Environmental Due Diligence

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The urgency of climate risk management in CRE: insights from the LightBox PRISM conference

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LightBox Insights
November 15, 2022 4 mins

Managing climate change-related risk is one of the biggest challenges facing the commercial real estate industry. LightBox convened a panel of experts at its recent PRISM conference to discuss strategies and solutions. Moderated by Willie Accame, industry advisor for the National Center for Atmospheric Research, the panel included Kevin Fagan, senior director and head of CRE economic analysis at Moody’s Analytics; Kevin Scroggin, director of risk management at LaSalle Investment Management; and Brett Bass, R&D associate at Oak Ridge National Laboratory.  

Accame began by noting that of the hundreds of buildings that are appraised, about 10 percent account for 80 percent of the risk. He said a potential ASTM standard would require firms to identify hazards through screening verifications that seek to understand current climate and weather factors, then look at what will happen in the future. They would assess and identify sensitivities and vulnerabilities, which requires “putting boots on the ground” and taking a close look at a property. After that, they would create a damage assessment rating program to arrive at order-of-magnitude costs for what a building or structure may be subjected to in the future so they can create appropriate resilience measures.  

Kevin Fagan said Moody’s is incorporating climate resiliency and climate risk into credit analysis, valuations, and forecasts. Much progress has been made in understanding the issue, which even a few years ago was generally swept under the rug—if a building had an insurance policy, that was considered good enough. But as the number of climate-based disasters continues to rise, financial instability is a growing concern. The Financial Stability Oversight Committee released a report last year with guidance on regulatory approaches to climate change and set up a task force to identify and fill data gaps, enhance disclosures, and model and manage risks.  

How do we mitigate potential financial instability? Fagan said financial firms are waking up to the challenge, which large institutional investors saw coming. They know they need to prepare, and the FSOC task force is prompting change.  We can no longer just ask if there is an insurance policy. We need to understand the trends behind them and what the climate history is in the area where the building is insured. Anticipated costs must be part of any credit analysis.  

During the next 10 to 20 years, we’re likely to see an increased frequency and magnitude of disasters, including storms, heat, rising sea levels, flooding, and wildfires. Moody’s is considering these in its reports and has started to model disasters based on NOI data and detailed property-level data. If a property is in a red flag area, Moody’s will calibrate that and put that into credit models.  

Kevin Scroggin said that LaSalle has spent a lot of time vetting climate impact change and risk management. The firm sees this less as a doomsday scenario and more as an opportunity. A lot of the focus has been on the physical risk side, but LaSalle is spending as much time on the transition side. “We know that risk exposure from a commercial real estate perspective is tied to economic loss. We have the whole issue around stranded assets. We have issues around inaccurate valuations. Those are pressured from both sides—the climate side and the transition side. We have a separate work stream focused entirely on transition and the issues that are coming to us from a transition risk exposure.” 

Scroggin said the industry needs better tools, and standardization in terms of decision-making on the front end for due diligence, portfolio management, capital allocation decisions, and broader portfolio management issues. LaSalle believes the insurance industry can play a real critical role. His firm has a number of initiatives underway, and is partnering with global insurance companies to better understand how to view climate risk management. “We’re posing questions from the due diligence perspective. How can we harden or secure our assets that are currently in the portfolio? How can we help look at portfolio management from a broader diversified basis? We want to have not only an individual asset view but also a portfolio view.” 

Brett Bass discussed how modeling building-energy use related to climate allows us to understand the impact of energy use in buildings and how it will impact the grid. ORNL developed AutoBEM, automatic building energy modeling software, to handle urban-scale building energy modeling. It requires a building’s footprint, height, type, and age to develop a model. Other data, such as occupancy, materials, etc., can be incorporated if needed.  

To get future weather data, ORNL creates climate models that use mathematical equations to characterize how energy and matter interact in different parts of the ocean, atmosphere, and land. Building and running these climate models is a complex process of identifying and quantifying earth system processes, representing them with mathematical equations, and repeatedly solving them using powerful supercomputers. The lab can take these climate models and morph them into something that can be used for building simulation.  

How do we prepare for climate change? As temperatures increase, said Bass, cities will need more energy to meet heating and cooling demand, requiring different analyses for different parts of the country. Modeling allows us to optimize construction because we can understand the impact of design decisions on a building’s energy use and how we should allocate resources in terms of retrofits. It allows us to find the optimal route forward. 

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