Commercial real estate is a showcase sector for climate-related impacts and the practicalities of risk management. Recently released guidance for investors and owners/managers highlights likely physical threats, recommended safeguard measures and key questions for gauging the preparedness of assets.

The University of Waterloo’s Intact Centre on Climate Adaptation has developed six industry-specific climate risk matrices to inform financial market participants in their decision-making and to encourage asset owners/managers to evaluate their holdings. These are presented in user-friendly chart form meant to be compatible with what’s characterized as an “ESG alphabet soup” of assessment and reporting frameworks many industries are now juggling.

“Fulsome disclosures must not only identify risks, but also identify what measures need to be implemented to reduce those risks and, in so doing, allow institutional investors to meet their duty as fiduciaries,” submits Kathryn Bakos, managing director of the Intact Centre and co-author of its new report on integrating climate risk analysis into institutional investing.

This comes as costs mount from a lengthening sequence of severe natural events, and a growing cast of regulatory bodies call for more and better response strategies. Data from the Insurance Bureau of Canada (IBC) shows that insured losses due to extreme weather surged from an average of $250 to $450 million per year in the period from 1983 to 2008 to an average of about $2 billion annually over the subsequent 14 years. The Fort McMurray wildfire accounted for the majority (70 per cent) of the chart-topping $6 billion in insured losses in 2016. However, $3.1 billion in weather-related claims in 2022 — the third highest amount for any year thus far — are considered a more insightful harbinger because they arise from multiple events occurring nationwide.

“Climate change models predict geographically dispersed impacts, and that is what Canada is experiencing,” the report observes. “Extreme weather, driven in concert with a changing climate, will continue to evolve and become increasingly severe over time, thus generally rendering greater costs across industry sectors. Market participants and stakeholders must, therefore, be vigilant and cognizant of the increasing potential for severe weather to impact investments over time.”

CRE tapped as model for action and potential returns on adaptation

Commercial real estate was chosen for an illustrative climate risk matrix — along with: electricity transmission and generation; property and casualty insurance; banking/residential mortgages; hydroelectric generation; and wind electricity generation — for its fit with the Task Force on Climate-related Financial Disclosure (TCFD) definition of sectors that are well placed to serve as models for broader industry. Those are sectors in which severe weather events can significantly disrupt operations and/or damage assets, but which generally have the expertise to understand potential business impacts and available means to mitigate risk.

Commercial real estate also provides the template for the report’s case study of the returns on investment in climate change adaptation. It models three scenarios — no adaptation; early adaption; late adaptation — for impact on rent income and share price, and concludes that early adapters will be in the best position to protect and enhance asset value.

“Laggards will bear the full financial consequences of the pricing-in of climate-related market-level impacts,” it warns.

The climate risk matrices are promoted as tools to help investors and associated financial market participants benchmark investees against standard thresholds of preparedness. Meanwhile, companies using the matrix to drive the process of identifying and mitigating climate risk should glean results that can also inform TCFD or other initiatives such as the Sustainability Accounting Standards Board (SASB) or the Carbon Disclosure Project.

“Relative to the physical risks of climate change, the outstanding challenge for market participants is to: (1) identify which extreme weather events have the highest probability of affecting individual industry sectors/sub-sectors, and (2) assess whether potential investee companies have implemented appropriate actions to mitigate extreme weather risks specific to sectors/sub-sectors,” the report states.

In developing the matrices, Intact Centre researchers surveyed experienced senior managers in each of the six sectors — ensuring representation from Canada’s eastern, central, western and norther regions — for their rankings of the most common climate-related threats and most severe impacts on their business operations, and their insight on risk-mitigation measures for those impacts. As well, the matrices draw on resources from organizations such as ISO, Standards Council of Canada, National Research Council, Canadian Standards Association, Sustainability Accounting Standards Board, Global Reporting Initiative, and the International Electro-technical Commission Standards.

Feedback from 13 institutional investors, which collectively hold $2 trillion in assets under management, also helped shape the final format — in particular their request for more detail in the risk reduction section of the matrices.

“The financial community should lead the way in developing climate risk matrices. There is no point in talking about TCFD, Sustainability Accounting Standards Board (SASB), ESG or any other combination of letters, if, at the end of the day, this stuff doesn’t translate into action that lowers the risk profile of the investable universe,” reflects the report’s other co-author, Blair Feltmate, head of the Intact Centre.

Priority attention for measures to reduce flood and windstorm risks

The climate risk matrix for commercial real estate identifies floods and windstorms as the top two perils in a list of prevalent climate-related hazards that also includes wildfires, extreme heat, ice/hail/snow loading and thawing permafrost. Flooding comes with an ominous legacy of property/equipment damage and destruction, subsequent mould infestations and business disruptions, and also brings potential health and safety risks for building occupants, including drowning or electrocution. Meanwhile, windstorms can severely damage or propel the liftoff of roofing, carry debris that can break windows and other fragile structural features and drive water into buildings.

In total, the CRE matrix lists 16 risk-reduction measures across the six categories of climate threats. Of these, top priority is given to placing critical infrastructure for HVAC, electrical and communications systems above expected flood levels or at least flood-proofing equipment where it cannot be feasibly elevated, and to reinforcing roofing with additional fasteners at the perimeter and corners.

Among the recommended measures, some involve capital outlay, such as improvements to building foundations to protect against thawing permafrost or installing higher-resistance glass (windstorms), thermal imaging cameras (loading), water sensors (floods) or HEPA filters (wildfires). However, others are tied to emergency planning, such as ensuring procedures are in place to respond to floods or extreme heat, or maintenance, such as keeping sites, including roofs and gutters, clear of combustible materials or proactively removing ice and snow from roofs.

To guide investors, the matrix includes a key performance threshold for each of the six climate-related risks with a suggested question to pose to asset managers. For example, to address flood risks the question is: Are HVAC, electrical, communication systems, and server rooms elevated or otherwise flood protected? To address wildfires it is: Does the HVAC system have capacity to cleanse smoke from the air? Senior CRE managers provided input in setting the thresholds for acceptable performance.

The risk matrix for electricity transmission and distribution targets the same six climate-related threats, but places the most emphasis on wildfire, which arcing from powerlines can trigger, and snow/ice loading, which can topple lines and towers. Risk matrices for the industries providing residential services focus on five threats — floods, wildfire, hail, wind and snow/ice — with the highest priority tied to floods and wildfire.

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