Protecting Property Value in an Unpredictable Environment

The commercial real estate industry is facing an unprecedented challenge: the ever-increasing threat of climate hazards. From rising sea levels to extreme weather events, these risks are no longer theoretical – they are practical issues with significant financial implications. As data on climate hazards becomes more readily available, property stakeholders have a critical opportunity to take proactive measures to safeguard their investments. This blog aims to shed light on the current landscape of climate risks in commercial real estate and share how the fields of resilience and valuation are collaborating to help investors make informed decisions.

The Current Landscape of Climate Hazards in CRE

Rising Insurance Premiums and Reduced Coverage in High-Risk Areas

One of the most immediate impacts of climate hazards on commercial real estate is the skyrocketing cost of insurance premiums. Insurance is a critical component of risk management for property owners. However, the rising costs and decreasing availability of insurance in high-risk areas are creating significant challenges. As the likelihood of climate-related damages increases, insurers are forced to raise premiums to cover the anticipated costs. This trend is particularly pronounced in regions prone to floods, hurricanes, and wildfires, where insurance rates have risen by upward of 200% for certain hazards. In some markets such as California, Louisiana, and Florida, carriers have even withdrawn coverage altogether, leaving property owners with limited options and increased financial exposure.

This rise in insurance costs directly affects a property's net operating income (NOI), which is a crucial factor in determining its overall value. Moreover, many lenders mandate specific insurance coverage levels as a condition for financing, further complicating the situation for property owners in high-risk areas. As climate hazards continue to intensify, the availability and affordability of insurance will become an increasingly pressing concern for the industry.

Although insurance costs affect NOI, the future costs of insurance are notoriously difficult to predict. Nevertheless, providing insurers with clarity regarding property characteristics and resilience measures that may be present provides the foundation from which accurate pricing can be obtained. In most circumstances, uncertainty creates risk which results in additional expense, so reducing uncertainty for insurers can help sharpen their pencils on pricing.

Structural Damage, Operational Disruptions, and Devaluation Due to Extreme Weather Events

Beyond the financial burden of higher insurance premiums, climate events can also cause significant physical damage to properties, leading to costly repairs, operational disruptions, and safety hazards. Extreme weather events such as hurricanes, floods, and wildfires can wreak havoc on structures, compromising their functionality and market value.

The impacts of these events are not just limited to the direct costs of repairs. Business interruption resulting from climate hazards can also lead to substantial revenue losses. Recent studies found that businesses in the U.S. experience a staggering $311 billion per year in lost revenue due to extreme heat alone. Additionally, 69% of small businesses impacted by a natural disaster reported being in poor or fair financial condition afterward, underscoring the long-term consequences of such events.

Perhaps the most significant risk posed by climate hazards is the potential devaluation of properties, especially in high-risk areas. As buyers and investors become increasingly aware of the financial implications of climate risks, they may become wary of acquiring properties with significant exposure. This reluctance can lead to lower property values, impacting the exit strategies and investment returns for current owners.

The statistics paint a sobering picture: 15–40% of businesses fail following a natural or man-made disaster, while 94% of small business owners believe a disaster event could seriously disrupt their business within the next two years.  A tenant that is out of business is not likely to pay rent. These figures underscore the urgency of addressing climate risks and incorporating them into property valuations and risk management strategies.

Ignoring these risks could prove detrimental, as properties in high-risk areas may become increasingly difficult to sell or refinance, leading to a potential loss of value and compromised liquidity. Proactive risk assessment and mitigation strategies are essential to maintain property values and ensure a viable exit strategy, regardless of the prevailing climate conditions.

Proactive Measures for Resilience

Conducting Comprehensive Property Resilience Assessments

Integrating climate risks into due diligence is essential but challenging due to inconsistent data from different providers. Accurate data is crucial for effective risk assessment and management. To assist in selecting the right climate risk modeling vendors, we've created a helpful guide with tips for evaluating and choosing providers.

At AEI, we conduct Property Resilience Assessments (PRAs) with meticulous care, collaborating with credible climate data providers. Our PRAs involve comprehensive inspections, stakeholder interviews, and extensive research to develop a holistic understanding of the specific risks each property faces. This approach ensures that you receive accurate and actionable information, enabling you to make informed decisions about your investments.

Furthermore, we incorporate the findings from our PRAs into our Real Estate Valuations, ensuring that climate risk is appropriately factored into the overall property value. This transparent and data-driven approach provides you with the confidence you need to navigate the complexities of climate hazards and make strategic investment decisions.

Developing Tailored Mitigation Strategies

While understanding climate risks is crucial, effective mitigation strategies are the key to preserving and enhancing property values in an unpredictable environment. At AEI, we leverage the insights gained from our PRAs to develop tailored mitigation strategies that address the specific vulnerabilities and potential impacts identified for each property.

Our approach involves identifying practical resilience measures, such as fortifying structures, implementing flood control systems, or enhancing emergency preparedness plans. We also provide detailed cost estimates and highlight potential incentives or financing options, enabling you to make informed decisions about your risk management strategies.

The benefits of proactive mitigation are clear: the National Institute of Business Sciences (NIBS) estimates indicate that, on average, for every $1 spent on federal mitigation grants, $6 is saved from future losses. By working closely with you to understand your concerns, the property's intended use, and the specific climate risks you face, we develop customized strategies that optimize resilience and preserve – or even enhance – property values.

Case Study: Enhancing Flood Resilience

One example involved a national portfolio holder of hotels. Among these properties was an historic hotel that was built in the early 1900s. We helped develop a multi-pronged approach to flood mitigation for this project including:

• A combination of wet and dry floodproofing.

• A deployable system requiring training and preparation by on-site personnel.

Each of these approaches is aimed at making the facility more resilient to flood inundation. The goal is to either prevent water from entering critical areas or to allow it in the parts of the structure that are designed to withstand and recover quickly from flooding, using materials that can be easily cleaned and put back into operation. This project is significant not just for its technical aspects, but also because it reflects the client's commitment to protecting a historic asset.

Final Thoughts

As climate hazards continue to intensify, proactive risk assessment and adaptation strategies are critical for safeguarding property values – the cornerstone of successful real estate investments. At AEI, we understand that property owners cannot afford to be reactive; they must anticipate and fortify against potential threats to protect their assets and ensure long-term value preservation.

Backed by our extensive expertise and data-driven approach, we empower clients to stay ahead of climate risks through our comprehensive Property Resilience Assessments that seamlessly integrate climate risk analysis into our Real Estate Valuations. Our tailored strategies go beyond merely identifying vulnerabilities; they provide practical, actionable solutions that directly address the unique challenges each property faces.

In this era of unprecedented climate volatility, partnering with AEI can help you navigate and mitigate climate risks effectively. Our unwavering commitment to due diligence and risk management ensures that your investments are fortified against the unpredictable forces of nature, shielding you from the potential devaluation and compromised liquidity that could jeopardize your returns and exit strategies.

Contact us today to schedule a consultation and learn how our comprehensive services can fortify your portfolio, safeguarding your property values and ensuring long-term, sustainable growth.