More Awareness Than Preparedness: CRE Falls Behind On Flood Resiliency As Risk Rises
Acknowledgment of climate change and the risks it poses for property owners and investors, especially through flooding, is growing, and through a major new Federal Emergency Management Agency policy change involving flood insurance, the federal government is adding to that awareness.
The information needed to protect properties is becoming more widely disseminated than ever before, and an entire industry is evolving to help property owners make better mitigation decisions. But while some big players with the resources to do so are taking action based on the ever-growing volume of flood risk and climate change data, still more haven't addressed the issue to meaningfully protect their assets.
The threat of flooding came into sharper focus when FEMA, which oversees the federal response to disasters, rolled out a major revision to the way it calculates flood insurance premiums, called Risk Rating 2.0, which took effect on Oct. 1.
Rather than relying on static flood zone maps that haven't been updated in decades, the new system purports to evaluate property risk for individual structures and parcels by including such variables as flood frequency, distance to a water source and property characteristics, such as the cost to rebuild.
Risk Rating 2.0 is so new that even experts in the federal flood insurance program are still uncertain about how well it will work, CT Mirror reports, though plan advocates such as Laura Lightbody say that the new system will result in fairer premiums based on a more precise assessment of flooding risk. Lightbody is the project director for The Pew Charitable Trusts' flood-prepared communities initiative, which is aimed at reducing the impact of flood-related disasters.
The long and short of the new system is that premiums will go significantly up for those whose properties are prone to flooding in one way or another. A handful of wealthy owners of high-value coastal homes will see their costs balloon by as much as $12K per year, the Washington Post reports, and even homeowners in Midwestern states near rivers and streams will see price hikes.
The National Flood Insurance Program will remain of use mainly to residential property owners since the cap for damages remains $500K. Commercial property owners can and do participate, but $500K doesn't go very far when it comes to restoring most commercial properties. Thus commercial owners need to buy private flood insurance, which can be hard to come by because, unlike the public National Flood Insurance Program, private insurers can pick and choose their clients.
Commercial owners will also need to take steps on their own to mitigate flood risk. Some owners with the resources like ESG policies and teams to implement them are doing so. More others can't, since mitigation of existing properties can be an expensive proposition for small-scale owners.
The risk of climate change-inspired flooding is generally associated with coastal properties. If the warming of the Earth continues as it has, between $66B and $106B worth of existing coastal property will be below sea level nationwide by 2050, estimates the Risky Business Project, an organization whose goal is to quantify the economic risks associated with climate change. Some $238B to $507B worth of property would be below sea level by 2100 under the same scenario.
Yet another wrinkle in flood risk is that while coastal and major river communities are more exposed to it than other places, few places are entirely safe from the possibility. Major inland flood events — that is, ones causing over a billion dollars in damage but not caused by a tropical storm — increased in the 2010s in the United States, according to the National Centers for Environmental Information. Climate change was a probable factor, but so were increases in population and wealth over recent decades, which contributed to greater damage potential.
Four separate billion-dollar inland flood events arose in 2016, doubling the previous annual record. The next year, two inland flood events hit California and Missouri/Arkansas, and in 2019, the U.S. was hit by large-scale inland flood events in Midwestern and Southern Plains states, causing at least $20B in damage.
New research by the First Street Foundation shows that at least 20% of U.S. critical infrastructure — such as airports, hospitals, police stations and power stations — are at risk of flooding in the next 30 years.
"Real estate companies are actively seeking information about addressing asset-level climate risk, especially for new developments and assets with longer holding periods," Cervest CEO Iggy Bassi said.
"Yet many owners are still a bit short on the expertise they might need," Bassi said. "They might have a dedicated ESG team, but none have in-house climate science expertise."
Cervest is a player in the growing market for climate intelligence, offering an analytics platform that allows users to assess climate change risk for individual properties or larger portfolios, including threats from water, heat and wind.
Smaller real estate owners, while perhaps aware of climate change risk, don't have the resources for dedicated ESG teams. They can, however, still access climate intelligence, Bassi said, which is the use of historical and current data to inform short- and long-term business decisions — in the case of CRE, how best to mitigate climate risk.
"The commercial real estate companies using our EarthScan product, for instance, which vary in size and geographic footprint, have one thing in common," Bassi said. "They need climate intelligence.”
In a report released on Monday based on a survey of more than 800 CRE decision-makers in the U.S. and the U.K., Cervest found that flooding topped the list of climate hazards, with 61% of executive respondents saying it poses the most significant risk to assets. Flooding was followed by extreme precipitation (59%), heat stress (46%), wind stress (40%) and drought (33%).
Still, the report found that corporate strategies favor emissions reduction over resiliency when it comes to the environmental aspects of their ESG policies. Close to 80% of respondents said their strategy prioritizes net-zero emissions over mitigating physical risks.
Overconfidence is probably a factor in this apparent disconnect. The survey found that CRE decision-makers might know about climate change risk, but they also overwhelmingly believe their organization is already well-prepared for climate change, with nearly 90% of respondents saying they understand the financial risks of climate change well or very well.
Nearly half of respondents haven’t integrated climate into their financial risk management. A similar proportion said their organizations aren't actively assessing physical climate risks right now, and only about one-third said they have a plan in place to deal with heightened physical asset risk.
Bassi said he expects that to change, but it will take time as investors and tenants increasingly pester owners and managers about their asset-level and portfolio-level climate exposure.
“Some of our customers have said they are investing in flood defenses following a major event, such as building a wall that extends below and above ground to protect an asset," Bassi said. "More adaptation and mitigation actions will follow. By pinpointing their risk — and opportunity — they can make decisions about adapting, divesting or retiring assets."
Some major owners are pursuing mitigation efforts portfolio-wide, including industrial giant Prologis. Private sector innovation will play a major role in overcoming the environmental challenges the world faces, said Ed Nekritz, Prologis’ chief legal officer and head of ESG, whose company's portfolio includes about 995M SF of mostly industrial properties in 19 countries.
“The three most common CRE business use cases we’re seeing include reformulating operational strategies to factor in climate risk, readiness for climate-related financial disclosure and including climate risk in property acquisition strategies,” Nekritz said.
Nekritz said that the company is well aware of assessing and mitigating climate-related risks across its portfolio, including increased flooding. Some of the measures it is taking include increased building elevations, site improvements and a focus on preparedness and recovery planning.
In its climate change report for 2020, Prologis noted that 27% of its properties are within 10 miles of major bodies of water, and 3% of its portfolio is within a mile of a coast, so sea-level rise and coastal flooding has the potential to impact its business and its customers' operations.
Prologis has flood insurance, which it acknowledges has the potential to become more expensive. The company also uses mitigation strategies that it believes are cost-effective, such as raising properties out of the base flood elevation or raising the height of dock doors.
In developing an industrial zoned property in the Airport Way industrial submarket in Portland, Oregon, Prologis undertook mitigation efforts due to the site's proximity to Columbia Slough, a water feature. Two 5-foot-wide channels were excavated south of the mitigation area to create a hydrologic connection between the mitigation area and the Columbia Slough, with more than 24,000 cubic yards of soil removed in the effort.
Kimco Realty Corp. uses a third-party firm to provide scenario modeling for flooding and windstorms for its properties, Kimco Vice President, Business Operations Will Teichman told REIT Magazine, saying the time to do that is well before a disaster strikes. Ahead of Hurricane Maria in 2017, Kimco had generators, fuel and roofing materials already in place for its retail properties in Puerto Rico because it anticipated the need. Those steps facilitated the reopening of those properties in days.
"The key to understanding the relative risk to each asset is climate change scenario modeling that is grounded in science,” Teichman said.
State and local public initiatives have become increasingly important in mitigating the risk of floods in recent years, Lightbody said. Besides protecting public spaces that private properties depend on, these initiatives will also raise awareness about climate change risk.
"Over the last five years, over 15 states have created the position of chief resiliency officers and are working through statewide resiliency plans, which represents a surge of effort by the states," she said.
In early October, the state of New Jersey released its multipronged Climate Change Resilience Strategy, a policy framework that lists 125 actions across six core priority areas to enhance the state's climate resilience. These actions include prioritization of state funding for coastal resilience projects to protect major population and economic centers, such as through marsh and beach restoration, inland ecosystem strengthening via water storage and filtration, carbon sequestration, urban heat mitigation, and public outreach to stress the need for climate change risk mitigation.
There are new local programs as well, representing a greater understanding that the potential can't be ignored anymore, though the goals locally are more than just about protecting existing properties.
In Dyersburg, Tennessee, the city is working with the Tennessee Department of Environment and Conservation on an infrastructure resiliency project that involves understanding the interplay of local streams and the city sewer system. The city mapped its streams, identifying those whose banks were highly eroded, a situation that historically has proven to be a threat to the integrity of nearby sewer lines. Then that map was overlaid with maps of poor-quality sewer lines to determine whether neighboring streams would be a candidate for bank stabilization.
But for all the public initiatives emerging to deal with climate change risk, much of the onus for protecting private properties will remain with their owners, CREtelligent CEO Anthony Romano said. CREtelligent provides a platform for commercial property owners and lenders to do due diligence, including environmental risk assessment.
"Real estate is a long-term investment, so commercial real estate interests need to re-evaluate how to handle their due diligence processes," Romano said.
The data is available now to analyze the environmental health of any property and make an informed decision, Romano said. It is now a matter of using that data to mitigate risks to existing properties through physical means — or avoid high risk altogether by making more informed investment decisions.