Nature estimates that residential properties exposed to flood risk in the US are overvalued by US$121–US$237 billion, depending on the discount rate. Climate change and externalities are not generally accounted in financial, and economic pricing and risk management. We are only beginning to understand pricing climate impact. Nature has done an interesting study on unpriced climate risk in residential properties in the US.
The biggest risk in climate change with respect to residential properties in the US is flood risk. Flood risk is not accounted for due to lack of availability of related regulations, data and awareness. While the study is focused on the US, similar situation exists across the world wherein climate risks are not accounted for in property pricing.
Interesting observations in the study include:
1. Costs of climate risk is not only the physical damage to the properties but also how the property owners and others respond to the damage. Are the tax payers to bear the consequences or the damage individualized?
2. 14.6mn homes have at least 1% probability of climate risk resulting in potential annual damage risk of $32billion.
3. 4.6% is the average discount for properties in the 100-year floodzone. However, the study estiamtes that these properties are 8.5% overvalued on average (thus causing housing bubble to develop).
4. As the risk and costs are not fully priced-in, Municipaliteis that are heavily reliant on property taxes are particularly vulnerable for budgetary shortfalls. Some municipalities in the US are receiving more than 50% income via property taxes.
5. Low-income property owners are in particular risk of being economically affected due to property price deflation.
The study illustrates the property valuation methodology taking into account climate risk. Whilst this is a US focused study, the methodology and need to price in climate risk is apparent and applicable globally.