Climate risk and the opportunity for real estate

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Published 2022-02-04
Point(s) of Contact
Organization(s) McKinsey
Where Washington DC
Press Release

Climate change, previously a relatively peripheral concern for many real-estate players, has moved to the top of the agenda. Recently, investors made net-zero commitments, regulators developed reporting standards, governments passed laws targeting emissions, employees demanded action, and tenants demanded more sustainable buildings.

At the same time, the accelerating physical consequences of a changing climate are becoming more pronounced as communities face storms, floods, fires, extreme heat, and other risks.

These changes have brought a sense of urgency to the critical role of real-estate leaders in the climate transition, the period until 2050 during which the world will feel both the physical effects of climate change and the economic, social, and regulatory changes necessary to decarbonize. The climate transition not only creates new responsibilities for real-estate players to both revalue and future-proof their portfolios but also brings opportunities to create fresh sources of value.

The combination of this economic transition and the physical risks of climate change has created a significant risk of mispricing real estate across markets and asset classes. For example, a major North American bank conducted analysis that found dozens of assets in its real-estate portfolio that would likely be exposed to significant devaluations within the next ten years due to factors including increased rates of flooding and job losses due to the climate transition. Additionally, a study of a diversified equity portfolio found that, absent mitigating actions, climate risks could reduce annual returns toward the end of the decade by as much as 40 percent.

Leading real-estate players will figure out which of their assets are mispriced and in what direction and use this insight to inform their investment, asset management, and disposition choices. They will also decarbonize their assets, attracting the trillions of dollars of capital that has been committed to net zero and the thousands of tenants that have made similar commitments. They will then create new revenue sources related to the climate transition.

Building climate intelligence is central to value creation and strategic differentiation in the real-estate industry. But the reverse is also true: real estate is central to global climate change mitigation efforts. Real estate drives approximately 39 percent of total global emissions. Approximately 11 percent of these emissions are generated by manufacturing materials used in buildings (including steel and cement), while the rest is emitted from buildings themselves and by generating the energy that powers buildings.

In addition to the scale of its contribution to total emissions, real estate is critical in global decarbonization efforts for reasons likely to be compelling for investors, tenants, and governments. Significant reductions in emissions associated with real estate can be achieved with positive economics through technologies that already exist. For example, upgrading to more energy-efficient lighting systems and installing better insulation have positive financial returns. Today, newer technologies also make low-carbon heating and cooling systems, such as heat pumps and energy-efficient air conditioning, more cost competitive in many markets and climates. These cost-effective upgrades can create meaningful change while also derisking assets.

We suggest three actions real-estate players can take to thrive throughout the climate transition:

  • Incorporate climate change risks into asset and portfolio valuations. This requires building the analytical capabilities to understand both direct and indirect physical and transition risks.
  • Decarbonize real-estate assets and portfolios.
  • Create new sources of value and revenue streams for investors, tenants, and communities.

Fundamental changes brought on by the climate transition will open new dimensions of competitive differentiation and value creation for real-estate players. More important, leaders will make a valuable contribution to the world’s ability to meet the global climate challenge.