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Why investors should prepare for climatic risks of their real estate assets

The built environment is of utter importance to decarbonize – ahead of other sectors – in order to limit global warming to well below 2 degrees. Consequently, climate change is becoming a central theme within the financial industry. Meanwhile, a considerable and increasing share of our buildings are exposed to various climate-related risks.

For us to be prepared to tackle the physical and transition risks entailed by climate change, further and more concerted action is needed in the real estate sector to ensure that the investments in climate change mitigation and adaptation focus squarely on overcoming these risks. The new joint study by Gaia Consulting and WWF Finland helps investors understand the climatic risks related to their real estate assets.

Institutional investors and companies are expected to report on voluntary basis according to the Task Force on Climate-related Financial Disclosures (TCFD) recommendations. The framework is already being incorporated into the CDP questionnaire and the ranking methodology Asset Owner Disclosure Project, for instance, and is expected to become the standard practice in climate-related reporting. We can therefore expect further demands on the financial sector and climate-proof investment activities across asset classes – including the real estate assets.

There is a growing community of investors who successfully demonstrate how climate-conscious interventions can both preserve and increase asset value. For example, greener buildings can result in higher rental and occupancy rates, lower operating expenses and higher asset values. Climate change mitigation and adaptation can also translate to lower stranded assets risks.

Understanding physical and transition risks is the first step

To ensure that the climate-friendly investments could also unlock financial gains, we need a deeper understanding of the physical and transition risks of our built environment.

Transition risks can occur due to market and technology shifts when transitioning towards a more climate-compatible economy. This could mean increased demand for energy-efficient lower-carbon buildings, products and services as well as new innovations in disruptive technologies. Eventually these can lead to shifts in asset values or higher operating costs in certain industries, and even affect supply and demand in key real estate markets due to, for example, migrating population.

Physical risks include both chronic changes and more frequent and severe extremes of climate, such as temperature, flooding, sea level rise and wildfires (TCFD, 2017). These could result in increased business interruption and damage across operations and supply chains with consequences for input costs, revenues, asset values, and insurance claims. For the Finnish institutional investors, sea level rise, flooding and storms constitute the most acute physical risks due to major part of the real estate assets being located in Helsinki and Espoo, both on the Baltic Sea coast line.The effects of flood map disclosure on housing prices in Finland have been studied indicating a significant price drop information disclosure for properties located in flood-prone areas. In other words, the effects have already empirical grounding.

How institutional investors should prepare for climatic risks

To adopt a more sustainable investment policy, institutional investors could develop green investment strategies to help in deciding between investment alternatives when keeping in mind the challenges of climate change mitigation and adaptation as well as enabling financial benefits in the future

Fortunately, several frameworks are becoming available for investors to better align their practices with climate science. Climate Bonds Initiative has published the Low Carbon Buildings criteria, which sets out what property assets are eligible for certification under the Climate Bonds Standard. Furthermore, the Science Based Targets Initiative is broadening its scope to cover institutional investors.

Especially the existing and often inefficient building stock has the largest mitigation potential. Therefore, investors should not only invest in more energy efficient buildings when planning new investments but also review their existing real estate portfolio for opportunities. Moreover, they could support the development of climate-friendly solutions by investing in companies that promote products and services that can advance mitigation and adaption in the built environment.

In the real estate sector, adaptation has been traditionally overlooked in comparison to mitigation. For investors, possible adaptation interventions include constructing more climate-resilient buildings or retrofitting existing buildings with adaptive structures or technologies such as green roofs and pervious concrete. Generally, to lower their risks, investors could invest in real estate assets where technical measures have been taken to protect the building from extreme weather events. Another option is to invest in resilience, i.e. invest in companies providing resilience-building products or services, such as rainfall storages or weather forecasting and modelling services (GARI, 2016).

In Finland, several institutional investors have published climate policies that include detailed and often numerical targets for the directly owned buildings, albeit not necessarily aligned with the available global carbon budget.

Unfortunately, publicly available climate change adaptation policies and strategies are virtually non-existent. This further highlights the apparent asymmetry between climate change mitigation and adaptation actions. Developing public climate change adaptation strategies could well be the next frontier for the Finnish real estate investors. The climate policies for real estate of leading institutional investors can be found in a second study co-written by WWF Finland and Gaia Consulting titled Building for Tomorrow – Exploring Case Studies, Legislation and Investor Best Practice in Greening Real Estate.

To comply with their fiduciary duty, institutional investors need to take climate change mitigation and adaptation into account in their real estate investment decisions. We wish to see the Finnish institutional investors to set the example for the entire industry.

Download the Climatic risks and opportunities in real estate portfolio management here.

Download Building for Tomorrow – Exploring Case Studies, Legislation and Investor Best Practice in Greening Real Estate here.

more information

  • Santeri Palomäki, Senior Consultant, Gaia Consulting, +358 40 760 2005, firstname.lastname@gaia.fi
  • Kaarina Kolle, Climate and Energy Officer, WWF Finland, +358 50 591 3072, firstname.lastname@wwf.fi