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Beyond location — how climate change could redefine real estate

All of civilisation as we know it was built during a time of climate stability. There were hotter years and colder ones, wetter and drier, but the average was stable.

Beyond location — how climate change could redefine real estate

A man looks through the remains of his family home destroyed by bushfire in Buchan, Victoria, Australia, January 23, 2020.

All of civilisation as we know it was built during a time of climate stability. There were hotter years and colder ones, wetter and drier, but the average was stable.

Yet for the first 95 per cent of human existence — roughly 200,000 years — the earth’s climate was constantly changing. How did our ancestors live? On the move. They were nomads.

Around 10,000BC, however, the climate stabilised. The atmosphere reached a composition at which it trapped just enough heat that it was too warm for new glaciers to form and yet too cold for existing glaciers to melt away. Glaciers expanded in the winter and contracted in the summer, but the minimum, maximum, and average size stayed the same.

Moreover, this stabilisation was at a temperature that was ideal for us. Sure, there were fluctuations, but weather patterns stayed in familiar ranges and the past was a good guide to the future.

A stable climate allowed for settlement, planning, investment and wealth. Humans began behaving quite differently, gradually developing the place-based institutions we now call civilisation.

In this environment real estate developed its mantra, “location, location, location”. Find the best location and own it for the long term.

That was good guidance in a stable world. What will we do now that the era of stability is over? How will the real estate industry change as the climate does?

Everyone involved must become more aware of the physical world and how it is changing.

Everyone in real estate needs to start incorporating the probable futures ahead when making decisions.

Over the last year, scientists at the Woods Hole Research Center (where I am a Senior Fellow) and I participated in a research project with McKinsey & Co. about physical risks associated with climate change.

This research shows clearly that climate change will not disrupt civilisation through marginal change. It will do so by crossing thresholds. 

Only a small fraction of homes, subways, or buses in Western Europe have air conditioning. As summers get hotter, sleeping, commuting, and working become miserable and offices need new air conditioning systems.

In North America the grades of concrete used in the past are now inappropriate given the frequency of very hot days. Sewer systems everywhere need to increase their capacities because new storms contain so much more water. Drought and wildfire are persistent problems in Mediterranean climates that used to get just enough rain to sustain their flora and fauna. Now, though, they face near permanent drought—crossing a new environmental threshold.

If you develop, own, manage, or occupy real estate, it should be a fiduciary responsibility to know the thresholds of your buildings and the infrastructure on which they rely.

DURATION

Just as the real estate industry will become more aware of the physical world, so too will financial markets. When they do, capital will dry up not just spatially, but temporally.

Equipped with good information about prospective climate outcomes, buyers, borrowers and lenders will all start asking not just “where?” but “for how long?” about every asset’s profitability, insurability and even viability.

Perhaps the most obvious application of climate science in finance will be by major banks and global investors who start to look at places in the world that will cross thresholds of extreme heat, overwhelming rainfall, wildfire, drought and sea level rise in the next 10, 20 or 30 years and simply decide not to invest or offer long-term loans in such places.

This is what I call the coming disappearance of duration.

Consider Australia’s fragile climate. The record temperatures behind the unprecedented fires during the 2019-2020 season, according to a paper by scientists Benjamin Sanderson and Rosie Fisher, are likely to be roughly average by 2040, unless emissions are curbed.

How does this knowledge affect your willingness to offer a 30-year mortgage?

First of all, the real estate industry should embrace climate science. It is mankind’s first good environmental forecast. It can be your guide. Its findings have been borne out by recent events and will become intuitive.

Second, do not expect someone else to tell you the risk for your industry. In particular, do not mistake the risks of climate change with regular insurance risk.

A common misconception is that climate change is principally an insurance problem. Insurance companies do need to incorporate good climate science to understand risks and many are seriously lagging in their efforts, but it is essential to keep in mind two things insurance companies generally do not offer: Policies that protect land value and policies that last longer than a year.

As one expert at a leading reinsurance company explained to me: “The first flood is an insurance problem as the policy pays to replace the windows and fix the lobby. The second flood probably is as well. After that each subsequent flood is an equity problem”.

This is because prospective buyers and lenders start to dry up.

This is where regulation comes in.

REGULATION

If we act quickly, we can make changes that allow people to continue working and living in a world that might be more challenging and expensive but similar enough to the past for peace of mind.

If we do not, a rapidly changing climate will cause suffering that is hard to conceive of and likely induce migration in numbers that are far beyond any precedent. But going back to the impermanent nomadism of our ancestors would be unviable.

How do we preserve civilisation’s great sources of wealth (and here I mean not principally monetary wealth, but the institutions, cultures, norms and systems that constitute civilisation)?

By returning to stability.

The good news is that the same science that accurately foretold the changes we are now experiencing tells us how to regain equilibrium: Net zero emissions of heat-trapping gases, especially CO2 and methane.

Construction materials like steel and cement, heating, lighting and other facets of real estate account for a huge share of emissions. In addition, city planning and building have a massive influence on transport-related emissions.

To achieve net zero, we need action by every investor, developer, landlord, and tenant from every city in every country. I concede that this sounds dramatic, but it is actually straightforward. Zero is clarifying. It is not some opaque ESG (Environment, Social and Governance) score.

What is also clear is the only way to get there: Regulation. Confronting the loss of wealth that is likely from climate change has to involve coordination.

If all of us tell the officials in the places where we live, work and invest that net zero has to be a non-negotiable goal, and that we need to prepare our communities for the environmental changes that are inevitable, we will be on the right path.

In real estate this will be largely through enlightened building codes, science-informed bond ratings, smarter infrastructure, retrofitting and giving nature more space in the city. The same frameworks that illuminate risks can be used to guide good, long-term decisions.

I know mitigating climate change is daunting, but take a walk and look around you. This civilisation is worth keeping.

 

ABOUT THE AUTHOR:

Dr Spencer Glendon is an economist and senior fellow at Woods Hole Research Center, a scientific research organisation that studies climate change impacts and solutions. This is an edited version of a piece which first appeared in the July 2020 issue of Urban Solutions, a magazine published by the Centre for Liveable Cities under the Ministry of National Development.

Related topics

climate change real estate property environment

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