REITs are using a data-driven approach to assess climate risk and strengthen their portfolios as stakeholder calls for more detailed information continue to grow.

04/05/2021 | by
Climate change art

As the climate crisis becomes ever more urgent, assessing the potential risk it presents to REIT portfolios has become a top issue for the industry—one that is being met with improved data and analytics, as well as board-level scrutiny.

It is a move that also reflects the growing calls from outside stakeholders for accurate information on how companies are positioning themselves in response to the threat.

In his 2021 annual letter to CEOs, BlackRock CEO Larry Fink noted that “no issue ranks higher than climate change on our clients’ lists of priorities. They ask us about it nearly every day.” Fink is one of a growing number of stakeholders highlighting the critical need for companies to address climate change, and the message is resonating across the REIT industry.

REITs are leveraging forward-looking physical climate risk data to understand their portfolios’ baseline and changing exposure to climate hazards, identify risk hotspots and portfolio trends, screen investments during due diligence processes, and benchmark against their peers, says Yoon Hui Kim, managing director, global client services, at Four Twenty Seven, a California-based climate risk data firm.

Laura Craft, senior vice president, head of global ESG strategy at real estate investment firm Heitman, says the focus on climate-related risks is rapidly accelerating.

“Five years ago, there wasn’t much conversation on the impacts of climate risk. Fast forward to now and there is a tremendous amount of dialogue,” Craft says.

A rapidly increasing number of REITs are reporting around climate change risks and opportunities following Task Force on Climate-Related Disclosures (TCFD) on assessing physical and transitional risk, as well as mapping and scoring climate risk within portfolios for reporting purposes such as in GRESB’s real estate assessment resiliency module.

“If you’re looking at climate change and climate risk, the number of events is increasing every year and the damages are massive,” Craft says.

Greater Scrutiny

Increased uptake of the TCFD guidelines has further highlighted the growing concern from investors and business leaders regarding the potential impacts of climate change on the economy and financial markets.

“When you have people like Larry Fink going out and saying that climate risk is investment risk, I think a lot more people are going to start listening,” says Uma Pattarkine, global ESG coordinator and investment strategy analyst at CenterSquare Investment Management.

At the same time, there is a meaningful demographic shift underway with aging millennials and women becoming more involved in investment decisions, she adds. Both of those groups tend to view investments more through an ESG lens, which could result in an estimated $15 trillion to $20 trillion flowing into the ESG space over the next two decades, she says.

Investors, meanwhile, are digging into corporate reports, GRESB assessments, and having conversations with REIT management teams to better understand climate risk and strategies for mitigating risks. Investors also are tapping third party data sources. “A lot of it has to do with getting our hands on as much data as we can,” Pattarkine says.

The Two ‘C’s’

Mark Delisi, vice president of corporate responsibility and energy management at AvalonBay Communities, Inc. (NYSE: AVB), says that for the multifamily REIT’s ESG focus, “the next decade is about the two Cs—climate and carbon—and they obviously go hand in hand.”

On the climate side, the focus is on continuing to improve the data to better understand where there is risk exposure and opportunity, and also to integrate that information into decision making, he says.

Mark Delisi VP, Corporate Responsibility and Energy Management, AvalonBay Communities, Inc.
“The next decade is about the two C’s—climate and carbon—and they obviously go hand in hand.” –Mark Delisi, vice president of corporate responsibility and energy management, AvalonBay Communities, Inc.

AvalonBay is taking a methodical approach to climate risk. Four years ago, the company conducted an internal analysis of climate risk within its portfolio, primarily around stronger storms and sea level rise. That produced some of the first insights into how the portfolio would fare against climate-related events. About a year ago, AvalonBay engaged a third party firm to update and expand on that earlier analysis related to about a dozen different types of natural disasters. The study assessed exposure at the individual property level, including 250-plus properties in its portfolio.

As with many REITs, the focus now is on how to leverage data to improve performance both in financial analysis and operations. For example, in dealing with wildfire risk, REITs have to consider back-up power generation, because it is likely that the utilities will shut off the power grid. “Resiliency is really a key component. It’s not just about acquisitions or divestitures, it’s about how we improve operational procedures,” Delisi says.

Focus from the Top

Kay Tidwell, executive vice president, general counsel, and chief risk officer at Hudson Pacific Properties, Inc. (NYSE: HPP), says climate risk is “definitely an issue that is top of mind for us today.”

The REIT has formed a dedicated, cross-disciplinary ESG team that is focused on both climate risk and helping the firm achieve carbon neutrality. The REIT has refined its corporate responsibility report to include all of its efforts related to climate risk and has also created a sustainability committee at the board level to lead its climate risk strategy.

Kay Tidwell
“I think we’re going to want to focus more on indirect risks and understanding what those are.” – Kay Tidwell, executive vice president, general counsel, and chief risk officer, Hudson Pacific Properties, Inc.

HPP performs an annual operational audit on all of its assets that looks specifically at property level actions that the company could be taking to mitigate risks related to natural disasters and improve energy efficiency. At the portfolio level, its climate risk assessment aligns with TCFD disclosures. The company takes the results of those assessments up through its standard risk committee, and also reports them out through platforms such as GRESB.

Historically, REITs have thought about climate risk at a property level, such as risks of flooding or fire. Those events have a relatively low probability. “So, it wasn’t necessarily something that was urgent or significant, and those risks also are mitigated largely through property insurance,” Tidwell says. “Now that has clearly changed as the climate crisis is getting more severe,” she adds.

In the future, Tidwell says, “I think we’re going to want to focus more on indirect risks and understanding what those are.” Those indirect risks, such as rising insurance costs and demographic changes, “are not necessarily called out when you think about climate risk, but they are significant, and they could become more significant as time goes on,” she adds.

Quantifying Risk

The data and analytics tools REITs are using to evaluate asset and portfolio level risk are also becoming more sophisticated, enabling REITs to better quantify climate-related risk exposure.

“Obviously, we have a sense of which assets, based on their physical location, are more prone to risks such as sea level rise. The key to understanding the relative risk to each asset is climate change scenario modeling that is grounded in science,” says Will Teichman, vice president, business operations at Kimco Realty Corp. (NYSE: KIM).

Will Teichman
The key to under- standing the relative risk to each asset is climate change scenario modeling that is grounded in science.” –Will Teichman, vice president, business operations, Kimco Realty Corp.

For example, Kimco leverages a third-party firm to provide information around scenario modeling for flooding and windstorms. The science-based assessment of climate risk scenarios allows REITs to better understand the potential financial and physical impacts and take necessary steps to mitigate risks.

One of the biggest financial risks associated with a severe storm is downtime to a property. For example, Kimco owns a portfolio of retail properties in Puerto Rico. In 2017, Hurricane Maria had a devastating impact on the island. Kimco was one of the first commercial property owners to have its properties back up and running within a matter of days.

“Part of the reason for that was advanced planning and knowing how to respond to and mitigate risks,” Teichman says. The company had pre-staged generators, fuel, and roofing materials for repairs. Longer term, there are permanent capital improvements that can be made to sites to mitigate against climate risks to make them more resilient, he adds.

Looking at the Larger Picture

Meanwhile, climate impacts on regional transport, electric, water, communications, and other infrastructure can also determine whether an asset remains operational during and after an extreme event, Kim at Four Twenty Seven says.

“Such impacts underscore the necessity of REITs to consider risk and resilience beyond the borders of their site and understand how the local communities in which they’re embedded are assessing risk and implementing measures to address these risks,” she adds.

Indeed, leadership at AvalonBay believes it is important not to overlook the opportunity side of climate risk. Some cities are making significant investments in infrastructure to manage climate risk, and there is real opportunity to invest in those markets, Delisi says. It is not just opportunity for AvalonBay and its stakeholders, he notes, but there is also an opportunity to help make cities more resilient and support investments in infrastructure.

“Our residents live in these communities. So, as climate change becomes more real, we want to be part of the solution—not just for AvalonBay in a vacuum, but for the wider community as well,” Delisi says.

Climate Reset

President Biden didn’t waste time making it clear that climate change is going to be one of the top priorities of his administration. On his first day on the job, he re-entered the Paris Accord. One week later, he kicked off what he referred to as Climate Day by signing a series of executive orders that prioritize the administration’s plan to confront the “existential threat” of climate change.

Biden has also created a White House Office of Domestic Climate Policy led by Gina McCarthy, former director of the Environmental Protection Agency (EPA), and has named former senator John Kerry as the U.S. special presidential envoy for climate. He has also set some ambitious goals on reducing the country’s reliance on fossil fuels and cutting carbon emissions. The question is: what can Biden realistically accomplish, and how is it likely to impact real estate owners?

Moving major climate legislation forward, such as a cap and trade policy or a carbon tax, could be difficult given the closely divided Congress. However, there are climate issues that do have growing bipartisan support, notes Ben Klein, co-chair of the health care and energy practice group at Invariant, a lobbying firm based in Washington, D.C.

For example, at the end of 2020 Congress passed a fairly sweeping energy bill with bipartisan support around topics such as energy efficiency and risk mitigation. The Biden administration will make the most of the tools available to them by focusing on regulatory changes and factoring climate change into procurement decisions.

Laura Craft
“Five years ago, there wasn’t much conversation on the impacts of climate risk. Fast forward to now and there is a tremendous amount of dialogue.” –Laura Craft, senior vice president, head of global ESG strategy, Heitman

“If you break down the administration’s climate agenda there are a number of pieces they can move on their own on the regulatory side and looking at climate risk disclosures is certainly a part of that,” Klein says.

Traditionally, the EPA has taken charge of new climate initiatives, but the expectation is that climate related initiatives will be forthcoming from a variety of federal agencies, such as the Department of Commerce, Department of the Treasury, and Department of Energy. “I think it will be a whole government approach, and that is what we saw with the executive orders,” Klein says. So, as a first step, agencies are going to be looking at the impact of climate change as they go forward in all of their rule makings, he adds.

Even before Biden took office, regulators were paying more attention to climate risks, notes Yoon Hui Kim, managing director, global client services at Four Twenty Seven. For example, the September 2020 report from the U.S. Commodity and Futures Trading Commission noted that corporate disclosures provide the basis for risk management, not only for individual companies, but more broadly across financial markets.

In addition, the Federal Reserve recently joined the Network on Greening the Financial System, a network of central banks and supervisors seeking to promote climate and environmental risk management in the financial sector.

One area where there could be early action is in Securities and Exchange Commission (SEC)-required carbon disclosures for public companies.

“Even absent the Biden administration, the financial market was moving in this direction. There has been more and more investor demand for information and understanding the impact of climate to the bottom line of companies,” Klein says. “I think the new administration will pick that up and move that forward very rapidly,” he adds.

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