Real Estate Investing: Incorporating Climate Change Risk into Your Due Diligence Process
Self-directed IRA investors who use their retirement dollars to buy real estate may want to add one more consideration to their due diligence checklist when evaluating an investment property: climate change risk.
From floods to hurricanes to forest fires, severe weather events are becoming more frequent. In 2018, severe storms left a trail of destruction in their wake. Two historic hurricanes—Hurricanes Florence and Michael—made landfall in the United States, resulting in catastrophic damage and flooding. Meanwhile, the Camp Fire became the deadliest and most destructive wildfire in California’s history, destroying 14,000 residences and charring an area the size of Chicago.
According to data from U.S. National Oceanic and Atmospheric Administration, quoted in a report by Morgan Stanley, the number of inflation-adjusted, billion-dollar climate disaster events in the US grew from 28 during the 1980's to 91 from 2010 to 2017. The average annual costs rose from $16.7 billion in the 1980's to $80.5 billion from 2010 to 2017.
Average Annual Cost of Natural Disasters
Sources: NOAA National Centers for Environmental Information (NCEI) U.S. Billion-Dollar Weather and Climate Disasters (2018). https://www.ncdc.noaa.gov/billions/ and Morgan Stanley, “Weathering the Storm: Integrating Climate Resilience Into Real Assets Investing.”
At PENSCO, we custody alternative assets for our clients’ self-directed IRAs and many of our clients invest in real estate. Real estate can be attractive to investors looking to hold alternative assets in their retirement accounts, given its potential to yield long-term gains.
Some of our clients use their IRAs to purchase houses directly as investment properties, allowing them the opportunity to grow their nest eggs through monthly rental income and capital appreciation. Others use their IRA dollars to invest indirectly in real estate through partnerships, LLCs or mortgage notes.
No matter how a self-directed IRA investor gains exposure to real estate, research is emerging that shows investors may want to look at whether or not changes in climate could have an impact on their real estate values.
Climate Change Risk and Lagging Home Price Appreciation
According to the Wall Street Journal, the price of homes on the eastern seaboard, which has been battered by fiercer storms and higher seas, is lagging behind those inland. ATTOM Data Solutions finds that in the past 10 years, home prices in the overall US housing market appreciated at double the rate than those in cities with the highest flood risk and at triple the rate in cities with the highest hurricane storm surge risk. It also found broader market home price appreciation outperformed cities with the highest wildfire risk over the last decade.
Meanwhile, research published by Harvard posits that climate change will result in “climate gentrification”—the idea that as climate change accelerates, property markets could become more or less attractive based on their exposure to climate change-related risks and their ability to address those impacts. In a case study, Harvard researchers found rising seas are making property in traditionally sought-after coastal regions in Miami-Dade County less favorable, while inland higher-elevation properties are in the county are becoming more desirable.
Jesse Keenan, the lead author on the research, said this is taking place because real estate investors, cognizant of the threat of climate change, are shifting capital to more stable land and properties. The result, he told CNBC, is that home values on Miami’s coast are already worth 10% less now than they would be if climate change didn’t exist, and home values in some lower-income neighbors are rising.
Assessing the Potential Impact of Climate Change on Real Estate
For investors seeking to gain insight on how climate change may impact real estate investments, Morgan Stanley outlines taking a three-dimensional approach, shown below.
A Three-Dimensional Approach to Assessing Climate Risk
Source: Morgan Stanley, “Weathering the Storm: Integrating Climate Resilience Into Real Assets Investing.”
The three dimensions are:
- Hazard: Investors should ascertain the likely hazards the area faces. What types of extreme events can occur? What is the likelihood of a hazard occurring and over what time horizon?
- Exposure: Investors should evaluate the exposure to expected climate impacts faced by their real estate investments. Does a market or asset lie directly in the path of potential hazards? To what extent are buildings and infrastructure situated in areas exposed to acute climate-related events?
- Vulnerability: How prepared are the local community, infrastructure and government to respond to disasters? What is the likelihood of people, ecosystems, economic sectors, supply chains or local businesses to suffer from climate-related hazards, and how might these affect real estate investments?
This is just one framework for approaching climate change risk due diligence. It may not be appropriate for every investor in every situation. After all, all real estate is local. But we do encourage self-directed IRA real estate investors to work with a tax and/or legal advisor when investing in property. It’s critical to understand the risks involved with any property investment—climate-change related or otherwise—and whether the opportunity matches your risk tolerance and long-term investment goals.
If you have questions about investing in real estate with your PENSCO self-directed IRA, please contact us at 800.962.4238.
This Blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.
PENSCO Trust Company performs the duties of an independent custodian of assets for self-directed individual and business retirement accounts and does not provide investment advice, sell investments or offer any tax or legal advice. Clients or potential clients are advised to perform their own due diligence in choosing any investment opportunity as well as selecting any professional to assist them with an investment opportunity. Alternative investments are not FDIC insured and are subject to risk, including loss of principal. PENSCO is indirectly affiliated with a registered broker dealer and with a licensed small business investment company through Opus Bank (“Opus Affiliates”). Other than the Opus Affiliates, PENSCO is not affiliated with any financial professional, investment, investment sponsor, or investment, tax or legal advisor.