UN body calls for ‘climate-adjusted’ pricing models to avoid sudden corrections in real estate sector

The UN wants real estate investors to help to design and test ‘climate-adjusted’ financial models in a bid to avoid an abrupt correction in pricing for the asset class. 

A project led by the UN’s Environment Programme Finance Initiative (UNEP FI) found that current property prices do not consistently reflect physical climate risks – in part because of buyers’ personal beliefs. For example, areas in the US with high levels of climate change ‘deniers’ had property prices up to 7% higher than homes located in ‘believer’ neighbourhoods, the study found, despite both being equally at risk of significant climate hazards.

Researchers said that the occurrence of a sudden extreme event could create an “extensive and persistent change in beliefs” in ‘denier’ communities, resulting in a sharp correction of property prices. According to data from Hurricane Sandy, which devastated New York in 2012, even properties that were not damaged remained 8% lower compared to benchmark in 2017, with no signs of recovery.

The researchers also noted that current valuation practices for real estate, which are largely driven by historical indicators, “suffer from a paucity of specific climate risk evidence and available data”. Valuers may also lack the necessary understanding and professional standards to enable them to fully integrate climate effects, they added.

To address these gaps, UNEP FI has called for improved disclosure practices to enable information on climate-related risks, asset loss and damages, insurance pricing and sales data to be shared between market participants.

In addition, it wants to set up a working group of asset owners and managers to design and test improved ‘climate-adjusted’ financial modelling for real estate, and undertake sensitivity testing against future climate scenarios. The results should form the basis of new industry best practices, said UNEP FI.

Real estate is the third largest asset class for pension funds – averaging about 8.7% of fund portfolios based on data over the last three decades.

The research was undertaken jointly by UNEP FI and partners from the Henley Business School at the University of Reading and the Brookfield Centre of Real Estate and Infrastructure at York University. Its publication comes soon after a landmark climate report from the UN's Intergovernmental Panel on Climate Change warned of  increasingly extreme heatwaves, droughts and flooding over the next decade.