Skip navigation
Hurricane Ian Florida RICARDO ARDUENGO/AFP via Getty Images

How Institutions Are Managing Climate Risk Within Real Estate Investment Portfolios

The increasing frequency and strength of severe weather events is forcing the commercial real estate sector to grapple with how to assess future risks.

The increasing severity and frequency of climate-related extreme weather events is one of several factors pushing commercial real estate owners and operators to step up efforts to analyze climate risk within portfolios. Institutional investors in particular are feeling growing pressure from investors and ESG mandates, as well as the need to prepare for a proposed SEC rule that will make climate-related financial disclosures mandatory for those companies that report to the SEC.  

Hurricane Ian was the latest in a growing number of climate-related disasters that have topped the $1 billion mark. Last year, the U.S. recorded 18 separate billion-dollar disasters and an additional 15 have occurred year-to-date, according to the U.S. National Oceanic and Atmospheric Administration (NOAA).

However, stakeholders in the commercial real estate industry are at very different stages of developing processes and identifying tools to assist in asset-level and portfolio climate risk analysis. One of the biggest challenges is that approaches in assessing climate risk vary widely and there is no consensus on standardization. Some providers are thinking about value at risk in terms of insured value, others look at change in asset value or replacement cost, notes Elena Alschuler, our Head of Americas Sustainability at LaSalle Investment Management. “Those are three very different metrics,” she says.

LaSalle Investment Management conducted a climate risk assessment across its entire global portfolio in 2022. “We do view it as something that is relevant to the financial performance, value and risk mitigation of our assets. So, we are trying to proactively address it,” says Alschuler. The firm conducted an in-depth review of different service providers and recently released the report How to Choose, Use, and Better Understand Climate-Risk Analytics in conjunction with ULI that aims to bring to light some of the issues and inconsistencies that exist around different climate risk analyses and provider approaches.

One of the key takeaways from the report is that there can be huge differences in physical risk scores for the same asset depending on the methodology and provider. For example, when addressing hurricane risk, many models only look at wind and coastal flooding and don’t include pluvial flooding—flooding caused by extreme rainfall, says Alschuler.

Another inconsistency among providers is whether or not they are considering baseline risk or the existing risk today. In its research of providers, LaSalle Investment Management found that some firms were not flagging assets in Florida for hurricane risk and were only flagging assets further up the East Coast in markets such as Baltimore, Boston and New York. The reasoning was that models were only accounting for forward-looking change in risk.

The problem that creates is a huge variance in climate risk assessment even among similar assets, says Alschuler. If an LP is getting reports from various investment managers or REITs on climate risk and one provider includes the baseline risk in their climate risk assessment and another doesn’t, it will create different results that makes one portfolio look much more high risk than the other. In addition, a lot of assessments don’t account for any risk mitigation measures or improvements that have been made to a property, or risk mitigation measures taken by the government, she adds. So, it becomes important for investors to dig in and understand the methodologies being used, she says.

Best practices continue to emerge

Although real estate owners are still in the early stages of developing climate-risk assessment strategies, many are looking to learn from what others are doing. For example, CBRE Investment Management uses a number of third-party tools including Moody’s ESG Solutions to get an initial indication on potential physical climate risk. Moody’s assesses exposure to critical physical risks including floods, heat stress, hurricanes/typhoons, water stress and sea level rise. CBRE Investment Management uses the results are used to analyze the physical climate risks associated with both new acquisitions and existing portfolio assets.

“If an asset or area is identified as high risk, we begin more in-depth analysis to determine mitigating factors that might have already been implemented or could be implemented to de-risk the investment,” says Helen Gurfel, head of sustainability and innovation at CBRE Investment Management.

PGIM Real Estate also uses Moody’s physical climate risk score for individual risk reports for new acquisitions and new developments, as well as the Physical Climate Risk Exposure (PCRX) module in Measurabl, an ESG data management software platform, for standing assets. Those tools help the firm to holistically evaluate climate risks, and existing standing assets are reviewed quarterly as part of portfolio reviews.

Additionally, PGIM Real Estate investigates an asset’s likelihood to be impacted by adverse weather conditions, such as wind or flooding, for assets flagged as high-risk and/or flagged for flooding and sea level rise risk factors. The company’s ESG team uses the information to make budget recommendations and determine a cost-effective manner to protect assets. “Our emphasis on resilience along with ESG ensures that we stay ahead of the curve with regard to the changes in our environment,” says Christy Hill, head of Americas Asset Management and global head of ESG at PGIM Real Estate.

An increasing number of institutions also are utilizing the voluntary Resilience Module included in the GRESB Real Estate Assessment, which aims to increases information for investors on how companies are assessing and managing risks associated with climate-related shocks and stressors.

LaSalle Investment Management created a global climate risk task force two years ago that initiated pilot projects with different providers before selecting one provider and rolling climate risk analysis out to its entire global portfolio. In some cases, the company also supplements information with additional sources. “You really have to treat it like it’s more of a flagging exercise,” says Alschuler. “We don’t see any of this as establishing value to the fourth decimal point. It’s much more about flagging assets that need to be looked at more closely so that you can dig in and bring critical thinking.”

Climate risks influence strategy

Ultimately, companies are hoping to better understand climate risk exposure as a means to enhance financial performance. Extreme weather events have the potential to impact asset-level and portfolio performance whether it is property damage from an event, capex needed to mitigate potential effects from storm damage or rising insurance premiums.

The exposure to climate risk for the CRE industry is significant. For example, there was an estimated $1.5 trillion in commercial and multifamily real estate assets that were in the five-day path of Hurricane Ian, according to MSCI Real Assets, which tracks assets valued greater than $2.5 million. Potential losses from even a single event are enormous. Rising insurance costs in high-risk areas are another concern. According to Swiss Reinsurance Company Ltd, climate risks globally are expected to add an estimated $200 billion to annual property insurance premiums by 2040.

Real estate owners and managers are using climate risk analysis to drive strategy and investment decisions. For example, LaSalle Investment Management has incorporated physical climate risk assessment into acquisition underwriting to identify any potential issues. That assessment takes into account mitigation measures and capex that might be needed at the asset level, as well as issues such as portfolio diversification. “The same reason why you don’t want high concentration of your assets in one real estate market, physical climate risk becomes another reason why you want to pay attention to physical market concentration in a portfolio,” says Alschuler.

A growing number of CRE owners and managers, including both institutions and non-institutions, are taking proactive steps to assess the potential impact of climate change over time as part of an ongoing risk-informed decision-making process. “In addition to considering climate risk, we focus on building resilience and environmental stewardship to both protect the environment and strengthen our global businesses,” says Hill. “That focus enables us to improve the potential for higher investment returns and benefit our clients, employees and shareholders as well for future generations.”

Hide comments


  • Allowed HTML tags: <em> <strong> <blockquote> <br> <p>

Plain text

  • No HTML tags allowed.
  • Web page addresses and e-mail addresses turn into links automatically.
  • Lines and paragraphs break automatically.