The Client: A large U.S.-based REIT

Users: Sustainability team

U.S. real estate investment trusts (REITs) are under increasing pressure from stakeholders to embrace ESG values. This trend is expected to drive more REITs to invest in green properties, which are broadly defined as energy-efficient buildings that minimize the impact on the environment and human health.1 At the same time, real estate investors have recognized the potential threats to their portfolios from physical climate risks that can impact different locations and properties in different ways. This includes hazards such as storms, floods, sea level rise, extreme temperatures and drought.

The sustainability team at this large U.S.-based REIT had been assessing climate risks in a very qualitative manner and wanted to take the analysis to a new level to stand out as an industry leader on ESG issues. The team wanted to adopt a more granular, quantitative approach that could help identify any vulnerabilities within the firm’s existing portfolio, improve the due diligence of potential new acquisitions and assist with desired external reporting following guidelines suggested by the Task Force on Climate-related Financial Disclosures (TCFD).

Pain Points

The sustainability team had conducted a high-level analysis of climate risks within the firm’s portfolio, pinpointing locations that were vulnerable to storms and sea level rise. It was clear that it was now time to look at a broader range of climate hazards, plus exposure at the individual property level. As such, the team wanted to identify a well-recognized third party that could provide:

  • Information on potential physical risks that may materialize in different locations throughout the U.S. over the coming years.
  • An understanding of how these climate hazards could impact different property types in different locations.
  • An assessment of the financial impact of hazards.
  • Scenario analysis to assess different future states to support reporting as per the TCFD.

The sustainability team contacted The Climate Service (“TCS”) to learn more about the firm’s capabilities. TCS was recently acquired by S&P Global and is now part of the company’s Sustainable1 division. Sustainable1 brings together S&P Global’s extensive ESG resources to provide clients with a 360-degree view to help achieve their sustainability goals.

Real estate investors are becoming increasingly concerned about the potential impact of climate-related events on their portfolios and are looking to identify well-tested data and analytical solutions to evaluate potential risks.

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The Solution

TCS described its work with the world’s largest real estate investment managers, which has involved using its proprietary Climanomics® platform to analyze millions of properties and provide a range of nuanced insights. Engagements have outlined the physical risks across clients’ real estate investment portfolios in a way that has supported due diligence, strategic decision-making and a comprehensive understanding of climate-related investment risk. Robust and consistent data models give a holistic picture of physical risks at the asset, company and portfolio -level, along with actionable takeaways.

Clients can use the platform on their own should they choose, inputting four pieces of information on each asset in their portfolio, including: (1) the specific type of asset (e.g., restaurants and warehouses), (2) the location, (3) the value of the property, and (4) ownership structure. The ownership structure can be owners who are investors and may need to repair damages, owners who are also tenants and may need to repair damages and face higher operating costs and non-owner tenants who may face higher operating costs. The Climanomics platform then evaluates the impact of seven major hazards on each asset, including extreme temperatures, drought, coastal flooding, fluvial flooding, water stress, tropical cyclones and wildfires.

This is done in conjunction with a sophisticated analysis of each asset’s unique vulnerabilities to each hazard. For example, geographical coordinates are reviewed, as elevation is one factor that will determine exposure to flooding – in this case, a higher altitude assumes less risk.

To quantify the financial risk, it is important to determine how a hazard will affect an asset in a way that is financially material. For example, how will an increase in temperature impact cooling costs or a flood impact clean-up and repair costs? Of course, this will depend on the type of asset and if it is highly vulnerable or not.

All hazards and assessments of vulnerabilities are considered for each asset to model the average annual loss, which calculates the cost of damage and/or lost revenue as a percentage of the asset’s value. These losses can be incorporated into financial models for owning and operating a property and assessing a climate-adjusted value. The total average annual loss is the sum of the financial impact of all hazards. This can be disaggregated by type of hazard and, within each hazard, by type of expense. The loss data is provided for each decade out to 2100 and four greenhouse gas (GHG) concentration scenarios. Using Climanomics would provide the sustainability team with:

An assessment of physical risks

TCS starts by utilizing publicly available raw climate data from sources such as NASA, the Intergovernmental Panel on Climate Change (IPCC), the National Oceanic and Atmospheric Administration, the World Wildlife Fund HydroBASINS and much more. The data may include information on temperature and precipitation, which expert TCS scientists use to build and refine their own climate models. For example, while precipitation is important for flooding, so is topography, land use and basin area, variables that are included in TCS’s hazard models.

TCS has a growing library of proprietary impact functions that model the vulnerability of 230+ individual asset types to climate- related hazards based on a wide range of factors specific to each asset type.

A price on climate change

The TCS Climanomics platform quantifies physical risks in financial terms (average annual loss) that are aligned with the recommendations of the TCFD.

Scenario analysis

TCS incorporates four climate scenarios based on the Representative Concentration Pathways (RCPs). An RCP is a greenhouse gas (GHG) concentration (not emissions) trajectory adopted by the IPCC. The pathways describe different climate futures, all of which are considered possible depending on the volume of GHGs emitted in the years to come.

Visualizations of insights

The Climanomics platform delivers simple charts, graphs, narrative and data for export that provide insights into the location, severity and timing of climate-related risks.

Inputs for TCFD reporting

The TCFD recommends the use of scenario analysis to assess climate-related risks and opportunities and asks companies to report on the extent to which adequate governance, strategy, risk management and metrics and targets are in place to address climate issues.

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Key Benefits

Members of the sustainability team recognized that climate change is a growing concern that could significantly impact the financial performance of the REIT’s business and, therefore, required deeper investigation. They were impressed with TCS’s bottom-up approach that starts at the asset level and aggregates to the portfolio level for multiple GHG concentration scenarios and time horizons, generating actionable results. A decision was made to subscribe to the offering, and members are now benefitting from having:

  • Hands-on access to an easy-to-use platform powered by a transparent methodology and rigorous science.
  • The backing of renowned leaders in the climate arena, plus ongoing training and support to use the platform efficiently and stay up to date on enhancements.
  • The ability to anticipate the impact of physical risks on assets and assess the possible implications for more vulnerable locations and property types.
  • An understanding of physical risks in financial terms to support a climate-adjusted view of investment risk.
  • A longer-term view of climate issues to avoid surprises with potential buyers who will likely undertake their own analysis of potential future risks.
  • Inputs to inform TCFD-aligned reporting, risk management and resilience.

1 "US REITs slow to embrace green building initiative", S&P Global Market Intelligence, October 28, 2021, www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/us-reits-slow-to-embrace-green-building-initiative-67225820.