Leveraging Data to Capitalize on Climate Volatility
Earlier this month, Climate Alpha joined CREtech, the Built World's largest innovation and sustainability conference, to showcase our location analytics platform and connect with leaders in the real estate and proptech space. During the conference, Jim Goundry, Chief Growth Officer took the stage to discuss how to leverage data to capitalize on climate volatility. Below is a summary of his presentation.
It's well known that climate change presents a wide variety of risks. While there are differing opinions and projections, it's important to remember that they are indeed projections. The most common question we hear from clients is, how do we use this data or how are other clients using this data?
Our goal is to provide a better understanding of how to use climate risk data.
It's important to understand climate analytics vs just climate risk, because when leveraged correctly, this data can and should be used to enhance the investment process.
Climate Alpha is climate and location analytics platform that leverages machine learning models to help clients understand the financial impact of climate change on their investments. While traditional vendors focus on climate change as a risk factor, we believe you can also leverage the data to improve market analysis and location selection.
When implemented correctly, climate analytics should be embedded in your investment process no different than sector projections, rental growth or other macro factors. We help clients understand risks at an asset and portfolio level, refine market analysis and deploy capital more effectively.
Gain a competitive edge by understanding a location beyond supply and demand fundamentals.
Climate risk should be thought of as an extension of your traditional market analysis, and should be embedded in the investment process like any other factor you would analyze such as rental increases, job growth, migration, etc. Since economic outcomes are strongly linked to both geographic location and the natural environment, incorporating climate analytics into the investment process is an opportunity to drive higher returns. Climate analytics can help investors:
Identify high-performing locations that traditional real estate research and deal sourcing techniques miss
Be more discerning within target markets, by leveraging data at a much more granular level than traditional market reports can
Identify mispriced investment opportunities, typically resilient locations that will experience a positive financial impact from climate volatility
What's important to real estate investors is not climate change or physical risk but how those factors will impact investments. To truly understand the impact, you need to understand the dynamics of the market, community and surrounding environment.
As mentioned before, two locations with the same physical risks won’t necessarily be impacted in the same way. You are likely looking at some of these factors today in your market and asset analysis, but the question is are you looking at all of them? Are you looking at renewables and infrastructure? Are you looking at investment driven by federal funding? If you are looking at the investment from the Inflation Reduction Act, it’s not even across the board – there are communities that will significantly benefit from the businesses that expand or set up there.
Now more than ever, reporting on climate risk matters to real estate.
It is well understood that climate change poses risks to the stability of the economy and the financial systems. The emergence of TCFD in 2015 was the first step with a set of recommended disclosures that are now the basis for pending regulations in the UK, Canada, Japan and several other countries. In 2021 IFRS established the International Sustainability Standards Board (ISSB) which just published its rules this summer and announced they will incorporate TCFD recommendations and take over those guidelines.
So, at least the industry is getting consolidation of reporting requirements.
But what is interesting, is these rules not only focus on risk but enable companies to communicate the broader sustainability-related risks and opportunities. Stressing the need for quantitative information where possible and emphasizing that disclosing climate-related opportunities is as important as disclosing climate-related risks.
Investors—and other stakeholders—have been increasingly interested in understanding not only companies’ impact on climate (for example through greenhouse gas (GHG) reporting) but also ways in which climate can impact companies’ finances.
Today we are seeing a mix of investor demand for understanding portfolio sustainability and climate risk.
The split can be red state/blue state or US/non-US or somewhere in between
However, we are seeing that investor demand grow. Investors that were asking for a heat map are moving a level deeper and asking to understand exposure by hazard, fund and at the asset level. Investors that weren’t asking in the past are now starting to ask questions of their GPs to make sure they are monitoring physical climate risk
You may also have internal sustainability initiates you need to tie into. As I mentioned earlier, focusing on not just the risk but implementing across the entire investment process to enhance research, market analysis and due diligence is a much stronger story to tell your investors
From 2021-2022 insurance rates across the country have increased by double digits and in some states over 25% - in a single year! And these are just averages, you hear stories all the time of rates doubling at renewal.
Sure, inflation is a factor, and we’d expect that to normalize but climate change driven aspect of the premium increase we can only assume will continue to increase. This has a very direct impact on cash flows, that is not being made up for by increased rents. The increase rents may cover inflationary increases across operating expense, but the net cash flow is decreasing.
And this is just generally speaking – you might find that these increases are coming as coverage is cut OR to maintain sufficient coverage, you need to pay even more!
If you are facing a refinancing, you are getting hit from multiple angles – the cost of capital is higher, net operating incomes are lower and lenders are asking for more capital. You might find yourself in a situation need to get additional equity, diluting your investment, to meet the requirements of your lender. We’ve looked at historical insurance premiums across fire and flood insurance and there is a strong correlation with historical risks. And guess what insurance firms use to come up with premiums? Historical catastrophe models so it’s a fair assumption to say rates are going to continue to increase – even net of inflation.
In addition to insurance premiums, utility bills, property taxes, and other expenses are also climbing very quickly and account for a larger portion of operating expenses than insurance. For example, utility costs are up ~40% over the last five years, partly driven by inflation but also due to climate change. Last winter was especially cold which drove up gas and electric bills in several major markets NY and Buffalo. Going forward, these operating expenses will likely strain Net Operating Income (NOI) long after inflation subsidies.
While climate scenarios are based on overall temperatures increasing, the actual impact is also the creation of volatility so we will see more spikes and drops in temperature. The same concept applies to storms, in some areas you may not see more storms, but the severity will be much greater.
To learn more on how to leverage climate data, reach out to our team at www.climatealpha.ai