A practical approach to assessing and managing physical climate change risks in global portfolios

Climate change affects all organizations

Every day it’s impossible to avoid learning about another catastrophic climate event in mainstream media. Extreme weather can destroy properties and valuables, threaten lives and cripple businesses. The Financial Stability Board has deemed climate change a risk to the global financial system and launched the Task Force on Climate-related Financial Disclosures (TCFD) to guide companies on how to disclose climate-related risks, opportunities and financial impacts.

The TCFD divides climate change risk into transition and physical risks. Transition risks concern market and regulatory changes – how your business is affected by new technologies, regulations and customer demands. Physical risks include acute risks from extreme weather events and chronic risks from longer-term shifts in climate patterns, for example higher temperatures.

Physical risks from climate change threaten the value of commercial real estate

Physical risks represent a threat to real estate because buildings must adapt to the changing climate in their region or risk obsolescence. Despite the threat, few owners understand their exposure to these risks and what management strategies currently are in place – especially across global, diverse property portfolios. This is not surprising as there is little industry guidance so it can be intimidating to take that first step into a previously unexplored area. That is why we worked with our client, The Healthcare of Ontario Pension Plan (HOOPP), to develop a pragmatic approach to assessing risk and resilience.

You start by understanding the portfolio’s risks and vulnerabilities… here’s how we did it

HOOPP is a real estate sustainability leader, recognized on three occasions by IPE with its Sustainable Strategy Award. This climate change risk and resilience assessment was a collaborative initiative between Quinn & Partners and HOOPP, conducted on HOOPP’s global $14 bn real estate portfolio.

The team worked with HOOPP’s insurance provider to acquire data on physical, climate change-related risks. For acute risks we analysed historical data for overland flooding, storm surge, wildfire and wind. For chronic risks we examined forward-looking climate projections for precipitation changes, temperature changes and sea-level rise, and created a forward-looking climate risk index.

We collected property resilience data using a survey deployed to nearly 200 properties across the world and developed a resilience score for each property. The risk and resilience score for each site was summarized in a matrix providing a portfolio-wide view of the state of climate change risk and resilience across all of HOOPP’s holdings.

This exercise demystified the risks of climate change and allows HOOPP to make informed decisions and disclose climate action to stakeholders – here are a few examples.

What regions and properties to target with climate action?

The risk data provides an overview of the likelihood and severity of threats in regions where HOOPP operates. Given the portfolio is mostly located in Canada, the primary threat is overland flooding. However, all properties are expected to experience precipitation changes and temperature increases.

The real estate team can rest easily knowing that no properties are at immediate risk of becoming a stranded asset, but actions are needed now to mitigate flood risk. This is also something that is becoming important for sophisticated tenants. The investment team can work with asset managers to invest in flood resilience by influencing operational and capital plans, based on the risk data and preparedness score for each property.

The data can also be used during acquisitions to evaluate whether buildings at risk of extreme weather are properly prepared and what upgrades should be budgeted for in underwriting.

Knowing how much to invest to minimize losses and insurance costs

There are no guidelines for how much to invest in resilience, especially when losses from damages and business interruption are covered by insurance and vary based on the severity of an event. In the process, our team learned that claims from water damage can range from a few thousand dollars to over $1,000,000 per event. But insurance is not a panacea. Flood deductibles are often higher than general deductibles, increasing the potential losses during a flood event.

As it relates to extreme weather, the costs of recovery are higher than the costs to prepare (source: U.S. National Institute of Building Sciences estimates that exceeding the building code to increase resilience can save $4 per $1 spent). Science also tells us that the likelihood of a climate event, such as flooding, is increasing for most properties. Finally, if a property is ever exposed to a flood, the deductible and premium will likely increase. Hence it becomes clear that the best climate change strategy is to invest in resilience.

One strategy can be to invest up to the deductible value. Industry guidance from groups like BOMA and REALPAC recommend numerous low-cost investments to improve resilience. The property survey reveals which resilience management practices are in place and which should be incorporated in budgets and operational standards. Armed with the information from this assessment, HOOPP can demonstrate to its insurers how it is acting to reduce risk to negotiate more favourable rates and deductibles.

The assessment sets a baseline for measuring improvement and supports disclosure

Our client now has a baseline from which it can track changes in portfolio risk and resilience. HOOPP can also disclose its climate-related risks, strategies, risk management process and metrics/targets in accordance with TCFD recommendations and PRI and GRESB resilience disclosures. It’s also the first step towards more in-depth scenario modeling and value-at-risk analysis at locations with the most at risk.

There will always be uncertainty when assessing climate risk, but that is no reason to delay. By its very nature climate change is rife with uncertainty. Changes are coming but it can be difficult to know the magnitude, timeline and compounding effects. Nevertheless, climate scientists have agreed on directional changes. Here in Canada for example, it’s going to get hotter and wetter and that’s going to affect commercial real estate from coast to coast. We may not know when the next large rainstorm or heatwave will happen, but we know they will become more frequent and extreme and what can be done to prepare for them. That is reason enough to act.

Quinn & Partners supports leading institutional investors, real estate and infrastructure companies with ESG integration and GRESB assessment services. In 2018, the value of all Real Estate and Infrastructure Assessments that the team submitted on behalf of its clients was CAD 210 billion, which is equivalent to 10% of all North American responses. Please reach out to Francisca Quinn, Managing Partner, Quinn & Partners, at +1 416 300 8068 for more information.www.quinnandpartners.com