Anticipating storms... at the risk of taking on water?

While adapting investment strategies to the vagaries of the weather is far from a new phenomenon for the real estate industry, the acceleration and increasing intensity of extreme weather events are forcing its protagonists to review their allocation and asset management strategies. While the damage is likely to be felt over the long term, the coming storm is sure to shake up real estate portfolios... at the risk of stranding certain assets.

Laurent Lavergne, Global Head of Sustainability at Axa IM Alts, points out that "investors are accustomed to incorporating physical risk assessment into their real estate investments", stressing that "these risks are generally well identified by all players in the ecosystem (investors, insurance companies and public authorities) and incorporated into investment decisions, the availability and pricing of insurance cover, and the master plans and infrastructures of public authorities".

And to do so, these players relied "on decades, and sometimes centuries, of weather data to correctly assess these risks and mitigate them where necessary. However, with global warming, we are witnessing an increase in the frequency and intensity of weather events, which poses a challenge to the sector," he warns. Past data are no longer sufficient to understand the risks that an asset in a particular location will face in the future".

For the acceleration of global warming and the frequency of extreme events is no longer a matter of debate. At the 2009 Copenhagen Conference (COP15), scientists warned that global warming in excess of 2°C by the end of the century (compared with temperatures in the 18501900 timeframe) would have irreversible consequences for the planet. This observation led to the Paris Agreement, signed in 2015 at COP21, under which 195 countries pledged to make the necessary efforts to keep warming below +1.5°C.

However, this target is now out of reach, 61 scientists involved in the work of the Intergovernmental Panel on Climate Change (IPCC) reported last year in an article published in the scientific journal Earth System Science Data, this threshold having in fact been reached for the first time in 2024. And the commitments made by governments at COP26 in Glasgow would put the planet on a trajectory of +2.4°C by 2100.

Extreme weather phenomena such as floods, storms and forest fires have always existed in the world, but the big difference lies in their frequency and intensity," says Constantin Sorlescu, Director of Professional Standars at Inrev. They hit harder, causing more damage to buildings and disrupting their operability to a greater extent".

For the French economy, this acceleration of the climate emergency and the difficulty of international players in achieving the objectives of the Paris Agreement represent an obvious threat. In an analysis published at the end of 2023, the French Environment and Energy Management Agency (Ademe) estimated that "a delayed transition could lead to nearly $1,100 billion in stranded assets accumulated over the period, i.e. nearly $50 billion a year between 2030 and 2050", and that "the delayed scenario would result in a loss of nearly 1.5 GDP points in 2030 and 5 GDP points in 2050".

For the real estate industry, the stakes are also high, points out Hala El Akl, Vice President of Sustainable Investing and Operations at Oxford Properties, citing a study carried out by JLL: "Around €580 billion of European real estate assets, or 37% of the global market, are located in the ten cities most vulnerable to physical climate risks."

Against a backdrop of accelerating extreme weather events, these assets are exposed not only to construction risks, but also to financial and legal ones. "For example, Arnaud Dewachter, founder of Real Esgate, explains: "The practical effects on the building will affect the peaceful enjoyment due to tenants, and may result in litigation relating to the actual occupancy of the premises. And if these risks are structural and threaten to cause recurrent damage, the very sustainability of the investment could be called into question.

"A 2°C rise in average global temperature may still be insurable, but what's certain is that a 4°C rise is not," Henri de Castries, then CEO of the Axa Group, told Le Parisien newspaper in 2015, on the sidelines of COP21. But what seemed like a doomsday scenario at the time is now a hypothesis evoked by the IPCC. "What is the intrinsic value of real estate in a world that is no longer insurable?" asks Arnaud Dewachter, who believes that "we are already entering a new era in which we will have to integrate a more defensive dimension into our strategy".

La Française REM has integrated the vulnerability of its assets to climate risks into its analysis grid, based on the model recommended by the Observatoire de l'Investissement Durable (OID). As Virginie Wallut, Director of Research and Real Estate SRI, explains: "All new buildings entering our portfolio are subjected to an in-depth analysis, and there is no question of acquiring a building that is highly vulnerable. In general, the solutions to be found would be financially unwise.

To better understand the exposure of its 4.3 million m2 under management, the company has also designed a tool, inspired by insurance models, to quantify the vulnerability of its assets as well as their financial impact. "For our portfolio as a whole, whose vulnerability is fairly low and concentrated on just one or two climatic hazards, the impact on its value, in cumulative costs, would be -1.34% by 2030 and -5.25% by 2050", she reports. These figures may seem "rather minimal" and "not likely to provoke a massive investment shock", she acknowledges... but they have doubled in comparison with the previous year.

Models are becoming increasingly forward-looking, incorporating cost increases as well as the occurrence of events," explains Virginie Wallut. We could therefore see an acceleration in the financial impact of these phenomena on real estate portfolios."

Arnaud Dewachter explains: "The first two environmental objectives specified by the European taxonomy are mitigation of climate change and adaptation to its effects. The first targets the main negative impacts of each sector of activity, the 'inside out', and the second the sustainability risks that may affect them, the 'outside in'."

While the real estate industry seems to have largely set about reducing its carbon footprint, aware of its crucial role as the main emitter and spurred on by new regulations such as the tertiary sector decree and the Bacs decree, it is slow to take the full measure of the multiple consequences that climate risks will have on the city and built heritage, according to the unanimous opinion of the professionals interviewed by Business Immo. "Arnaud Dewachter observes: "The question of sustainability risks and building adaptation has not yet been truly integrated by professionals, and the projection is too long-term.

Although he is keen to stress that "the vast majority of Inrev members still express strong ESG convictions in our surveys", Constantin Sorlescu notes that the environmental dynamic is stalling on a European scale: "A few years ago, everyone seemed to be moving in the same direction, vying to be the first to achieve carbon neutrality. Today, however, we are witnessing a slowdown, if not a retreat, in terms of regulations, which is sending contradictory messages to the industry."

Thierry Laquitaine, Director of SRI Europe at AEW, observes that there is "more communication than action", and reports varying degrees of awareness within the city fabric: "Most of the institutional market became aware of the importance of the subject when the green taxonomy was published in 2022. For other players, on the other hand, awareness came much later." Moreover, exposure to climate risks is "more of an investor concern," he laments. I don't see them systematically taken into account by developers and project managers, and you really need a specific request from the owner or asset manager for this subject to be taken into consideration".

Hala El Akl is more reassuring: "We're at a real turning point. Climate risk is no longer theoretical: it is manifesting itself in real time, from forest fires in Europe to heat waves in North America. This is leading to a more systematic assessment of these risks, fueled by stricter regulation, increased lender scrutiny and growing tenant demands."

On the other hand, although climate risks are becoming more integrated into financing and insurance underwriting, as well as allocation strategies, she notes that "these risks do not systematically lead to a project being vetoed". According to Laurent Lavergne, the real estate industry's still timid adaptation to the effects of global warming "can be explained by the fact that the evolution of these risks is complex to model, that there are many possible climate scenarios, and that the plans of public authorities to mitigate or adapt their urban planning and infrastructures are not yet clearly defined".

The calculation is all the more difficult for investors to integrate because "even in a period of energy cost inflation, the capex to be deployed for the repositioning of existing buildings will be very substantial, while the return on investment is not necessarily obvious and will be appreciated over a very long time".

"Climate change is a multifaceted threat to the real estate sector, affecting cash flow, value and long-term financial performance", argue Paul Tostevin and Connor Chilton, respectively Director and Analyst at Savills World Research, in an article co-authored last March. But for those players in the city fabric prepared to adapt to it, "it also offers opportunities", they add: "Determined developers, owners and occupiers have everything to gain from a flight to prime assets focused on resilient real estate.

As climate adaptation becomes a key criterion in investment and expansion decisions, cities that create resilient infrastructure make their real estate more attractive to residents, businesses and visitors." A conviction shared by Constantin Sorlescu: "The financial appeal of a climate-resilient building can be compelling, as it reduces energy costs, secures better loans and offers a more attractive space to tenants, ultimately helping to preserve asset value and liquidity. So it's not just a cost item, but can become value-generating for a portfolio."

Recalling a study carried out a few years ago by AEW and partners, Thierry Laquitaine adds that "investing €1 today avoids spending €4 to €6 later on the impact of climatic hazards, so that inaction costs four to six times more than adaptation".

To capitalize on these opportunities, "investors need to be aware of the rapidly changing level of exposure to risks linked to climatic events, and will need to better understand the impact of different scenarios not only on their assets, but also, more broadly, on the environment of which these assets are a part", believes Laurent Lavergne. Yet, noting that "the debate among investors is shifting more towards the financial aspect and long-term value creation", Constantin Sorlescu points out that "obtaining accurate information is a major obstacle" and that "accurately assessing your portfolio's vulnerability to physical climate risks requires a lot of work because you have to deal with fragmented data and uneven assessment methods".

Because "determining the cost of climate risks is not a linear process" and "each property is slightly different and will need to be adapted according to its risk profile", investors will face a major challenge in rolling out a standardized capex plan for their entire estate.

For companies like ours, a more responsible approach is in line with our fiduciary duty to assess these risks. To achieve this, we have strengthened the skills of our dedicated sustainability team and placed particular emphasis on the quality of our data, so as to provide our executive committee with the tools they need to make informed decisions."

To this end, last year the management company completed the assessment of its entire direct portfolio with regard to extreme weather events. "The first step is to understand where your challenges lie, but my advice would be not to wait until 100% of the data is complete and accurate before acting, as you risk analytical paralysis," she warns. As soon as you have 70% or 80% of the data, start working on your plans."

Once this reconnaissance work has been carried out, "it needs to be integrated into current practices and key stages in the life of the building, from construction to acquisition, renovation and operation", agrees Thierry Laquitaine, adding that his group "defines investment pockets with different levels of priority and then deals with the most exposed buildings". Over and above the different strategies adopted by each of these players, he concludes that adapting the city's fabric to climate risks requires a change of scale: "It's clear that the problem is systemic, so adapting buildings must go hand in hand with adapting all human systems and our organizations. We need to think as a team, not just in terms of real estate, but also in terms of the private and public sectors, because an adapted building in an unsuitable environment is bound to collapse."