish a comprehensive strategy with measurable targets.

 

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