There is little question that climate change is creating unprecedented risks—everything from the long-term threat of rising sea levels to increasingly frequent severe events, such as floods, wildfires and hurricanes. In 2021, the total damage caused by weather disasters was $329 billion globally, according to insurance broker Aon.1 In the U.S., the National Oceanic and Atmospheric Administration counted 20 climate-related disasters that caused at least $1 billion in damage (Exhibit 1).2 These events caused total damages of $145 billion. In the KPMG 2021 CEO survey, climate jumped to the No. 1 risk in 2021, up from fourth place in 2020.3
Yet despite the growing risk, many organizations have not yet prepared for the likelihood of natural disasters by comprehensively assessing the vulnerabilities of their buildings and developing a strategy of environmental resilience. Nor have most companies considered the cost of transition risk—adapting commercial real estate for a no-carbon environment.
Exhibit 1: Severe weather events are increasingly common and costly
US 2021 billion-dollar weather and climate disasters
Note: This map shows the approximate location for each of the 20 separate billion-dollar weather and climate disasters in the United States in 2021. Source: NOAA, 2022
With growing threats, climate risk is rising to the top of the corporate ESG agenda. It is not only prudent to start thinking about how to make physical assets—plants, warehouses, and office buildings—resilient, and factoring climate risk into real estate decisions, it is also central to advancing ESG efforts. Investors expect companies to be assessing and mitigating physical and transition climate risks and embedding these considerations into strategy. In Europe, companies are required to disclose their climate risks. A similar requirement is under consideration by the Securities and Exchange Commission in the U.S.4
This paper outlines how organizations should assess climate risk across their entire portfolio of real assets, such as factories, distribution centers, and offices, and then design a strategy that integrates these risk calculations into its long-term portfolio management. We will examine the types of risks companies should plan for, and the ways in which resilience should be built into the long-term management of real estate holdings.
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Two types of risk to manage
Companies need to consider two types of climate risk related to their real estate assets: the physical risks such as damage to buildings and potential increasing operating costs; and the risks/costs associated with the transition to energy-efficient and low emissions buildings.
In addition to retrofitting buildings or investing in new ones that meet new standards, real estate owners face regulatory and reputational risk. In the future, for example, an owner might face penalties for emitting too much carbon in some jurisdictions.
Also, some stakeholders might react negatively to companies that are seen to be slow in moving toward zero-carbon goals. Consumers might buy less from a company that is perceived to be a laggard on climate issues.
Economists and financial analysts can help develop models to forecast the likely impacts of both physical and transition risks. Cost estimates of climate risk should include the cost of closing a factory due to flooding or the effect of rising temperatures on the demand for air conditioning and the impact on carbon emissions. Companies will also need to predict how future climate-related changes in regulations might impact their costs. An assessment might include the cost of asset write-offs, stranded assets, lower valuations and the impact of increased operating expenses due to climate change.
Creating climate risk strategy and action plans
The recommended strategy to prepare for the potential impact of climate change comprises two phases. The first phase involves evaluating the maturity of the company for climate change readiness, including assessing climate risks and evaluating the resilience of assets and the overall business strategy. The second phase transforms the company in preparation for climate risk and reporting.
Exhibit 2: A two stage roadmap for addressing climate risk
Phase 1: Develop strategy
1. Evaluate TCFD climate risk readiness: Evaluate the extent to which your business’s processes and controls enable climate readiness, resilience, and TCFD-aligned reporting.
2. Assess risk and opportunities: Understand physical risks, transition risks, and opportunities by scenario, value chain component, and geography.
3. Review strategic response planning: Review current business strategy, risk mitigation plans, resilience investments, and develop strategic responses and recommendations.
Phase 2: Implement strategy
4. Transform your organization: Implementation of your strategic responses across your business and creating a climate resilience business/operating model.
5. Measure progress and reporting: Detailing your TCFD-aligned climate narrative to the market based on your risk and actions today, and the pathway ahead.
Phase one: Develop strategy
Evaluate whether, and to what extent, governance, strategy, risk management, metrics and targets enable climate readiness and resilience. Risk reporting should follow the guidance of the Task Force on Climate-Related Financial Disclosures (TCFD). TCFD focuses on evaluating climate governance, climate strategy, risk management related to climate issues, and climate metrics and targets. Its framework is designed to help companies disclose climate risks and perform comprehensive assessments of physical and transition climate risks and opportunities.
Using the framework, a company examines climate risks across a number of trajectories and pathways, which include temperature change, transition type, and time horizon. This analysis enables an assessment of the organization’s vulnerability to climate change and an evaluation of the potential implications for the business strategy.
New technologies incorporate sophisticated models of climate risk, including geospatial data gathering, artificial intelligence, machine learning, and detailed economic projections. Using mathematical models, organizations can quantify the financial impact of risks and opportunities over different time horizons for an entire real estate portfolio, or for individual assets and specific geographies. The company then develops response strategies to mitigate and adapt to the specific effects of climate change on its business through physical-asset resilience and targeted strategies.
Phase two: Implement strategy
In this phase, companies implement a climate-resilient business model that embeds strategic responses to climate risk across the enterprise. These responses might include incorporating climate risk assessments in portfolio management and assessing climate risk as part of investment due diligence.
Some companies are investing in energy-efficient building materials, such as low-E windows or finding ways to make buildings more resilient, such as rainwater harvesting to protect against drought, or more aerodynamic designs to withstand against high winds.5 Companies are also switching to renewable energy sources, such as equipping facilities with rooftop solar.
Although climate risk requires continual evaluation as new data becomes available, it is important to share the implications of climate risk and the new strategy with stakeholders, including investors, employees, and regulators. Companies should publish a climate risk report that is aligned with TCFD guidelines and customized to the risks faced by the organization. This should chart the path ahead, so that stakeholders can judge the success of the strategy. According to TCFD, more than 2,600 organizations used TCFD guidelines in 2021, an increase of over one-third from 2020.6
Client story: Assessing climate risk for a company with 600 properties
KPMG has developed a solution that correlates multiple layers of physical risk onto a map of the entire U.S., enabling organizations to assess short- and long-term risks by specific asset and location. KPMG used this enabler to help address the needs of a real estate holding company that has 600 properties scattered throughout the U.S., Canada and Europe.
The company wanted to analyze the current level of risk and where to apply disaster-mitigation investments most effectively. After a detailed risk analysis, KPMG found that 41 of the properties were likely to transition from low to high risk due to a rise in sea level. There were an additional 163 properties located in areas of water stress and 37 susceptible to the effects of wildfires. In response, the company determined which properties required investments in protective measures and which ones to divest. That created a long-term plan for its asset portfolio.
