Property investing in the era of climate change

Coastal areas have some of the most expensive and profitable land for development and investment. Estimates are that by 2050, however, many of these areas will be impacted by rising sea levels. Buy and hold strategies seem to be growing in popularity, and in addition to doing their due diligence with financing, contractors, and partners, savvy property investors are going to have to start paying attention to the impact that climate change will have on their investments.

According to Climate Central’s list of cities most vulnerable to coastal flooding by 2050, 20 of the top 25 cities are in Florida, with the remaining five being Virginia Beach, VA, Boston, MA, Norfolk, VA, Charleston, SC, and New York, NY (which tops the list). Florida is starting to buy properties in order to raze the land and allow room for rising water before waiting for property damage to occur.

“By the end of the century, 13 million Americans will need to move just because of rising sea levels, at a cost of $1 million each, according to Florida State University demographer Mathew Haeur, who studies climate migration. Even in a ‘managed retreat,’ coordinated and funded at the federal level, the economic disruption could resemble the housing crash of 2008,” Bloomberg reports.

Some property investors are on the move, watching out for residential mortgage-backed securities that haven’t accounted for climate risk in high-risk areas like Florida and Texas. While many investors think they’re too diversified to be impacted by climate risk, otheres argue that mortgage securities don’t adequately reflect the risk identified by a growing body of data, and that the situation echoes the mispricing leading up to the mortgage credit bubble in the mid-2000s.

Indeed, the Union of Concerned Scientists warns of a looming housing crash even worse than the previous foreclosure crisis based on the effects from climate change.

Making the first move
Sebastian Jaramillo is a partner with Miami-based boutique firm Wolfe Pincavage and has seen how sea level rise is affecting real estate policies and development in South Florida—and how it isn’t. He thinks that mortgage lenders will be the ones to eventually make the industry think twice about buying and building property in at-risk areas.

“I’m actually surprised that it hasn’t happened yet, but I think the initial impact will come from the lending side,” he said. “Maybe some lenders will start to scale back, they may not want to do 30-year mortgages for some of these properties. The minute they do that, I think that’ll have an impact on development.”

Developers might begin to consider whether it’s worth the initial investment in a project if their sales might be somewhat restricted due to the lack of financing availability, Jaramillo adds. Many communities in South Florida have already started to see some effects of rising sea levels and municipalities have taken measures to protect against increasingly frequent flood waters, but preparatory measures are the exception rather than the norm.

Part of this is because even though the mortgage industry is fairly conservative, it’s also slow to change, slow to react, and slow to make any kind of adjustments to the status quo. Another reason that no one is willing to rock the boat is because for the most part, the boat is experiencing smooth sailing. Real estate values continue to appreciate, both homeowners and investors are experiencing record amounts of equity, and Jaramillo said that alarm bells about property on low-lying coastal areas haven’t had any impact on the secondary market, where no one is saying they’re not interested in those mortgages.

Potential to lose value
Climate-related incidents have cost residential and commercial real estate investors $300 billion since 2017. Despite the dramatic loss of property value that could happen quite quickly, Jaramillo again expresses his surprise that lenders aren’t sounding the alarm.

Not everyone is at risk. Developers will often take out a short-term loan for a project, so as long as they can finish a project quickly, they’re not too concerned with what happens to it in the long run. Jaramillo suspects that if lenders do start curtailing activity on the residential side and buyers have an issue financing their purchase, however, that will have an immediate impact on development in terms of sales projections and expectations.

Policy is also lacking. In Florida specifically, where so much of the local economy relies on tourism and real estate development, it’s not an easy stance for a policymaker at any level of government to take a hard stance against development because of rising sea levels, the true extent of the damage not having happened yet.

“There should be some level of concern and adjustment, at least on the development side, because we don’t want to be in a situation where the entire life savings of a community are destroyed after the sea level catches up with us, and some of these low-lying areas are going to be—I don’t want to sound dramatic and say flooding all the time, but flooding constantly,” Jaramillo said.

Another side of this is that the transference of value would move from the coast to inland properties that rest on higher ground. Bloomberg suggests that this would worsen the affordability crisis, as those who couldn’t afford to move or rent in safer areas would be at higher risk. If and when private investors begin to demand a much higher return for backing mortgages in areas with high climate risk, there’s a likelihood that lending will slow in those areas, and real estate prices will take a hit. This would make it difficult for owners to offload the properties, which won’t be suitable for owners or renters.

Commercial properties won’t be left unscathed either, and their ability to weather climate-related changes can have an impact on property values in surrounding areas.

“Commercial buildings that supply jobs to the local community can also get burned down, torn apart or washed away. Even undamaged companies may suffer a sharp drop in business,” according to a statement by Wade Sands, CoreLogic marketing operations professional.

How investors can prepare
For developers or investors who are planning for the long haul, considerations are going to have to be about much more than price. If buyers are increasingly unwilling or unable to step when an investor needs to unload the property, it’s a better idea to look elsewhere in areas that aren’t as susceptible to impacts from increasing sea level rise.

“[Investors] should be aware that there may be a change may be coming from a financing perspective, and that that would impact their ability to find potential tenants or potential properties to make their deals work, and some of these changes may happen relatively overnight. Maybe a couple of the major lenders might start making adjustments on their end, and the rest of the industry may follow. The problem is, if you’re not prepared or if you’re not anticipating it, you may be left there holding the bag with a project that’s maybe midway though or pending development, or with potential tenants out there and you may not be able to make it work,” Jaramillo said. “The timing reminds me of when the bubble burst on the real estate market . . . almost literally overnight, it just stops.”

As lenders continue to sit on their hands, investors should also be thinking about changing their strategy quickly, and whether they’re prepared to be the first ones to make a move.

“I guess we have to wait and see if, in the coming years, [the industry starts] making more adjustments,” Jaramillo said. “So far, everybody’s lending like there’s no tomorrow.”