Building Resilient Portfolios: Navigating Flood Risk and Climate Change for Sustainable Real Estate Investment

According to the Environment Agency, since 1998 we have seen six of the ten wettest years on record. In 2022, for the first time ever, we saw three named storms in one week.

One of the key messages coming from COP27, is that we must plan and prepare for increasingly extreme weather events. To help our clients prepare and build portfolios resilient to flooding, Associate Water Services Consultant, Alex Perryman, and Environmental Transactions Services Unit Director, Graham Duffield hosted a free CPD webinar. In our latest insight, Alex Perryman answers our clients' most frequently asked questions and the key takeaways for investors who have suffered from or are concerned about their portfolio's resilience to flooding both now and in the future as a result of climate change.

The World Economic Forum published an updated flood risk analysis in the Nature Communications Journal in September 2022, stating that 23% of the world population (1.81 billion people), currently faces significant flood risk.

The devastating floods in Western Europe in 2021, killed over 200 people and were listed as one of the top 10 biggest natural disasters worldwide by economic damage from 1980 to July 2022 (Statistia 2022).

“Under optimistic climate change scenarios (RCP 2.6), sea levels are estimated to rise up to 0.55 m by 2100, putting especially large coastal cities at risk.” - Flood exposure and poverty in 188 countries, Nature Communications Journal.

By the year 2030, the Global Assessment Report (GAR 2022), published by the United Nations Office for Disaster Risk Reduction (UNDRR), estimate that there will be 560 climate-related disasters per year, globally. 

As the number of climate-related disasters increases, so does the economic cost to businesses. With an average cost of $170 billion per year across the world during the past decade, and the number of climate-related disasters predicted to continue to rise, investors must invest and adapt to be flood risk and climate resilient, mitigate and adapt to extreme weather events.

2023 will see the disclosure of climate-related risks become mandatory for investors and their portfolios of assets through frameworks such as The Task Force on Climate-Related Financial Disclosures (TCFD). It is time now to act and build climate and flood-resilient portfolios that build value for your next divestment/investment cycle.

Why is flood risk and climate change important in real estate investment?

As investors, you want to safeguard your assets from future risks such as increased flood risk caused by climate change by safeguarding your assets. This will lessen the risk of your assets devaluing over time or the inability to sell an asset as a result of climate change.

They may also be CapEx implications to provide flood and climate-resilient measures or increasing challenges in the ability to obtain insurance at commercially acceptable rates, especially if it cannot be demonstrated that your assets are flood or climate resilient.

Under initiatives such as the EU Taxonomy (expected to be reflected in the UK Green Taxonomy) and through others such as The Task Force on Climate-Related Financial Disclosures (TCFD) and Taskforce on Nature-related Financial Disclosures (TCND) there are a range of drivers for sustainable construction.

We need to better understand what are the main drivers in order to understand what is required to safeguard your assets.

What Are The Main Drivers Behind Effectively Managing Flood Risk?

The main driver is the TCFD. The TCFD breaks down risks into Physical and Transitional Climate Risks, in which ‘flood risk’ clearly falls into the Physical Risk category. Other physical risks include acute event-driven risks such as drought, floods, extreme precipitation and wildfires or chronic long-term climate risks such as rising temperatures and sea-level and accelerating loss of biodiversity etc.

The TCFD is a framework, formed by the Financial Stability Board to help identify the information needed by investors, lenders and insurance underwriters to appropriately assess price, and disclose climate-related risks and opportunities over the short, medium and long term.

The TCFD is the go-to ESG reporting framework for investors and ultimately helps companies develop an overarching ESG strategy.

The TCFD is currently voluntary, but it is due to become a mandatory requirement next year in 2023. The exact date is yet to be confirmed, which is why our investor clients are asking questions about climate change and flood risks in relation to their current Assets Under Management (AUMs).

EU Taxonomy

We are at a stage now where it is a reasonable assumption that much of the world will feel the implications of the EU Taxonomy (and the Green UK Taxonomy if implemented). 

EU Taxonomy works on two principles;

1. Do no significant harm - 70% of materials on site, not including hazardous materials, must be retained, reused or recycled. 
2. Make significant contribution - yet to be defined

Most companies throughout the world have at least started to think about their sustainability journey with many making progress towards sustainable goals. 

Under the EU Taxonomy, contributions towards the climate change adaptation objective require some companies to make an assessment of physical climate risks which have the potential to impact the company and its facilities. Our Delta Simon's reports are used by our clients to inform EU Taxonomy alignment as well as TCFD disclosures as part of a joined-up approach. It's not mandatory for all, but for some companies, seeking to align to the EU Taxonomy is part of their best practice.

The TCFD breaks down risks into two; physical climate risks and transitional climate risks. 

Physical risks can include acute event-driven risks such as drought, floods, wildfires, extreme precipitation, etcetera or chronic long-term climate risks such as rising temperature and sea levels. Flood risk falls into the physical risk category.

Our wider Delta Simon's team can assess physical risks as well as transitional risks arising from changes in policy and new technologies such as the growth of renewable energy, as well as support with ESG assessment and advice.

Value At Risk (VAR)

Another key driver for effectively managing flood and other physical risks is the Value At Risk (VAR), the measure of an asset or portfolio of assets.

With an increase in flood risk as a result of climate change and without flood and climate-resilient measures implemented over time, there is a real risk of devaluation of an asset or portfolio of assets. Furthermore, there could be operational disruption or additional salability and insurance challenges.

To reduce the potential financial risks, implementing a series of measures to reduce potential risk, including the installation or retrofitting of flood and climate-resistant and resilient measures, is essential. Such measures include floodproof doors, window shutters, raising, and relocating sensitive equipment, use of floodproof building materials, etc.

These kinds of resilience measures can be effective in mitigating flood risk up to 0.6 metres in depth. Anything exceeding 0.6 metres requires a Water Entry Strategy.

If your site is considered to be at risk, it is imperative that flood warning measures and response plans are prepared to ensure business continuity, safe emergency and evacuation and a clearly defined set of approaches and set of responsibilities.

Clearly, there will be a cost to install these measures, therefore there are potential CapEx implications to ensure there is a return on investment for any upgrades or improvements to your physical assets. 

CapEx can also be undertaken on any new opportunities to ensure the risks are appropriately assessed and that mitigation is accounted for which ultimately helps your decision-making in terms of whether to keep/buy or sell an asset.