Real estate: Setback

The frequency and severity of natural disasters have increased in recent years, driven by climate change. This trend is expected to continue, even under the best assumptions. For example, under an orderly transition (RCP2.6) meeting Paris Agreement goals by 2050, hurricane costs are projected to rise by 12%, 14%, and 15% in Florida, Louisiana, and North Carolina, respectively. In the worst case, costs will increase between 41% (Florida) and 53% (North Carolina) (Figure 29). These natural catastrophes have a profound impact on the housing market, influencing property values, insurance costs, and overall market dynamics.

Homeowners affected by disasters often face immediate losses, including damage to their homes and possessions. But there also longer-term effects as the perception of future storms changes. Considering these households’ perceptions of hazards damages, an analysis reveals, in the aftermath of hurricane Sandy in New York in October 2012, a persistent negative effect on flood zone housing values, with even non-damaged properties showing an 8% price penalty by 2017 and damaged properties experiencing an immediate 17-22% drop, followed by only partial recovery . In general, houses exposed to sea level rise sell for about 7% less than similar properties that are not exposed . But this effects works also the other way round as new buyers place higher values to adaptation measures. For example, before Hurricane Katrina (New Orleans, August 2005), the elevation of properties in flood-prone areas had a minimal effect on selling prices, adding only about 1.4% per foot. However, after Katrina, the significance of elevation became much more evident. Water level marks allowed buyers to better gauge elevation, resulting in a 4.6% price increase per foot in areas affected by flooding.

The impact of natural catastrophes on the wider housing market is further complicated by the ensuing market dynamics. Housing markets within exposed areas display a temporary negative supply shock. This supply shortage can drive up prices in the short term. For instance, a study reveals that home prices in hurricane-exposed areas increase by 5% on average in the three years following a hurricane, peaking at 10% in the second year, compared to unexposed areas. Concurrently, the probability of home transactions in these exposed areas drops by 7% from the baseline⁹.  However, prices tend to normalize as supply levels recover over time. But hurricanes, disrupting local economies, can have also an effect on housing demand, as income levels are lowered. In that case, the overall net effect remains uncertain. Bottom line: It is clear that exposure to natural catastrophes will play an increasing role in housing markets. However, it is less clear how that will impact the general level of housing prices. It cuts in both ways.

Therefore, the bigger impact on housing prices might be come from transition risks. Although transition risks are not as immediately pressing as physical risks for real estate, they are still significant. The primary way these risks impact real estate is through the energy consumption of buildings, particularly for heating. 

Many regions have revised their building codes to require new constructions to meet higher energy-efficiency standards and use renewable energy for heating. While older buildings are sometimes exempted from these rules, this is not always the case. The UK's Minimum Energy Efficiency Standard (MEES) exemplifies how buildings can be subject to transition risks . The UK assigns an Energy Performance Certificate (EPC) rating to properties, ranging from A to G, with G being the least efficient. As of 2018, the average EPC rating for rental properties was E. Under the MEES regulation, starting from April 2018, properties with ratings F or G could not be rented out under new leases, and this rule expanded to include existing leases from 2023, with penalties for non-compliance. 

Figure 30 illustrates the projected impact of the energy transition on the House Price Index (HPI) in the UK between 2022 and 2050, using two scenarios from the NGFS: the Below 2°C (orderly transition) and the Delayed Transition (disorderly transition). The analysis reveals that, compared to a baseline scenario with no climate change, the HPI in the UK is expected to decline by 9.3% under the Below 2°C scenario and by 13.1% under the Delayed Transition scenario. Given today’s value of British private households’ real estate stock of EUR 8.3trn, these declines would wipe out EUR 770bn and EUR 1,1trn, respectively or EUR 11,240 and EUR 15,840 in per capita terms. These projections align with NGFS data for Germany, where cumulative HPI declines of 18.1% (EUR 2.2trn or EUR 23,920 per capita) and 24.5% (EUR 2.7trn or EUR 32,380 per capita) are expected under the Below 2°C and Delayed Transition scenarios, respectively. Applied to all markets under consideration, home owners are in for facing losses of up to EUR 30trn. These strong declines are triggered by the steep fall in the prices of energy-inefficient buildings, depressing the overall market. In future, housing prices are set to be defined less by location and more by energy efficiency.

Australia's transition under the Below 2°C scenario is expected to have a minimal impact, with some projections even suggesting a slight positive effect on the economy. This contrasts with countries like Germany and the UK, where the transition may be more challenging. The key factor is Australia’s sharp decline in energy consumption, driven by its ambitious climate policies under the Below 2°C scenario. Central to these policies is a rapid increase in carbon pricing, set to rise more quickly and to higher levels by 2050 than in the EU and UK.