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  • Writer's pictureRealFacts Editorial Team

Integrating Physical Risk into Real Estate Investment Decision-Making: The New Way to Underwrite

two people talking about real estate investment

During the recent Urban Land Institute’s Spring meeting in New York City, the 5th annual Resilience Summit brought together industry professionals to discuss the integration of physical climate risk into real estate investment decision-making. The summit, which featured discussions on climate risk's impact on portfolio strategies and investment decisions, provided valuable insights into how the industry is adapting to these challenges.

Climate change poses various risks to commercial real estate (CRE) assets, including floods, wildfires, heat waves, drought, and sea-level rise. Recognizing these risks, investment managers and developers are increasingly integrating climate data into their investment processes. This integration, while partly driven by regulations, is fundamentally about enhancing returns while managing risk.

Key to this integration is the assessment of climate risk exposure for each asset. Investment firms are now screening every asset for its physical climate risk exposure, utilizing external data providers to assess risk factors such as structural damage during storms or flooding, insurance challenges, and the economic vitality of regions. Clear, defensible data is essential, with many firms using report cards for each asset to facilitate discussions at the investment committee level.

An example provided by one speaker illustrates the thoroughness of this approach. For instance, when considering a coastal Florida hotel, the discussion of risk encompasses potential structural damage, insurance challenges, capital expenditures, and the economic vitality of the region. An annual reassessment evaluates the adjusted cash flow in a downside scenario, ensuring the investment remains viable.

While climate risk screening provides a directional understanding of risk, it also identifies assets requiring further analysis. This includes on-site assessments and market evaluations to gauge resilience. However, comparable market-level resilience screenings are still lacking at scale, prompting firms to rely on local expertise and analyst research.

This information guides various actions throughout the investment process, from acquisitions and market selection to building resilience strategies and portfolio management. For value-added investors, understanding climate risks within the sell-off timeframe is crucial. They need to assess whether identified risks can be mitigated and the cost implications of doing so.

Despite increased awareness of climate risks, firms are not necessarily pulling out of exposed markets. Instead, they are exploring opportunities to strengthen assets against potential damages. Property type plays a significant role in risk and resilience; some assets rebound quickly from disasters, while others, like logistics facilities, are heavily reliant on the surrounding environment's resilience.

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