08. Risk and returns

Climate change and reactions to social inequality are changing the geographic landscape of risks and opportunities for corporate occupiers and real estate investors. While some historically successful cities may struggle to adapt, the door is open for new business centres to capitalize on growing environmental and social awareness. Real estate investment decision-making models will need to be recalibrated to take account of these new locational drivers.

Gone are the days when investors could rely on a quick contaminated land survey, a check on the local zoning plan and a comprehensive insurance policy for their acquisition due diligence. The Environmental, Social and Governance (ESG) agenda first impacted most real estate investors through a tightening of regulatory and fiduciary standards. In many parts of the world, environmental considerations have risen rapidly up the agenda. Recently, social issues have become more prominent in business decision-making. The risks and opportunities associated with all three are unevenly distributed across the planet which is particularly significant for real estate investments that are, inherently, geographically fixed.

Risky business

Investors have long been used to accounting for variations in governance regimes within and between countries. Business regulations, “Ease of Doing Business”1 and differential tax levels all impact the attractiveness of a city – and its buildings – to an occupier. The focus on climate is more recent and is being looked at across two key dimensions – physical risk and transition risk.

Transition risk arises from the process of adjustment to a low carbon economy, as either market forces or government legislation impact the value and attractiveness of particular assets – or locations. As governments at various levels introduce policies to encourage movement towards carbon neutrality, the geographic pattern of grants, incentives, taxes, and regulations becomes ever more complex. As we discuss in EcoLogical, this is particularly true given that local rather than national governments have been at the forefront of policy action2.

Physical risks arise from the actual or potential impact of changes to the climate or weather in the vicinity of a building. We have seen numerous recent examples of the disruption caused to life and property through floods, fires, droughts, and other extreme weather events. Scientific evidence indicates they are happening with greater frequency and causing a higher level of devastation. Analysis by the United Nations3 shows there were 7,348 major environmental disaster events which caused nearly $3 trillion worth of damage between 2000 and 2019. This marks a sharp increase on the 4,212 disasters, causing $1.6 trillion of damage, that occurred in the preceding 20 years. Similarly, Munich Re have highlighted that the biggest and costliest Californian wildfires have occurred in recent years4.


Analysis by the United Nations shows there were 7,348 major environmental disaster events which caused nearly $3 trillion worth of damage between 2000 and 2019.

The fact that recent events have impacted major metros, from tornados in Nashville to subway flooding in New York and severe inundations in European capitals, has reinforced the impression that the risk to real estate is increasing. The events may be geographically specific, but the impact is not necessarily localised. When unusually cold weather and three successive storms hit Texas in February 2021, the state (which has its own power grid) was unable to cope with the demand for power. Rolling blackouts left an estimated 4.5 million homes and businesses without electricity for several days, at an estimated cost of $195 billion5.

Similarly, social frictions and inequalities are leading to disruption, with knock-on effects for the economy and, in many cases, real estate. Rioting in 140 US cities following the death of George Floyd in Minneapolis was estimated to have caused in excess of $1 billion in damage6, making it the second costliest civil disturbance in US history after the LA riots of 1992. The Gilets Jaunes protests in Paris in 2018 caused widespread disruption – and led to a significant rise in international visitors cancelling flights to the city7. Perceptions of the safety and stability of these cities as business locations are inevitably affected.

Flight to experience

The real estate investment landscape is therefore changing due to several distinct but interconnected drivers. First, market and regulatory pressures mean investors are being forced to identify, quantify, and disclose the risks they face from climate change8. Increased transparency in reporting makes it easier for the providers of capital to assess the risks associated with a particular investment or fund – and to price their equity or debt accordingly9. The process is being accelerated by greater availability of data and analytics to help evaluate the risks involved. On balance, this will tend to discourage investors from buying or developing in cities – or parts of cities - with higher environmental or social risk.

Second, even if investors are prepared to take on certain risks, this is likely to come at a cost. Insurance premiums have been escalating rapidly in recent years, with US markets seeing increases of 30% to 50% even in unaffected locations. In higher risk areas, costs have gone up by multiples of 2 or 3 – and in some cases conventional insurers have pulled out of the market altogether10. Governments are helping plug the gap in some locations, but pressure will grow to avoid future development in such locations. And even if insurance is available, it often comes with mitigation actions attached – which also add to the costs without necessarily enhancing returns. What has not yet been fully factored into pricing is that in some locations, insurance will either be completely unavailable or priced at a level which renders development or investment unviable.


Finally, the costs and disruption caused by environmental or social impacts are not just of concern to investors. Occupiers – and their employees – are forming their own view of the risks associated with states, cities or micro-locations. Their corporate disaster planning and operational management decision-making will increasingly reflect a fuller and more sophisticated assessment of the environmental and social risks associated with a particular location or building. Facilities in riskier locations are likely to see lower demand, exacerbated by their higher costs. The impact on rents is inevitable.

Consequently, we believe both occupiers and investors will be attracted towards those locations that are future-proofing against ESG risks.

Every city has a different risk profile, but no place is risk free – so attention will focus on what is being done to identify, manage and mitigate that risk. This will favour places like New York City which provides a wide range of guidance alongside specific regulation relating to building design, development, investment, and management of extreme climate events11. Clearly, ESG issues are only a part of the equation that occupiers and investors need to evaluate – but as a relatively new and rapidly evolving area, at the margins these issues will have a disproportionate effect on flows of businesses and investment capital in the years ahead.

We therefore expect there to be a “flight to experience”, whereby investors and occupiers favour those places that have an historic track record on climate risk and how to address it. For example, the Netherlands is a major commercial hub for the North Sea region, and is renowned for comprehensive flood defences12, so it could gain from a pivot towards ESG priorities in real estate. Conversely, an increasing focus on climate and social risks may count against some Emerging Market locations. Some of the most significant climate and sustainability problems are found in the developing world, because of their geographic location or breakneck economic expansion. Swiss Re Institute estimates that in a worst-case scenario for climate change the ASEAN nations will see the biggest GDP hit, followed by the Middle East and Africa13.

New outlooks

It is easy to become focussed on the cost and risk aspects of climate change, but the picture is not all negative. Our new carbon neutral and sustainable economy will naturally develop its own centres of excellence and dominant locations, which will present new investment opportunities for the property sector. Green industries and technologies are creating thousands of jobs, with universities and cities emerging as centres of excellence in these new sectors. The North East of England has rapidly developed as a centre for offshore wind farms, thanks to a large local maritime engineering industry. A new cable has also been laid under the North Sea to bring in hydroelectric power from Norway. This abundance of clean energy is drawing in other green industries into the region, such as the establishment of a new battery gigafactory near Blythe14. Risks in some areas present opportunities in others.

The ESG agenda is changing the way we think about places and their relative attractiveness. Events that were previously assumed to be rare (like natural disasters), factors that were taken for granted (power supply and law & order), or dangers handled by insurance have historically been under-represented, or effectively ignored, in investment decision-making. We are heading towards a geography reshaped by ESG, where those cities and states that make the most progress on mitigating climate risks and social inequality will prove attractive to talented workers and successful companies. The opportunity is there for upstart cities to work their way up the ranking of global gateway cities.

Green industries and technologies are creating thousands of jobs, with universities and cities emerging as centres of excellence in these new sectors.

1World Bank (2019 et al) https://www.doingbusiness.org/en/reports/global-reports/doing-business-2020 2Link to Building Resilience, Avison Young Ten Trends for 2020 and EcoLogical cities trend 3https://www.undrr.org/publication/human-cost-disasters-overview-last-20-years-2000-2019 4https://www.munichre.com/topics-online/en/climate-change-and-natural-disasters/climate-change/climate-change-has-increased-wildfire-risk.html 5https://www.power-technology.com/features/the-great-state-of-texas-explaining-the-power-crisis-and-what-happens-next/ 6https://www.iii.org/fact-statistic/facts-statistics-civil-disorders 7https://www.ft.com/content/62e2f894-fc8c-11e8-aebf-99e208d3e521 8See The colour of money 9See The colour of money 10https://www.rpsins.com/media/3793/rps_2021_us_property_market_outlook.pdf 11https://www1.nyc.gov/site/planning/plans/climate-resiliency/climate-resiliency.page 12https://www.ft.com/content/44c2d2ee-422c-11ea-bdb5-169ba7be433d 13https://www.swissre.com/media/news-releases/nr-20210422-economics-of-climate-change-risks.html 14https://worldbatterynews.com/battery-tech-developer-britishvolt-selects-site-for-first-uk-gigafactory-p578-165.htm


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