By Kaitlin Sullivan
Natural disasters have racked up record costs in the past two years, with disaster-related insurance claims in the United States alone reaching a record high of $144 billion in 2017. Total losses across the country—mostly city infrastructure and underinsured commercial real estate—were more than double that. A new report by a global investment firm said that trend is likely to continue as climate change puts both physical assets and financial markets at risk.
BlackRock Investment Institute predicts that climate impacts, including extreme rainfall events, warming temperatures and rising sea levels, will carry a heavy economic cost in nearly two-thirds of metropolitan areas in the U.S. over the next 40-60 years. Those areas will lose the equivalent of at least one percent of their gross domestic product––which, in areas like Tucson, Ariz., Miami, Fla. and New York City, equates to hundreds of millions of dollars––and those losses will be passed along to investors, the study says.
A widespread scientific consensus has linked rising greenhouse gas emissions to extreme weather events and other disasters, including hurricanes, drought and wildfires, posing massive threats to both financial markets and physical assets. To measure the risk, BlackRock’s analysis focused on three sectors tied to long-term physical investments: commercial mortgage-backed securities (CMBS), electric utilities and the $3.8 trillion municipal bond market.
“The reason we picked these three sectors is because these are long-dated assets. Cities and buildings theoretically will be there in 30 years, utilities will need to provide their services and they all have a physical asset component to them,” a BlackRock representative said in an interview.
The report found that current municipal bond rates fail to reflect the varying levels of risk climate change poses to different regions throughout the U.S.; and that bond markets in areas such as Florida, a state particularly vulnerable to sea level rise and tropical storms, will likely weaken over time, in step with the state’s economy.
“If this becomes a growing drag on the economy we think that this risk will grow faster than local economies over time,” a BlackRock representative said.
The report, which looks at the risks to long term investments through the end of this century, uses trend data to predict which states will suffer the greatest economic loss due to climate change. Authors calculated risk based on a “no climate action scenario,” assuming greenhouse gas emissions continue along current trends. While geography safeguards some regions from the most severe climate impacts, the southern half of the U.S., which is more susceptible to extreme heat and tropical storms, could face serious economic blows.
Widespread Economic Impacts
Risks to investors extend beyond the coastal real estate market. Drought, flooding and warming temperatures are predicted to lower agricultural yields, including the nation’s $52 billion corn market. City infrastructure, including everything from bridges to utilities, is vulnerable to extreme weather. Based on BlackRock’s analysis, metropolitan statistical areas (MSAs)––geographical regions that may include multiple cities with high population density and strong economic ties––have already suffered climate consequences.
“All major MSAs are already suffering mild to moderate losses today — the result of cumulative changes to the climate since our 1980 baseline year,” the report said.
The BlackRock analysis shows that the risk of Category 4 or 5 hurricane hitting a commercial real estate property in the U.S. has risen by 137 percent since 1980. If nothing is done to curb emissions, the risk of the same property being hit by a Category 5 hurricane in the next 30 years is projected to increase by 275 percent. This threatens commercial mortgage-backed securities.
Office buildings and retail properties typically last decades, making them subject to climate risks that amplify over time. A warming climate could lead to a rise in losses to their underlying loans. New York, Houston and Miami account for one-fifth of all U.S. market value tied to CMBS loans, according to the March 2019 Bloomberg-Barclays Aggregate Index. All three are also among the top four highest-risk areas according to the BlackRock analysis, and “New York City would see likely sea level rises of up to three feet by 2080, exposing roughly $73 billion of property to potential losses.”
Based on data from recent hurricanes that made landfall in Houston and Miami, the analysis found that, “roughly 80 percent of commercial properties tied to affected CMBS loans lay outside official flood zones — meaning they may lack insurance coverage.”
Global investors stand to lose across nearly all asset classes, said Kirsten Snow Spalding, senior director at Ceres, a sustainable investment nonprofit that was created in response to the Exxon Valdez oil spill in 1989.
“There’s physical risk to everything they hold––not just buildings but infrastructure such as bridges, water treatment plants and agricultural land; physical threats impact everything in the real asset class,” she said
The report also found that the rates customers pay for utilities in the U.S. are too low and do not reflect climate risk.
The paper’s authors analyzed the risk of 269 publicly listed utility companies and found that while prices spike after extreme weather events, the increase is temporary. On the contrary, some of the most climate-resilient utilities are already charging higher rates, pointing to higher overall rates in the future as utilities work to become more resilient.
“We believe this premium could increase over time as the risks compound and investors pay greater attention to the dangers,” the report stated.
Warming temperatures will also drive demand for electricity to run cooling systems, particularly in the southern U.S. According to BlackRock’s projections, by late century, Tucson, Ariz. could spend around $338.5 million annually on additional energy costs. Those rising costs could drive the region’s workforce to move to cooler climates.
“People and assets could be compelled to drift northwards and we expect that,” said Mark Muro, senior fellow and policy director at Brookings Institution. Both the workforce and tax base in cities like Tucson would decline, which would impact real estate values and add volatility to the municipal bond market.
Coastal and Southern States Are Most Vulnerable
Both the BlackRock paper and a report released by the Brookings Institution in January found that states in coastal regions and those in the southern half of the country will be disproportionately impacted by a warming climate.
“There is extreme variation across the country. We have concentrated sense of harm across the southern tier especially in Florida and the Gulf States where all types of infrastructures are in the way of harm,” said Muro.
BlackRock’s analysis found that Salt Lake City could experience 75 percent fewer days with freezing temperatures by the end of the century. Orlando could endure more extreme heat, with almost 180 days per year reaching 95 degrees or higher. In total, around one-quarter of U.S. metropolitan areas are projected to see more than 100 days a year topping 95 degrees, versus around four days each year currently.
According to Spalding, investors are starting to take notice of the risk climate change poses to their portfolios. While divesting from fossil fuel producers––which disproportionately contribute to climate change––is an attention-getting approach, it won’t be enough because so much of the economy still relies on fossil fuels. She said investors must think across asset classes, or groups of investments with similar characteristics such as energy, and put pressure on all businesses to recognize the economic risk posed by climate change, and how their actions exacerbate it.
“The geographic thinking is for investors very important,” said Spalding. “Rather than asset class by asset class, if you think geographically, that goes across all classes and suddenly your risk profile looks very different than if you would have just asked what are the highest emitters in my portfolio.”