BiggerPockets Real Estate Podcast - 895: BiggerNews: How Climate is Exploding Insurance, Building, and Investing Costs w/Natalie Ambrosio Preudhomme

Episode Date: February 16, 2024

The climate crisis is already here, and the cost of real estate is being directly affected. Insurance premiums are skyrocketing, costs to build are rising, and your reserves need to be bigger than ever. Tornados, hurricanes, fires, and floods threaten your properties, so how do you protect yourself from what’s coming? Where are the least-affected areas, and how do you ensure your rental property portfolio doesn’t go up in flames or get drowned out by the rising tide? Moody’s Analytics’s Natalie Ambrosio Preudhomme is on this BiggerNews to talk about one thing—climate catastrophes. Natalie spends her days looking through data on the financial implications of climate risk and how she can better help real estate investors navigate around or outright avoid the most devastating effects to come. Plus, researching what you can do to prevent property damage if you're in an at-risk area.  Natalie outlines how climate risk will force more local governments to increase regulations (and fines), the safest investing areas in the country, and whether the sky-high insurance premiums can continue. Whether you’ve got rentals, commercial real estate, or just own your own home, these risks WILL affect you, so pay close attention to Natalie’s insight. In This Episode We Cover: The financial implications of severe climate risk that go FAR beyond just rising insurance prices  New government-enforced emission regulations that will affect businesses  The areas of the country that will be least exposed to rising climate risk  The skyrocketing price of insurance premiums and why Natalie says something’s got to give Could the cost of construction rise as new energy-efficient homes become the standard? And So Much More! Links from the Show Find an Agent Find a Lender BiggerPockets Youtube Channel BiggerPockets Forums BiggerPockets Pro Membership BiggerPockets Bookstore BiggerPockets Bootcamps BiggerPockets Podcast BiggerPockets Merch Join BiggerPockets for FREE Learn About Real Estate, The Housing Market, and Money Management with The BiggerPockets Podcasts Get More Deals Done with The BiggerPockets Investing Tools Find a BiggerPockets Real Estate Meetup in Your Area Expand Your Investing Knowledge With the BiggerPockets Books Be a Guest on the BiggerPockets Podcast Grab Dave’s New Book, “Real Estate by the Numbers” Hear Dave on The “On the Market” Podcast Watch Dave on the “On The Market” YouTube Channel Dave's BiggerPockets Profile Dave's Instagram BiggerPockets' Instagram Climate Change: Why Top Investors Are Paying Attention (and You Should Too) Stay Up-to-Date with Moody’s CRE Research Connect with Natalie Natalie's LinkedIn Click here to listen to the full episode: https://www.biggerpockets.com/blog/real-estate-895 Interested in learning more about today’s sponsors or becoming a BiggerPockets partner yourself? Email [e-mail]. Learn more about your ad choices. Visit megaphone.fm/adchoices

Hey everyone, welcome to the Bigger Pockets Real Estate Show and this episode of Bigger News. I'm going to be your host today, Dave Meyer. And today we're going to be talking to Natalie Ambrosio Prudome, who is a commercial real estate expert at Moody's Analytics. And she is an associate director of research there. And she focuses specifically on climate. And we wanted to bring on Natalie today to this show because climate has been impacting real estate investors forever, but particularly over the last couple of years. I don't know if you all have heard, but I've been talking to friends in California and in Florida, and insurance costs

are going through the roof. Some insurance companies are just leaving those states altogether. I've personally been dealing with this a lot in Colorado, where there are wildfires. It's been really difficult to even get insurance. So we're going to bring on Natalie today to share some data and information with us all that can help you make more informed decisions as an investor. And I mentioned earlier that Natalie is an expert in commercial real estate. And I think that's important to note because this type of data about which places might see floods or which places are going to see insurance premiums increase the most are things that the big investors, like big institutional investors like BlackRock and some big commercial reeds, they're all

looking at this data. And so I think for us as smaller, you know, I'm just generalizing most of the people who listen to the show are residential investors. And I think the people who listen to the show, no matter how big or small you are as an investor, you should be looking at this data to help you make decisions. One, about the cost benefit analysis of any risk mitigation strategies you might want to implement. Or two, help you decide where you want to be investing. So with that said, let's bring on Natalie Ambrosio Prudome from Moody's Analytics. Natalie, welcome to the show. Thanks for being here.

Thanks so much for having me. Could you start by telling us a little bit about what you do at Moody's Analytics? So I'm on our economics and thought leadership team within our commercial real estate part of the business. And so I focus specifically on climate change. And so I do research and market outreach, really connecting the dots on climate risk and traditional commercial real estate metrics that are institutional investors and lenders care about. And why do commercial real estate investors care about climate and climate risk?

So there's a lot of ways this is really starting to unfold that I can dive into, but kind of at the foundation, there's both physical climate risks and transition risks, which are both starting to have financial implications. And so just really quickly I'll define both of those and then we can kind of dive in. But physical risks are things like acute severe weather events like wildfires, floods, individual heat waves. And then there's also chronic stresses that are unfolding over a longer time frame, such as sea level rise or water stress and drought. So those are our physical climate risks that are threatening real estate assets.

And then this transition risks, this is the. bucket of risks that we face from the transition to a low-carbon economy. And so this can take a few different shapes. It includes like regulations around emissions reductions, as well as shifting technology and then also shifting consumer preferences and demands. Okay, great. So that's really helpful in understanding those two different things that you study. And are you saying that both these physical and transitionary risks have financial implications for commercial real estate investors? Yes, exactly. And so there's different ways that this is made manifest, but starting on the physical risk side, there's kind of the obvious impacts of if an asset itself is hit by a flood or a

wildfire, then there's, of course, lost revenue during the business disruption. There's increasing operating costs due to the repair and maintenance and all of that. And then there's also some less obvious rippling indirect impacts. So even if the asset itself isn't hit, but there's a hurricane or storm in the region. So transit infrastructure is down or flooded. Employees can't get to work or supply chains are disrupted. And there's instances of this happening where like a manufacturing facility itself wasn't damaged, but the employees couldn't get to work after a storm, so it had to halt its operations for a couple days, which of course leads to disrupted revenue. And so that's a few of the ways that physical risks affect real estate. There's also these broader ways,

such as through increasing insurance costs, which really has broader implications, kind of at a market level as well as for asset value. And then just briefly on the on the transition risk side, there we are seeing a rolling out of what's called building performance standards, which they take different shapes, but they're typically at the city or state level and they put restrictions on the amount of emissions from the building or the energy use of buildings. And so this and there's fines associated with going over those emissions. And so, again, this is changing the calculus where it's no longer like, yeah, it'd maybe be nice to have a green building. But now it's like, oh, we're going to get fined if we have emissions over a certain level.

So this is really a financial conversation. I think there's a lot to unpack here. But before we jump into it, I just want to ask, who is looking at this data currently? Because we're talking about commercial real estate, and that's your specialty. But are the lessons and insights that you uncover in your work also applicable to residential investors and some of the, you know, smaller types of investors that make up most of our audience? Yeah, absolutely. And I think some of the examples we'll discuss today are, it's pretty easy to see that they are widespread across a physical asset. Real estate, and I've in the past done research on the climate impacts across different asset classes. So all that to say that, yes, if anyone is invested

in a physical asset on the ground somewhere, then that's at risk from a lot of these things we're talking about. Okay, great. So I just want everyone listening to know that even though some of the examples we might talk about are about commercial real estate and perhaps larger assets that a lot of what we're talking about may be applicable to even smaller assets or the things that you invest in. Now, let's talk a little bit about the physical risk. As a real estate investor, you know, there's always physical risk. So there's always been risk of fire of flooding. Can you tell us what has changed recently and the scale of that change? Yeah. So there's a few different things to unpack here. I'll put a pen in insurance because that's a huge thing to unpack. But kind of taking a step back, like you said, there's always been. for millennium, people have thought about floods happening next to rivers. And we've always been kind of developing with this in mind. The huge shift in our mindset now is that it's really evident that the past is no longer an

accurate representation of what the future is going to hold. So it's no longer a reliable indicator to say, well, this asset flooded once in the last 100 years. So we should be pretty safe with that in mind going forward. The increase in global atmospheric temperatures is having a rippling effect there on local conditions. And it's doing that in a way that is really changing the frequency and severity of these events like storms and floods and temperature, extreme temperature events. And is that happening universally across the country or is it located more in certain areas? It is a global phenomenon, this climate change trend.

However, the way that it impacts conditions varies locally. And so we do work at Moody's. We at Moody's acquired RMS, the catastrophe modeling firm, and some other climate risk providers. And so we really leverage an array of data sets, including global climate climate models and more local, like hydrological models and things like that, that really try to wrap our heads around and communicate to the market around what the changing conditions are like at a very specific location. And so certain areas may have a major increase in risk and others may be

less so, correct? I always get the question, okay, like you study this, where should I move? And I typically say that yes, there are some regions that tend to be less exposed, at least to the hazards that we have a visceral reaction to, like hurricanes or wildfires. There are areas, so the upper Midwest or the Pacific Northwest. There is some wildfires in the Pacific Northwest, but those areas tend to be less exposed to these visceral hazards. However, my first answer is usually it's more about picking your climate hazard because it would be very hard to find a place that's not exposed to any of these changing conditions. So yeah, you might be trading more intense precipitation for wildfires or things like that. So it's really a matter of choosing which one you want to

prepare to deal with and build resilience too, if that makes sense. It does. So would it be fair to say as an investor your approach should be just to try and understand the risks as best as possible because then you can mitigate them. Exactly. Yeah. The first step is leveraging, really thinking about forward looking, leveraging forward looking data that shows you how your assets are going to be exposed to these changing conditions and then exactly figuring out what to do about that risk. So now that we understand why this climate data matters for investors, we're going to get into first and foremost how you can access this information and boil it down to numbers that apply to your real estate decisions. We'll also talk about some of Natalie's

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It's about building durable, tax-aware wealth over time. Learn more at biggerpockets.com slash bam. Welcome back, everyone. I'm here with Natalie Ambrosio Prudome, an associate director of research at Moody's Analytics. And right now, she's walking us through her latest research on climate and how it impacts investing decisions. So how could a, you know, a small, medium-sized,

real estate investor start to understand some of this data and how it might impact their portfolio? We have tools and there's other tools out there to where, and just using ours as an example, you can put in an address or upload a portfolio of dozens or thousands of addresses and receive back information on that exposure. And there's two components to that in our data. There's the exposure layer, which shows you based on its location and the broader area, how an asset is exposed to these changing conditions we've been talking about. And then there's an impact layer, which shows the estimated average annual damage that that asset will face from a specific hazard.

So yeah, they can leverage tools and really wrap their head around, okay, what is my asset exposed to? And then also what is the financial implication of that? And really having that dollar estimate can then inform various strategic. decisions on the investing in resilience or asset level risk mitigation because one can look at how much the risk mitigation costs and think about the estimated average annual damage and kind of multiply that out over the either the hold period of the asset or the life expectancy of whatever risk mitigation you're talking about and do some calculations to figure out the

best steps. Wow, very cool. So can you help us sort of maybe contextualize this with an example So I maybe, if you have another example, go ahead, but I have a property I own. It's in the mountains in Colorado wildfire territory. So how could I, you know, use your tool or the data that's out there to better position my property as an investment? You can start by exactly using some sort of data to understand the changing conditions at that property. And so wildfire, there's lots of different components that contribute to wildfire risk at an asset. There's changing moisture deficit or so changing precipitation patterns as well as kind of long-term drought patterns. And then that combines with your burnable vegetation that's in the surrounding area.

And so understanding those metrics. And again, there's data sets that combine all of that into a number. that kind of shows you your relative risk based on those metrics. And then really understanding your property, too. And so if there's a defensible space around that property, so that's when there's room between the building itself and any vegetation, or when different, if there's outbuildings or different things on the property, making sure those are spread apart.

So that's kind of the first step is just understanding kind of the situation around the exposure to these physical phenomenon and then also what's happening at your asset. And then the second step is thinking through, okay, so if I am in a spot that really is exposed to this phenomenon that's going to make wildfires, how can I implement risk mitigation measures? And that's why it's just important to understand, like we started with, to understand which risk your asset is exposed to because it can be overwhelming thinking, I need to prepare for everything, climate change has in store. But being able to prioritize based on what you're exposed to, then really helps narrow into, okay, what risk mitigation measures are there? And I can move forward

with those. This is super important because as investors, so much of our decision making comes down to essentially a cost benefit analysis. And when I hear about climate risks and, you know, let's just use this example of my property, it's hard. It can be hard to know. how much money to spend on mitigation and how much risk you're at. Because my HOA in the area does a great job. They offer these, you know, defensible space, which if you don't know, it's basically like removing vegetation near the house so that if a tree, you know, there's no trees really close to the house that might catch and then light the house on fire. But, you know, obviously that costs money. And so it's hard to know, like, is it worth it? Am I really at risk? So it sounds like whether it's

wildfires, floods, or any other climate risk, there is now increasing amounts of data that can help us as investors sort of decide what mitigation approach is worth it and is going to be, you know, a positive decision for me over the lifetime of me owning a particular asset. Exactly. Yeah. Having this data that shows the financials at risk, the cost of this potential damage, which really helps drive that resilience conversation in a way that's been a bit challenging in the past. And do you have any sense of like, this is probably too broad of a question, but I'll see if you have any rules of thumb.

But is there any data you've seen that shows like how much more capital expenditures that people need to put into their property is, you know, in order to properly mitigate against some of these risks. So I think that is very context specific. So, and that's another important part and a challenging part of this resilience conversation is that it's very location specific. Again, down to not just the characteristics of your building, but also who's using the building. What are the activities happening within that building? All of that influences things like energy demand or supply chain considerations. And those are our key ways that, the costs of climate change translate into financial costs. And so I don't have a number like that

off the top of my head because it's very specific based on all of these local factors. Yeah, that makes sense. All right. Well, I think hopefully as some of these data sets get built out even more, you can start to at least comp some properties and see what costs what. Now, you mentioned a really important topic for real estate investors, which is the cost of insurance. Can you just talk generally about how insurance companies, like, are they looking at the same data? Is this what they're looking at? And is this partially fueling why we're seeing premiums go up so much? Yeah. So we've been doing a lot of work to wrap our heads around the insurance landscape. We, similar to you, I'm sure, are really seeing this have a tangible impact

on CRE transactions, where its lenders are finding. that their borrowers are struggling to achieve the necessary insurance requirements without having premiums that actually present a cash flow risk. So insurers have been pulling out of high risk areas. Some of those that have pulled out of California or stopped writing new policies did in fact cite increasing hazards as one of the reasons. And so yes, to answer your question, we are seeing that this is behind the changing conditions. We've been doing some research on this that I can dive into if that's of interest. Yeah, I'm super interested because it makes me really wonder about the future of insurance for homeowners or investors in these markets.

In California, we're just seeing fewer providers. Same thing is going on in Florida. I know in Colorado, there's certain areas where it's very difficult to get a policy, even if it's for a, you know, just a single family home, just a place to live. And so it is confusing about how this might really impact the long-term housing market and potentially like not to be overly dramatic, but I guess if there's no insurance, it could really impact where people choose to live. Oh, yeah, absolutely.

And I think that's happening to some degree now, definitely not being dramatic. It's being very realistic about what's going on. And so, yeah, and there's a lot. of pieces to dive in here. And so just to keep setting the scene, I guess, a tiny bit around what we're seeing. So last summer, early fall, we did some research on just trying to understand the landscape of increasing insurance premiums. And so we looked at the line item of the insurance line item and operating cost data that we had on CNBS properties, commercial mortgage mortgage back securities. And we

did this across our five key property types of multifamily retail, industrial office, and hotel. And we found that there wasn't a clear geographic trend in terms of markets that saw increasing insurance premiums. They were really scattered across the country. But we saw that the majority of properties across the country were seeing average growth rates, compound. average annual growth rates of over 5% for insurance. And there were a large share that were over 10% of those caggers in the last five years. And that was the time frame we looked at. And so that's all that to say that this is a substantial issue that's really scattered across the country.

And so that's just laying the scene a tiny bit. And then you were asking around kind of what's going to happen and what the insurers are looking at. in terms of data and their reactions. And so it's really a multifaceted challenge in question because the insurance industry is also a fragmented across the different states. And so the markets function fairly differently depending on the state that you're talking about. And they're also, of course, highly regulated. And so depending on the state and the hazard that you're talking about, there's even been challenges in making it possible for insurers to leverage forward-looking data to set their premiums.

So in California, insurers weren't historically allowed to use forward-looking models to determine their wildfire premiums. Really? And so that presents significant challenges. And so there's a lot of conversation dialogue happening right. now between policymakers and the insurance industry and homeowners or borrowers and scientists even really trying to figure out next steps for this and thinking around changing some of these these regulations and just thinking about different ways to to really combat this this question of well these

some areas are just going to keep getting hit and so are we going to keep developing there something needs to give i think the industry has reached a point where it's clear that something needs to give. And now we're working to identify the way forward. Got it. Thank you. Yeah. I think for everyone listening, this is something really important to watch because it really does have an impact. I have a friend who's a big real estate investor in Florida and told me he's planning to sell most of his properties because even though he had good cash flowing deals, the increase in insurance premiums has really damaged his business. there's no end in sight necessarily. Like hopefully things start to slow down, but he told me on a

certain property more than doubled. He had one that almost tripled in a single year. And so it makes it really difficult to predict, you know, just like very difficult to know, you know, one of the major expenses in your business. Now, so far, this has mostly been, you know, the big high profile ones just so everyone knows have been in California and in Florida. But I imagine you know, in Colorado, I know there's wildfire risk, a lot of the West, there's wildfire risk. So I'm curious to see if this continues. So something that will have to keep an eye on over the next couple of years. All right.

So now we're really in the thick of it. And we're about to take another quick break. But when we come back, Natalie's going to tell us about what she expects to see in terms of new building standards and how this fits into the bigger picture of housing supply and affordability. So stick around. Did you know you can go on vacation and actually earn money? Because while you're out exploring new horizons, your home is sitting there, dark, silent, and wildly underemployed. And it could be making you extra cash.

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research means for investors. Let's pick up where we left off. Now, Natalie, I want to switch to something you talked about earlier, which is about building and building standards. So you said building performance standards are changing. And I have a lot of questions about that. But can you just give us a little background context on that and how building standards are changing? The term, the building performance standard specifically is referring to buildings' climate

operations or emissions. So specifically, these are related to emissions reductions at buildings or reducing energy use at buildings. They take different forms, whether they're actually assessing the emissions or the energy use. But the end goal really is to reduce the emissions of buildings. Are these at a federal level, state level, or how are they implemented? So in the U.S., they're rolling out in a fairly fragmented way. In terms of how they're rolling out to date, there is what's called the National Building Performance Standards Coalition, and that's a group of state and local governments that have committed to publishing building performance standards by Earth Day this year, so in April of this year. And then there's a second cohort who have committed to it

by 2026. And this isn't to say that there aren't any published already. There are a handful of cities around the country in a few states who do already have building performance standards. And so I'll have to say, it is rolling out in a very fragmented way, but we do expect to see an acceleration of this rollout in the next couple years. And what is the objective of most of these programs? The root objective is to reduce emissions of from the building stock. But buildings, emissions are responsible for a large share of cities' emissions. And so these are feeding into their broader climate commitments that many cities have made. But yeah, it's really focused at the building itself and reducing emissions.

From the little I know about constructing large projects, you know, I'm a more small-time investor here. When I hear about these building standards, and it strikes. me that adhering by them might be a more expensive form of construction. Like if it's just even a more energy efficient appliance, it usually is more expensive or, I don't know, Windows, energy efficient windows are more expenses. Or HVAC system. So totally. My question is, is the total construction cost going to be higher for these types of buildings? Absolutely. And And we're thinking about it a lot because a lot of these apply to existing buildings. There's a lot of conversation around the retrofit costs to then comply with these laws to avoid the fines.

And that's something that we are looking at closely and that that's what our clients are asking. Is it better to just pay the fine or to actually retrofit? And so that's this. We are talking about cost benefit analysis on the physical risk side and this is cost benefit analysis. on the transition risk side. I will say there's a lot of opportunity in this space to look at all of these numbers and then move forward strategically. And so things like replacing your various appliances at the end of their useful life. And just when it's time to replace them, replacing them with energy efficient versions. And that's just one example. But there's ways to

really plan this out in a strategic way that makes the best use of the costs. and the benefits. One other thing I'll say on this in terms of construction also, there was just an example that I was writing about in Boston. They did include numbers that showed how much more expensive it tends to be to develop this type of very, very highly energy efficient building. but then also the fact that it uses so much less energy that those costs will certainly be recouped in the lifespan or before the lifespan of that building so that the savings were significant even in light of the increased cost of construction. Interesting. Yeah, because I think one thing that I think about quite a lot is that

there's a shortage of housing in the United States and there's a shortage of housing. and there is, of course, this effort to increase the, to reduce emissions or improve the resilience of buildings. But if that makes it even less, more expensive, it's already very expensive to build. If it makes it even more expensive, is that going to dissuade people, developers from developing, and just further exacerbate the housing affordability problems? that we have right now. Two things I will mention there.

One, and this gets back a bit to resilience where it is an investment up front, but that the savings are substantial and kind of the interfacing of both the sustainability or transitionist side and the resilience side, things like reducing energy demand. And things like that, yes, they reduce emissions. They're sustainable. but they also prepare for increasing heat waves and surging costs we've seen in energy demand through the summer. And so things like affordable housing or just any housing, it's particularly important to ensure that

the asset is resilient and that those who are using the asset will be safe and be able to function during these extreme events. Like power outages, yes, they create a substantial commercial disruption, but they also are human health and safety concern. I agree and see the long-term value of making more resilient, more energy-efficient buildings. I think what hangs me up sometimes is just the details of how the industry works, where it's like what might happen is the developers who take on the most risk will face increase construction costs while the eventual owners and operators of the building or the tenants of the building

are the ones to enjoy the benefit. And so that's what worries me is that there's not an incentive for developers to build if it's just more expensive for them only to save other people money. Does that makes sense? Yeah, so a few things on that. We are seeing with this increasing demand, so tenants are increasing their demand for greener, more resilient buildings. Again, large corporations are making climate commitments and then need to have their offices or their facilities in buildings that allow them to comply and meet their commitments. And so with this increasing demand, there is already some research that shows the greenium or the fact that folks are willing to pay more for these green buildings. And we expect more research to be coming out on that as more and more folks really focus on this issue. So that's one, just this relatively simple fact that increasingly they will be able to sell or at least the greener buildings for higher prices. And again, this is already shown to be the case. The other thing I'll mention too is just green financing.

And so there are a variety of incentives from the Inflation Reduction Act. There's also various rebates and utility incentives. And then there's also things like PACE, property assessed clean energy, which is another thing that's rolled out at the state level. And so it's only authorized in certain states. but that's a specific financing mechanism for green properties that allows for the financing to be paid or received up front without any payment. And then it's tacked on to the like the property taxes of the property essentially. That's how it's repaid.

And so there is a variety. It's a fragment in space that that needs to be a little bit. better understood, frankly, and kind of fleshed out with the resources getting to the right people. But green financing for buildings is a space that can help with this as well. Well, Natalie, thank you so much for sharing your research and knowledge with us. Before we go, is there anything else you think our audience should know from your recent work? Yeah, thanks so much for the conversation. I will just really underscore that we're working hard to connect this exposure to climate hazards with the financial implications, really doing work that

demonstrates the impact on things like vacancy rate, asking rents, operating costs, and then net operating income. And so I would say this is a really exciting and important space to keep watching and paying attention to, and it's only going to become more important in the coming years. So, yeah, thanks so much for having the conversation with. with me. Absolutely. And if you want to learn more about Natalie and her team's work, make sure to check out our show notes, which you can find below, which will link to all the research and report and great work that she's doing. Natalie, thanks again for joining us. Thank you. Thank you all for listening to the Bigger Pockets Real Estate podcast. Make sure you get all our

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