The Property Market and Climate Change

Nicki Hutley, former partner at Deloitte Access Economics and a Climate Councillor and prominent economist, stated, "It is evident that Australia is rapidly becoming an uninsurable nation. Ineligibility for insurance or exorbitantly rising premiums are becoming increasingly prevalent as a result of climate change.

Climate Valuation estimates that climate change-driven riverine flooding will cost Australian property values $170bn by 2050 as buyers adjust for increasing insurance costs, or a $45,000 loss per vulnerable property.

According to research conducted by JLL , there is a direct correlation between increased occupancy rates and rents and the sustainability of properties. In certain markets, this influences property value in a positive direction, leading to a capital value premium of as much as 20%.

In 2019, a report from Climate Council stated that the property market is projected to experience a loss of $571bn in value by 2030, $611bn by 2050 and $770bn by 2100, as a result of climate change and extreme weather. Furthermore, if emissions continue to be high, the property market is anticipated to sustain further value losses in the future.

Dr. Karl Mallon in 2019, stated that Australians will face growing difficulties in affording home insurance. "On current trends, by 2030, one in every 19 property owners faces the prospect of insurance premiums that will be effectively unaffordable,” he said.

The Actuaries Institute's research reveals that approximately 12.5% of households currently experience significant financial strain when it comes to affording home insurance. The study revealed that the typical cost of home insurance increased by 28% to $1,894 in the period ending on March 31. Properties with the highest risk, such as those located in flood-prone areas, had a 50% rise in premiums.

Dr. Karl Mallon stated that Millennial homebuyers are now environmentally conscious and advised purchasers who are apprehensive about natural disasters to inquire about specific matters. "Is it in a flood plain? What return frequency is the flood? Is the building elevated above the ground? When was it built? Was it built to a building standard, say before 1990? Or after 2000?" he said.

In October 2021 the Department of Climate Change, Energy, the Environment and Water said that up to $63bn (replacement value) of existing residential buildings are potentially at risk of inundation from a 1.1-meter sea-level rise, with a lower and upper estimate of risk identified for between 157,000 and 247,600 individual buildings. A considerable percentage of Australia's infrastructure, including communication and transportation networks, is situated in close proximity to coastal population centres.

Munich Re reports that preliminary assessments of global losses caused by natural disasters amounted to c.US$270bn, which is comparatively less than the exorbitant expenses incurred in 2021. The amount of insured losses is c.US$120bn, which is comparable to the previous year (and once again surpasses the c.US$100bn benchmark). Unaddressed climate risks could reduce the returns of a diversified equity portfolio by as much as 40% this decade, according to a McKinsey & Company report citing a study on the subject.

The Bank for International Settlements – BIS has published a study on climate risk assessment in the insurance sector. In this context, climate risk refers to any financial hazards that emerge from climate change within the insurance business, encompassing a wide range of possibilities. The aforementioned description, when applied to the real estate industry, accurately describes climate risk within the property market.

In its 2023 report, the Australian Government's productivity commission has recognised that climate change-related hazards are highly relevant to buyers' interests. It also observes that vendors may not freely reveal these risks due to their potential influence on the value and future usage of the land. The productivity commission is suggesting that obligatory disclosures be considered for climate change related concerns.

Lawyers in NSW have a duty to inform their clients about the risks related to climate change impacts. These risks have the potential to affect the value of the property, its ability to secure financing and insurance, and its future development potential. Fortunately, there is a report available as part of the standard conveyancing search process that can provide a customised and detailed evaluation of the climate change risk for a specific property in the near future. Hence, it would be highly risky for a lawyer in New South Wales (NSW) to neglect or fail to advise their clients of the option of conducting a search, and to not even mention it when obtaining instructions from them.

The NSW EPA has published its groundbreaking Climate Change Policy and Action plan, which outlines the strategies that the state's environmental regulator will employ to tackle the origins and repercussions of climate change.

Precisely determining the financial impact of floods on property prices is crucial for promoting climate adaptation and eliminating counterproductive incentives for building in flood-prone areas.

Evaluating potential climate risks can offer advantages to specific individuals or groups involved. Investment professionals have the ability to recognise promising alpha factors in the field of low carbon technology innovation. It would be beneficial for banks to implement measures to safeguard credit portfolios and establish a transparent framework for disclosure. Asset owners have the opportunity to enhance their understanding of the long-term effects of climate change on their investments. This knowledge can be used to make better decisions regarding asset allocation, evaluating external managers, and meeting regulatory disclosure requirements. Insurance companies have the ability to assess the potential consequences of climate change on the physical environment and how these changes might impact insurance premiums.

Credit losses may be incurred by Australian institutions as a result of the physical hazards associated with extreme climate events. Mortgages, constituting an estimated two-thirds of the portfolios of significant banks in Australia, represent a potentially serious exposure to climate change. A housing price decline may ensue if the longer-term risks of climate change are not adequately reflected in current values. In such a scenario, banks may be left with less protection against borrower defaults than anticipated. Even in extremely vulnerable regions such as the U.S. state of Florida, there is little evidence that 'at risk' properties are adequately priced to account for climate change, according to a number of international studies (Keys and Mulder 2020; Bernstein, Gustafson, and Lewis 2019). The price of properties deemed to be "high risk" of being impacted by climate events might consequently plummet, and banks might incur substantial credit losses in the event that borrowers default.

APRA has developed the CGP 229 Climate Change Financial Risks, which was designed to assist banks, insurers and superannuation trustees on managing the financial risks of climate change.

In a paper from RBA, the mortgage exposure of Australian banks to climate phsyical risks where estimated by combining disaggregated climate risk forecasts with micro-level data on banks' mortgage exposures. This was based on the XDI-Climate valuation.

The XDI-Climate Valuation data evaluates the potential risks associated with five different hazards in Australia, including riverine flooding, coastal inundation, forest wildfires, wind storms (excluding cyclones), and ground subsidence during drought conditions. The forecasts provided are based on specific addresses, however, the subsequent analysis is based on aggregated forecasts by suburb. The climate data are combined with the mortgage exposures from the Reserve Bank of Australia's loan-level securitisation database. The primary risk indicator utilised in this context is the Value at Risk (VaR) of the properties.

The VaR takes into account the expenses related to maintaining and managing properties, such as insurance, repairs, replacements, and maintenance costs. There is no indication of a decrease in the property's value. A property is considered "high risk" if its VaR exceeds 1%. Approximatly 3.5 % of homes in Australia currently have a VaR greater than 1%, as reported by XDI-Climate Valuation. This percentage is expected to rise to 8% in the next 80 years.

The pertinent factor concerning the collateral exposure of banks in climate-sensitive regions is the increase in climate risk that has not yet been adequately reflected in property prices. This can be quantified, for instance, by converting the increase in natural disaster costs attributable to climate risk (as assessed by the change in VaR beginning in 2021) into long-term declines in housing prices. This identifies properties that are presently not deemed "at risk" but are anticipated to develop into an emerging risk in the future.

Nonetheless, there are certain restrictions associated with the VaR metric. We may overestimate the risks to bank portfolios in this exercise on the assumption that their future exposures will remain constant. It is anticipated that banks will progressively integrate climate hazards into their lending determinations. In addition to excluding land values, the VaR metric likely exaggerates the effect of increased technical insurance premiums on housing prices.

The MSCI Inc. 's Climate VaR model Climate VaR can be utilised to assess the potential risks and opportunities related to climate in an investment portfolio as well. The climate risk model is a proactive model that evaluates the future expenses associated with properties in light of potential climate change impacts. The expenses encompass a range of potential hazards and challenges, with a long-term outlook extending to 2100. The costs are estimated using scenario analysis.

The G20 Financial Stability Board’s TCFD recommended in 2017 to use scenario analysis to assess climate change related impacts within the financial sector.

Scenario analysis is a process for identifying and assessing the potential implications of a range of plausible future states under conditions of uncertainty as described by FSB Task Force on Climate-related Financial Disclosures (TCFD).

MSCI Inc. 's scenario analysis for commercial and residential real estate enables investors and real estate managers to evaluate both transition and physical climate-related impacts in their portfolios.

The Executive Director at MSCI Inc. , Bryan Reid demonstrated using the Climate VaR model on how the nature and magnitude of physical risks may differ across assets and portfolios.

One of the few sceptics who predicted the housing market was on the verge of collapse in 2007, Dave Burt , is of the opinion that an unacknowledged climate risk could result in a recurrence of past events. 20% of U.S. residences, according to DeltaTerra Capital , have "significant exposure" to a mispricing issue due to flood risk. At this time, there is a 1% annual probability that 15 million properties in the United States will be flooded, and annual damages to residential properties are estimated to surpass $32bn. Amid the worsening climate emergency, they also cautioned that the frequency and severity of flooding are expected to increase, which could result in an 11% rise in the number of U.S. properties vulnerable to flooding and a minimum 26% increase in average annual losses by 2050.

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