The Emperor’s New Coastline: An Initial Framework for Real Estate Investing In a Time of Climate Change by Daniel Hare B.A., Government, 2005 Georgetown University Submitted to the Program in Real Estate Development in Conjunction with the Center for Real Estate in Partial Fulfillment of the Requirements for the Degree of Master of Science in Real Estate Development at the Massachusetts Institute of Technology September 2020 ©2020 Daniel Hare All rights reserved The author hereby grants to MIT Permission to reproduce and to distribute publicly paper and electronic copies of this thesis document in whole or in part in any medium now known or hereafter created. Signature of Author _________________________________________________________ Center for Real Estate August 14, 2020 Certified by _______________________________________________________________ Jennifer Cookke Lecturer, Department of Urban Studies and Planning Thesis Supervisor Accepted by _______________________________________________________________ Professor Dennis Frenchman Class of 1922 Professor of Urban Design and Planning Department of Urban Studies and Planning Director, MIT Center for Real Estate Page Left Intentionally Blank 2 The Emperor’s New Coastline: An Initial Framework for Real Estate Investing In a Time of Climate Change by Daniel Hare Submitted to the Program in Real Estate Development in Conjunction with the Center for Real Estate on August 14, 2020 in Partial Fulfillment of the Requirements for the Degree of Master of Science in Real Estate Development ABSTRACT This thesis investigates the scientific underpinnings of climate change, its physical manifestations, the complications society faces in adapting to this phenomenon and its likely impact on real estate investment values. It concludes by proposing an initial investment framework for real estate investors concerned with climate change. This framework highlights non-traditional due diligence considerations and asserts that probabilistic valuation methods allow for more accurate asset underwriting. The first chapter is structured as a general primer on climate change and includes references for those who would like additional reading on its science. The second chapter describes the geophysical effects of climate change. The intent here is to provide enough background for readers to understand its causes and potential severity. The third chapter covers how geopolitical actors are responding to a warming world and introduces important macroeconomic trends. The fourth chapter outlines the substantial engineering and insurance challenges ahead and presents cases of societies that have won and lost while dealing with either a changing climate or extreme weather events. The fifth chapter highlights key economic, legal, and demographic research on climate change’s impacts to date and those that are likely to occur going forward. The purpose of these chapters is to provide historical context for how dramatic atmospheric changes can lead to dramatic economic losses, and to provide some lessons that real estate investors should incorporate when underwriting new opportunities. The conclusion summarizes the first five chapters and offers an initial framework for how real estate investors can incorporate climate change into their underwriting, including a brief review of how property values are currently underwritten using relatively short-term, deterministic discounted cash flows. In closing, I describe how a longer timescale underwriting with additional simulations is beneficial to account for the uncertainties associated with climate change and suggest further research to explore possible market mispricing of assets based on widely divergent upside and downside skews given likely future climates. Thesis Supervisor: Jennifer Cookke Title: Lecturer, MIT Center for Real Estate 3 Acknowledgements Few tasks of consequence are accomplished alone, and this thesis is no exception. I would like to thank my advisor, Jen Cookke, for her patience – as I spent a great deal of time researching this topic before putting pen to paper – and support throughout this process. I also owe a debt of gratitude to Professor David Geltner for his excellent real estate finance courses, his pioneering work on real options – including his collaboration with Professor De Neufville. Thanks to John Holdren and Henry Lee for their multidisciplinary class on the Energy Climate Challenge, which provided useful context and resources for this thesis. I would also like to thank my incredible classmates, along with the outstanding faculty and staff at MIT’s Center for Real Estate for providing me with a great education that stands out as one of the best experiences of my life. Finally, I am very grateful for my amazing wife and family, who are constant, inexhaustible sources of love and support. Without them, my time at MIT would not have been possible. 4 Table of Contents ABSTRACT ................................................................................................................................................. 3 Acknowledgements ...................................................................................................................................... 4 Table of Contents ......................................................................................................................................... 5 Introduction .................................................................................................................................................. 7 Chapter 1 - Climate Change Basics: History and How It Happens ............................................................ 14 Background ............................................................................................................................................. 14 Big Picture: The Climate Challenge ......................................................................................................... 19 History of Scientific Research ................................................................................................................. 20 Mechanisms and History of a Changing Climate .................................................................................... 24 The Weather Report: Likely Future States .............................................................................................. 31 Chapter 2 - The Negative Effects of Climate Change ................................................................................. 38 Overview ................................................................................................................................................. 38 Effect: Increased Temperature and Humidity ........................................................................................ 40 Effect: Sea Level Rise ............................................................................................................................... 44 Effect: Harsher Storms, More Droughts, Floods and Wildfires .............................................................. 47 Effect: Damaged Ecosystems and a Cloudy Future ................................................................................. 52 Effect: Ocean Acidification and Bleaching .............................................................................................. 53 Effect: Food and Water Insecurity .......................................................................................................... 54 Chapter 3 – Human Activity, Skeptics and Your Bottom Line ................................................................... 57 Reminder: Civilization’s Links To Warming ............................................................................................. 57 What Are The Positions Of Climate Skeptics?......................................................................................... 59 How Are Self Interested Parties Reacting? ............................................................................................. 61 Why Does Climate Change Matter For The Economy And The Real Estate Community? ...................... 64 Chapter 4 – The Road Ahead: Challenges and Case Studies ..................................................................... 67 Insurance and Ensured Extreme Weather .............................................................................................. 67 Engineering Complexities and Costs ....................................................................................................... 75 Centuries Below Sea Level: Dutch Exceptionalism ................................................................................. 77 From Sea to Shining Sea: America at Risk ............................................................................................... 79 Delta Blues: Sinking New Orleans ........................................................................................................... 80 Atlantis in America: Underwater in Miami ............................................................................................. 84 5 Chapter 5 – By the Numbers: The Economic Literature on Property Values and Climate Change ......... 87 The Cost of Sea Level Rise ....................................................................................................................... 87 Other Price Drivers: Hurricane and Wildfire Risk.................................................................................... 90 A Crystal Thermometer: Temperature and Forward-Looking