Climate risks in the real estate industry: the need for action

The real estate industry is facing a crucial challenge: managing the risks posed by climate change. A recent study by the Urban Land Institute (ULI) shows that ESG (Environmental, Social and Governance) criteria will have a significant impact on the valuation of real estate assets over the next 12 to 18 months. Despite this finding, current valuations do not fully reflect the challenges and opportunities posed by climate change, its social impacts and the basic requirements of tenants/occupants.

The study highlights that 69% of the organisations surveyed already include transition risks in their investment decisions. Nevertheless, there is a significant proportion of 31% who either only occasionally or not at all take these risks into account. This underlines the need for a standardised and transparent methodology for assessing transition risks in order to prepare the real estate industry for the challenges ahead.

This article therefore first deals with the issues that the real estate industry is confronted with in the course of climate change and then provides an overview of the current legal framework.

Types of risks in the real estate industry

The real estate industry faces a variety of risks that are exacerbated by climate change. The Urban Land Institute (ULI) study identifies several key risks that are important for investors and owners:

• Built-in carbon: The carbon emissions contained in building materials increase the environmental impact of buildings. One example of this is concrete buildings, which have a large CO2 footprint due to energy-intensive cement production.

• Aging and depreciation: Outdated buildings that do not meet current sustainability standards are vulnerable to depreciation. An office building without modern insulation can serve as an example, which causes high energy costs and is less attractive for tenants.

• Energy costs: Rising energy costs can significantly affect the profitability of real estate, such as a residential complex with outdated heating systems that incurs high operating costs.

• CO2 price: The introduction and progressive tightening of CO2 pricing could increase the operating costs of real estate. For example, owners of commercial real estate with poor energy efficiency may face increased charges due to high emissions.

• Reputational risk: Companies that do not operate sustainably risk their reputation and thus their market position.

• Cost of decarbonisation: Switching to low-carbon technologies can come at a significant cost. One example is the retrofitting of a building with solar systems and energy-efficient systems.

• Access to insurance: Properties in high-risk areas may struggle to obtain insurance coverage. Just think of a coastal hotel, for which the owner no longer receives insurance against flooding due to rising sea levels.

• Tenant vacancies: Vacancies can arise when tenants prefer more sustainable options. For example, it is conceivable that shopping centres will lose tenants due to a lack of sustainability certificates, because these tenants' ESG strategy imposes stricter requirements on the company's premises that the centres in question do not meet.

Legal References and Adaptation Strategies

The Climate Adaptation Act (Klimaanpassungsgesetz, KAnG) forms the basic framework for climate adaptation strategies in Germany. In addition to a general part, it consists of regulations on climate adaptation by the federal government, consideration requirement, climate adaptation by the states and final provisions. This structure stipulates that the federal and state governments must develop measures to adapt to climate change in order to avoid or reduce its negative effects. The precautionary climate adaptation strategy is a central element of this act. It is revised every four years and is based on a climate risk analysis that is updated at least every eight years. The federal government already issued a corresponding adaptation strategy at the end of last year. The federal states and cities are required to draw up their own climate adaptation strategies on the basis of the Climate Adaptation Act.

In the "Buildings" field of action of the federal government's climate adaptation strategy, goals such as the adaptation of buildings to protect users and the reduction of financial risks in buildings are defined. These goals are to be achieved through information-, control- and promotion measures, with a focus on nature-based solutions and the improvement of structural precautions.

The Frankfurt Strategy for Adaptation to Climate Change contains concrete examples of the implementation of adaptation measures at the municipal level. It emphasises the importance of green infrastructure, such as green roofs and façades, to reduce urban heat and improve quality of life; this is to be further deepened by the adoption of a statute pursuant to Sec. 91 of the Hessian Building Act (Hessische Bauordnung, HBO). It also highlights the need to secure the water supply through sustainable practices and to strengthen the city's resilience to extreme weather events, such as adapting the design of public spaces to urban flood protection standards.

Another example from the Frankfurt strategy is the promotion of measures to improve energy efficiency in buildings in order to both reduce CO2 emissions and lower operating costs.

These measures are part of a comprehensive approach that includes both climate change adaptation and mitigation. These legal frameworks and strategic measures make it clear that builders and investors are increasingly confronted with legal requirements and adaptation strategies that will influence their planning and investments.

Conclusion

The real estate industry is at a crucial turning point. The challenges of climate change require not only adjustments in the development and management of real estate, but also a rethink in the entire industry. Climate protection is a global challenge of the first order that requires a comprehensive transformation process. The first steps towards adapting urban development to climate change have been taken through the creation of the KAnG and the climate adaptation strategies. There is therefore no longer a problem of knowledge. The problem and the real feat to which the industry must now devote itself is the implementation of these goals in national law and in practice, especially at the level of the states and municipalities.

For the real estate industry, this means that it must act proactively and adapt to new legal and environmental requirements. The integration of ESG criteria into investment decisions and the consideration of climate risks are no longer optional measures, but necessary steps to remain fit for the future. The industry must rise to the challenge of creating sustainable and resilient buildings that meet the requirements of the future.

The subject matter of climate adaptation law is extremely complex, and empirical evidence for its effectiveness is still rudimentary at best due to the diverse causal relationships. Therefore, legal advice on the implementation of climate adaptation strategies at portfolio and property level seems advisable.

It is up to the players in the real estate industry to make their contribution to overcoming the climate crisis through decisive action and the willingness to change and at the same time remain economically successful.