Commercial properties increasingly vulnerable to weather-related risks
A new report highlights the risks to commercial real estate owners from natural catastrophes and climate-related disasters, which are happening with increasing frequency.
The report by Heitman LLC, a global real estate company, in conjunction with the Urban Land Institute, found that the increasing risks from catastrophes are bringing new challenges to commercial property owners in terms of risk mitigation and securing appropriate property coverage, which may become more difficult in the future.
There are two main risks facing commercial property owners: physical and transitional risks associated with increasingly volatile weather.
Physical risks - This includes catastrophes, which can lead to:
- Increased insurance premiums
- Higher capital outlays
- Increased operational costs
- Decreased liquidity
- Falling value of buildings
Transitional risks - This includes economic, political, and societal responses to climate change and more volatile weather that can make entire regions or metropolitan areas less appealing due to increasing weather events.
The report notes that commercial real estate owners in some areas that have seen regular catastrophes have started seeing either higher premiums for their property policies or decreased coverage. At this point, they reported, the price point and risk is still acceptable, but they worry about the trend going forward.
The majority of commercial real estate owners have not yet seen significant insurance premium hikes or severe coverage reductions.
Commercial property owners and investors are now starting to reassess the way they manage their risk, and they have realized they cannot rely on insurance protection alone.
Primary impacts facing commercial property owners
First, there are catastrophic events, like extreme weather such as hurricanes and wildfires. Impacts include:
- Costs to repair or replace damaged or destroyed property.
- Property downtime and business disruption.
- Potential for increased insurance costs or reduced/no insurance availability.
Then there are changes in weather patterns. This includes gradual changes in temperature and precipitation - such as higher temperatures, rising sea levels, increasing frequency of heavy rain and wind, and decreased rainfall - which are likely to exaggerate the impact of catastrophic events. This can affect commercial properties in the form of:
- Increased wear and tear on or damage to buildings, leading to rising maintenance costs.
- Increased operating costs due to the need for more, or alternative, resources (energy and/or water) to operate a building.
- Cost of investment in adaptation measures, such as elevating buildings or incorporating additional cooling methods.
- Potential for increased damages from catastrophic events.
- Potential for higher insurance costs or reduced/no insurance availability.
What owners are doing
Survey respondents said they currently use insurance as their primary means of protection against extreme weather and climate events.
Sixty-nine percent of real estate and hospitality industry managers said they had seen an increase in rates in the year to the end of the third quarter of 2018, with an average rise of 9.1%. Many wondered how their properties could be insured if climate volatility increases.
While insurance will cover damages from catastrophic events, it will not cover loss in value from a reduction in the asset's liquidity. When you hold a property for years, it leaves you exposed to risks over the whole period and the potential for investment devaluation.
Although insurance might provide short-term protection, more property owners and investors are looking for better tools and common standards to help the industry get better at pricing in climate risk in the future. These include:
- Mapping physical risk for the properties they currently own.
- Incorporating climate risk and catastrophe susceptibility into due diligence when purchasing new properties.
- Incorporating physical adaptation and mitigation measures around their properties.
- Engaging with policymakers on city-level resilience strategies, and supporting the investment by cities in mitigating the risk of all assets under their jurisdiction.