After Tropical Storm Allison slammed into southeast Texas and Houston in 2001, the Texas Medical Center (TMC) in Houston learned valuable lessons about building resilience against deadly storms. The tropical storm dumped about 40 inches of rain on Houston, causing massive flooding and widespread damages to residential areas and businesses. At TMC, the flooding destroyed years of medical research and caused substantial structural damage to the largest medical complex in the world.
Following Allison, TMC spent enormous sums of money to fortify its infrastructure to protect the medical complex against another superstorms. The TMC elevated sensitive equipment like emergency generators and switching gears and installed submarine doors that are essentially steel barriers to preserve hospital buildings, among other things. All the planning and investment worked out in 2018 when an even bigger storm, Hurricane Harvey, hit Houston and led to 51 inches of rain. TMC remained fully operational during the storm, never suffering any water intrusion or power outages and continuing to receive patients.
Climate change has caused major natural disasters like Hurricane Harvey to become more common and powerful, and TMC’s investment in building resilient infrastructure highlights one example of how property owners can defend their assets against climate threats. Writing in the Harvard Business Review, John Macomber, senior lecturer in finance at Harvard Business School, said TMC’s investment in reinforcing its medical complex made sense because of the direct and indirect cost of getting hit by another superstorm in a hurricane-prone area like Houston was significant. Macomber added that TMC had access to capital to make the improvements, too. But, he said, not every investment in building resilience and reinforcing assets like this makes sense.
“We can’t pay for a blanket policy to resist sea rise and rainfall and fire in every situation forever, regardless of cost/benefit,” Macomber wrote.
Macomber’s research, and others, suggest climate change will begin to impact where and how commercial and residential real estate is built and that it’ll happen sooner rather than later. To some extent, it’s happening already, as evidenced by TMC’s investments in resilience against major hurricanes. Macomber has developed a model that says there are five basic choices on where and how to build to protect real estate assets against climate change: reinforce, rebuild, rebound, restrict, and retreat. The Harvard professor says these basic principles can be used as a decision-making tool for property owners and CRE investors when thinking of climate risks. And the dangers of climate change to the built environment continue to pile up, and they’re expected to get worse.
There were 22 separate billion-dollar weather-related climate disasters in the United States in 2020, according to NOAA’s National Centers for Environmental Information. That number shattered the previous record of 16, recorded in 2016 and 2011. The billion-dollar climate disaster events included seven disasters linked to tropical storms, one to wildfires, 13 to severe storms, and one to drought. Combined, the 22 disasters cost the United States $95 billion in damages, and many of these damages were to the built environment.
Property owners have traditionally used insurance as the primary way to protect assets against extreme weather and climate events. Rather than limiting investment in certain areas with high climate risks like wildfire corridors, the question is usually more about how to properly insure the building. But in some areas particularly prone to natural disasters, insurance premiums are going up and coverage availability is going down. As extreme weather events increase, some property owners and investors are beginning to question how long insurance will protect assets in very vulnerable areas. “I find it hard to believe that people are capable of underwriting all of these risks,” an interviewee told the Urban Land Institute in their report Climate Risk and Real Estate Decision-Making.
Macomber thinks CRE owners and investors need to take a hard look at their assets and portfolios given the increased extreme weather risks, and he says simply fortifying buildings against disasters like hurricanes is only one option. “It depends on how scary the peril is,” he said. “In California, we’ve definitely heard stories of people saying, ‘Okay, I’ve had enough. I can’t keep seeing these fires and living with my go-bag.’”
In his HBR article, Macomber uses the example of small shopkeepers and restaurants in Elliot City, Maryland, who were exhausted by consecutive years of flooding in a low-lying area. Eventually, many in the city abandoned the historic downtown for higher, drier land, which made sense because the price to reinforce the flood-prone area by building sea walls was too high, and resources were too thin. Another course of action, according to Macomber, is to ‘rebound.’ He cites Miami and Miami Beach, where most new commercial or condo buildings are designed with the idea of ‘living with water.’ They have extra-high first-floor elevations, and expensive equipment is located out of harm’s way and often on the second floor or higher.
Another option is to simply rebuild in disaster-prone areas, a strategy that has been used often “if you’re rich or you can use someone else’s money,” Macomber wrote. “People get kind of lazy if they think someone else is going to bail them out,” Macomber said. “One thing to keep in mind is that the payout is never full. Whether it’s the insurance company or FEMA, they’re not going to make you whole financially, although they may help you. The second thing is there’s not unlimited money, and it’s getting harder and harder to get this money from Congress.”
Macomber noted that in recent years, Congress has authorized about $200 billion per year for disaster relief in California, Texas, Iowa, and Florida, in addition to subsidizing the National Flood Insurance Program (NFIP). He says it’s unclear how long these massive tax-payer-funded bailouts can continue; indeed, it seems unsustainable with climate events increasing and becoming ever-more expensive.
Macomber’s last strategy is to ‘restrict,’ meaning not investing in new property assets in harm’s way. He says some private-sector mortgage and insurance companies are already doing this, and so are large asset owners like REITs and retailers. “I don’t know what Amazon is doing with all of their warehouses,” he said. “But you have to think that with all the information they have, they’re not putting them in places that have electrical grid problems, flood problems, or wildfire problems. They have the capital to go someplace else. But with a company with less money and less access to information, they have to go to a piece of land that’s cheaper and maybe in a riskier area.”
In the years ahead, commercial real estate owners and investors will have to make some tough decisions on how they’ll protect their assets against climate threats. In most cases, they’ll choose among the five options Macomber’s research has indicated: reinforcing buildings, retreating from high-risk areas, rebounding and living with the risks, rebuilding and depending on government bailouts, or restricting and choosing not to locate in risky locations. Each decision will depend on various circumstances, including how bad the extreme weather risks are and how much capital is accessible. But one thing seems inevitable: climate change risks will increasingly affect property valuations and markets, and the property owners who are best prepared for these effects will be much better off.
“The summer of 2021 really made people aware of not just storm surge, but also flooding, wildfires, and extreme heat like what happened in Oregon,” Macomber said. “And these things are much more top of mind than they were than just a few years ago for real estate site location questions.”
In some cases, doing what the Texas Medical Center did to build ultra-resilience to possible hurricanes and superstorms is the smart bet. But not everyone has access to that type of capital, and battening the hatches isn’t always the wisest thing to do, as Macomber’s research suggests. In areas pounded by severe storms or terrible wildfires year after year, a smarter move may be to retreat from the location and find a safer spot to build or invest. Extreme weather events linked to climate change set records in 2020, and insurance companies are responding in kind, meaning coverage is getting more expensive and harder to obtain in some cases. Factoring in climate risks in decisions over site locations will be increasingly important in the future, and it’s beginning to happen already. When the next billion-dollar natural disaster hits, it will be hard to argue that the property owners affected couldn’t have done anything to prepare.