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

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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

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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.

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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

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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 Pricing ...... 91 Where To? Demographic Research and Possible Migration Patterns ...... 93 Money Talks: Institutional Investor Awareness ...... 96 Conclusion – Takeaways and Next Steps to Underwrite Real Estate ...... 97 Takeaways ...... 97 Next Steps ...... 99 Tomorrow’s Climate, Today’s Underwriting: Climate Due Diligence For Real Estate ...... 99 The Usefulness of a Real Options Approach and Monte Carlo Simulations ...... 103 References ...... 107 Introduction ...... 107 Chapter 1 ...... 107 Chapter 2 ...... 110 Chapter 3 ...... 111 Chapter 4 ...... 113 Chapter 5 ...... 115 Conclusion ...... 117

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Introduction

“We expect too much of new buildings, and too little of ourselves.” - Jane Jacobs, The Death and Life of Great American Cities

The purpose of this thesis is to alert the real estate investment community of the coming reality of climate change and its nascent implications for property space and capital markets. Specifically, this thesis hopes to caution climate skeptics about optimism that the atmospheric stability enjoyed in recent times will continue, and to outline the dangers that this phenomenon poses to real estate holdings. The morality of whether global heating is good or bad, and opinions of whether a warmer or cooler future is preferable are functionally inconsequential compared to the larger picture: temperatures are changing and even a slight climate shift, regardless of its direction, will wreak havoc on our civil society and economy. To concretize this paper, the focus will be on the United States and one of the most intuitive to imagine, discrete to model, and hardest to manage aspects of climate change: sea level rise.

Though certain predictions of a climate apocalypse in the next decade are likely overblown, the continued heating of our environment and construction of property in harm’s way puts us on a collision course for large scale value destruction and unhappy outcomes in the course of our and our children’s lifetimes. While this paper primarily focuses on the United States, this trend will occur globally and indeed wreak greater havoc on many of the developing nations that are least equipped to deal with it. The conclusion of this thesis highlights the currently mispriced risk that a changing climate represents to property owners and makes an initial attempt to construct a framework for avoiding exposed real estate, and for finding and underwriting property investments that will perform relatively well in the years to come.

This paper was inspired by a few simple questions that have plagued me as a real estate investor for the better part of a decade, namely “is climate change a real phenomenon?”, “if the impact will be as catastrophic as scientists claim then why aren’t real estate investors responding accordingly?”, “with relatively better weather, ample water and protection from more chaotic oceans, will struggling Rust Belt Cities be reborn as the economic hubs of the United States?”, and “is there a way for real estate investors to profit from climate change?”.

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Over the coming decades, climate change is projected to cause large scale movements of people and goods that could meaningfully change society as it is reshaped. Eventual adaptation is likely to include large scale migrations of currently vulnerable populations, thereby increasing demand, rents, and property prices in the cities to which they relocate. To date, the investment community has been slow to respond to this likelihood, with skeptics questioning scientific evidence, public companies worrying about quarterly earnings, front office employees focusing on annual bonuses, and private equity funds investing and harvesting deals over three to ten-year timelines. Politicians with limited jurisdictional authority to enact change and myopic focuses on reelection have shown limited ability to ameliorate the long-term problem.

Misaligned incentive systems and timescales have caused many investors to not focus on possible climatic outcomes, which creates a unique opportunity for intergenerational wealth creation for patient, long term, value-oriented investors. Specifically, covered land plays (which are currently cash flowing assets that have future redevelopment potential) in areas that are positioned to thrive in a future atmospheric state, are likely to outperform over the long term with return probability distributions skewed towards higher upsides while concurrently enjoying the protection of limited downsides (when priced on current yields). Alternatively, properties on parcels and in markets more exposed to climate change are likely to have return probability distributions with substantial downside likelihoods that are currently underappreciated. An example to illustrate this risk: in Florida, after 19 years in the mean high tide, private property becomes state owned in a trust for the public, but previous owners are still subject to CERCLA liability. Other states have similar provisions, as the public trust doctrine is part of American common law and is based on the premise that the land beneath navigable waters should be a shared public resource (Flournoy, 2017). This little-known fact means that assets that owners may try to get cash flow out of over their remaining useful life may not only have lower residual values, they may have substantial and unavoidable liabilities as their coastal property is inundated and pollution remediation is required. Fundamentally, a profit motive recalibrated to account for climate change, should allow for more efficient uses of resources and capital, and lead to a smoother, safer future for society at large.

The hope of this paper was selfish: to identify which cities, neighborhoods and individual parcels are best positioned to withstand the coming calamities of sea level rise, increased temperatures,

8 longer droughts, hotter wildfires and more powerful hurricanes, so that I or investors I represent could buy them at their fundamentally mispriced current values and profit over the long term. Through writing this paper, I came to three important realizations: first, identifying specific cities and parcels that will benefit is an exercise beyond the scope of this thesis; second, this is a situation where a profit driven private market response can help society even if politicians are slow to act; and third, real estate investors are fundamentally and categorically mispricing assets by incorporating a silent but wholly inaccurate assumption into their cash flow models: that the climate is stable.

Given the limited timeframe and resources available for this thesis, I narrowed its scope to focus on two goals, 1) to provide a narrative to the real estate community to help them understand the grave threat of climate change and the need for immediate action on their part, and 2) to draft an initial framework for how investors should think about this risk as a due diligence item and how they should explore adjusting their financial modeling to incorporate a real options approach using Monte Carlo simulations, which more accurately reflects the true value of property given meteorological flux.

Noted economist and climate researcher Nicholas Stern aptly described climate change as “the greatest market failure the world has ever seen” (Rotman, 2011), as the unpriced, negative externalities of greenhouse gas emissions lead society to face an unsettled environment that will cause – among other calamities - species and plant extinction, rising seas, and more powerful hurricanes. While humanity will no doubt adapt to and survive in a warmer future, there will be a lot of geophysical and economic turmoil in the interim. Stern noted that unchecked, this could lead to a 5% (possibly up to 20%) loss in gross domestic product “each year, now and forever” (Stern, 2007). Over a shorter timeframe than people would like to believe – namely, a mortgage cycle on a new house – we are likely to see low lying buildings wash away, public infrastructure face the threat of more frequent flooding, tax rolls will fall, and certain exposed populations will be forced to move to more protected areas.

The following map from the United Nations neatly displays how this is currently thought likely to play out across North America (Ionesco, Mokhnacheva and Gemenne, 2017).

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Source: Ionesco, Mokhnacheva and Gemenne, 2017

A collective action problem of a truly global scale, governing bodies have limited ability to implement and enforce solutions that are likely to lessen meaningfully the impact of climate change. Even with greater public authority and resources, the scale of the problem is so large that private market responses are also needed to ensure a bright future. With any luck this paper will help to reorient the incentive systems of the real estate community in a way that is operative to responding to this inevitable problem. Hopefully, investors will realize that on a sufficiently long timescale and with a correct perception of risk, their profit motive can be usefully aligned with

10 the common good and help to relocate people and their valuables out of harm’s way, so that we do not put lives at risk or needlessly waste money. Rather than just profiting investors, this thesis hopes to profit society at large by encouraging practical deployments of capital that will foster resilient communities in areas with good long-term prospects for survival.

This thesis is meant to serve as an introductory guide on how the real estate community might think about climate change as a part of its investment process. It offers background on the topic, highlights cases and research that are informative to future projections and argues for how cash flow proformas should be adjusted to more accurately reflect the risk of different locations.

This thesis assumes that the reader has relatively little familiarity with the science of climate change or the academic research done on mitigation and adaptation options for dealing with this phenomenon. As such, the first chapter is structured as a primer on the topic and includes references for those who would like additional reading on the science and politics of the matter. My intent here is not to be a definitive scientific tome on the topic, but rather to provide enough background for readers to understand its severity and enough context for them to draw their own conclusions on how to approach the matter.

The second chapter describes the geophysical effects of climate change. This includes a review of each of the major physical aspects of climate change, including among other things warmer temperatures, rising seas, and more intense droughts. The third chapter covers geopolitical and macroeconomic trends. It shows how major governmental and non-state actors are reacting to this phenomenon, and includes high-level projections describing the costs of climate change.

The fourth chapter describes cases of societies that have won and lost while dealing with either a changing climate or large scale, 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 investors should incorporate when underwriting new opportunities.

The conclusion summarizes the first five chapters and briefly suggests how investors should incorporate climate change into their underwriting. In closing, we describe how property values are currently underwritten using relatively short-term discounted cash flows, make an argument

11 as to why a longer timescale and additional simulations are necessary to account for climate change and highlight the opportunity for more research to show how a real options approach and Monte Carlo analysis could uncover current market mispricing of assets based on widely divergent upside and downside skews given likely future states. Note that this section does not predict which regions and types of property are either likely to win or lose in a warming future, as this is a subject in need of more academic research beyond the scope of this thesis. An opportunity for highly useful research exists for climate scientists, urban planners, demographers, economists and investors to work together to do a deep dive on what different climate scenarios mean for regional habitability, what the current carrying capacities are of different cities, taken together what these suggest for possible migratory trends and, as a consequence of the aforementioned analyses, offer recommendations of how cities should rezone, governments should invest in infrastructure and supply chains and property markets should adapt.

Again, this thesis is chiefly a narrative for the real estate investment community to highlight the misunderstood scientific, political, demographic, and economic problems posed by climate change. Unfortunately, the impacts of climate change will be uneven. While society at large will be negatively impacted as it adjusts to climate change, regional outcomes will not be uniform. Winners and losers will emerge, with more resilient locations – places projected to have moderate temperatures, abundant potable water, arable land, well placed infrastructure and limited exposure to extreme weather – poised to achieve supernormal appreciation and returns, as people move themselves, their skills and their money to these safe havens.

Recent polls from CBS News and the Washington Post show that between 70-80% of Americans now believe that human activity is causing climate change, which is a dramatic increase from just a few years earlier (Johnson, 2019). The good news is that this will likely lead to more proactive adaptation, but it will also mean that the window for forward thinking real estate investors to purchase well located land will narrow as competition increases. As behavioral economists like Daniel Kahneman and Amos Tiversky have shown, investment behavior is often driven by psychology (Kahneman, 2011). Investors often seek comfort in consensus and display a follow the herd mentality when selecting where to put their money. With growing public consensus around the causes and potential impacts of climate change, there could well be an

12 overnight shift in investor psychology that benefits certain properties and leaves others permanently impaired. This paper seeks to inform curious investors as to how they can get ahead of this trend.

My hope is that, at a minimum, all readers of this thesis – believers and skeptics alike - will come away with a better understanding for the scientific, demographic and political implications of climate change, and a clearer vision of how to incorporate its uncertainties into their investment behavior. With wide implementation, this private market response will foster better outcomes for all members of society in the decades to come, as capital is deployed to more durable locations, and human suffering is minimized as people look into the future to proactively and prospectively adapt.

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Chapter 1 - Climate Change Basics: History and How It Happens

“It used to be location, location, location, now it’s climate, climate, climate.” – Orrin Pilkey

Background

While a growing body of scientific research emphasizes the negative aspects of climate change and the serious threat that it presents to human well-being and economic development, policy progress to mitigate its impact and adapt society to withstand it has been hampered by both a lack of public and political understanding of its likely magnitude. While it is true that the timing and scale of climate change’s impacts on humanity are not perfectly predicted, it is also true that the probability of disruptive outcomes is substantial and poised to increase without immediate and coordinated action. Beyond just switching from fossil fuels to cleaner energy sources and limiting emissions, additional adaptation will need to be undertaken to ensure the functioning of our infrastructure, homes, and civil societies, and thereby to preserve the value of our investments.

This chapter provides a very basic grounding in the science of climate change to help orient the skeptical investor as to why this geophysical trend is inexorable and nearly certain to impact the value of their portfolios in the years ahead. The Intergovernmental Panel on Climate Change defines climate change as a change in the state of the climate that can be identified and measured by changes in the mean and/or the variability of its properties and that persists for an extended period, usually decades or longer (Intergovernmental Panel on Climate Change, 2007). At its core, climate change is a simple energy in versus energy out problem. We know that when humans consume more calories than they expend they put on extra weight. Similarly, when the Earth takes in and keeps more of the Sun’s radiation than is needed to maintain its current temperature the planet gets warmer. Over time this increase in temperature manifests in a host of problems, from sea level rise to harsher storms; ocean acidification; more droughts, floods, and wildfires; lower crop yields and greater food insecurity.

For the purposes of this thesis, the focus will be on one of the easier to understand and model components of climate change, sea level rise. The topography of land adjacent to the ocean and

14 the bathymetry of the sea floors are well mapped and known, as are the amounts of water in the oceans and on glaciers. While the rate of glacier melt is difficult to predict and harbors potential for substantially higher seas, the amount of relatively well understood variables involved in sea level rise make it easier to study than the other negative effects of climate change. From a real estate perspective, this paper will cover a variety of product types, but given greater data availability, devote more attention to the single-family housing market.

Some initial facts to contextualize the problem:

 In the continental United States (global average temperature shown in following chart), the mean temperature has increased roughly 1.5°F over the past century and of this an estimated 80% has been observed in the last 30 years (Houser, Hsiang, Kopp, Larsen, Delgado, Jina, et al, 2014; Menne, Williams, & Palecki, 2010; Walsh et al., 2014);  The five warmest years in recorded history have been the last five years and July 2019 was the hottest month ever recorded (Climate Central; chart below);  After previously using imprecise maps, new elevation data from CoastalDEM (a neural network designed to assess water levels globally) tripled estimates of global vulnerability to sea-level rise and coastal flooding (Kulp & Strauss, 2019);  Sea levels have risen on average by 8-9” (not uniform across coastlines, in some places rise is much higher, ex. USA’s East & Gulf coasts) since 1880. Of this, 3.2” has occurred since just 1993 (Lindsey, 2019);  Sea level rise is occurring at an accelerating pace and has more than doubled from 0.06 inches/year for much of the twentieth century to 0.14 inches/year from 2006-2015. Many locations in US have seen frequency of high-tide flooding increase by 300-900% in the last 50 years (Lindsey, 2019);  This year, Greenland is expected to lose 440 billion tons of ice, a rate not expected until worst case scenario modeling of the year 2070; this is enough ice to flood the whole state of Pennsylvania in a foot of water (Borenstein, 2019);  Projections of future global sea level rise show from 12 inches (assuming large curbs to emissions) to up to 8.2 feet by 2100 (Lindsey, 2019);

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 According to the United Nations, globally close to 40% of the population lives within 100 kilometers of a coast, and around 10% of the total population lives near a coast and fewer than 10 meters above sea level (Hindlian, Lawson, Banerjee, Duggan, and Hinds, 2019).

Sources: Berkeley Earth (left) & Climate Central (right)

We will review the preponderance of evidence showing humanity’s contribution to recently observed warming, explore the aspects of this trend that are not fully understood or easily modeled, and conclude with a review of the various types and potential differing magnitudes of threats that climate change poses. The hope is that an understanding of the science will engender an understanding of the risk to one’s pocketbook, soberly focus the real estate community on the currently misunderstood underlying value of property and facilitate a private market response. With any luck, a change in investor behavior to favor purchasing and developing buildings in more resilient areas will aid communities in need of managed retreat and serve to smooth society’s transition to a hotter, more unstable future.

It is important to begin by noting that scientists are like cautious investors: rational (at least aspirationally) and inherently skeptical beings. They consider future outcomes probabilistically and make decisions based on the best available information (Emanuel, 2016). Like an investor who regularly appraises her assets’ current market values to determine whether she wants to continue to hold or sell them, scientists continually test the assumptions and results of experiments to determine whether a new hypothesis or previously held theory should be

16 supported or rejected in light of new evidence. The massive volume of scientific evidence in favor of anthropogenic climate change (of which we will only scratch the surface in this paper) has been rigorously generated through this process, and - like stock, bond and property markets - is subject to uncertainty as future events overturn past understandings (Emanuel, 2016). Given what we know about the planet today, somewhere between 90% and 100% of publishing climate scientists hold that humans are responsible for the warming in global mean temperature observed in the past 30-40 years, as a result of an anthropogenic increase in atmospheric greenhouse gases dating back to the Industrial Revolution; this statistic is based on an extensive study of thousands of peer reviewed papers and a survey of their authors (Cook, 2016; Emanuel, 2016), and is supportive of the oft cited but embattled “97% consensus” attributed to Harvard professor, Naomi Oreskes (Ritchie, 2016).

While climate scientists have different specialties and somewhat differentiated understandings of what is driving the current and future environment, there is great convergence around a key point, as the vast majority of them believe that continued warming presents significant risks to humankind over the coming centuries (Emanuel, 2016). Of particular concern, are the possible near-term tipping points – from the melting of the Greenland and Western Antarctic Ice Sheets to the release of greenhouse gases trapped in the Siberian permafrost - that would set off feedback loops leading to accelerating, nearly irreversible and catastrophic results, including sea level rise and temperature increases far exceeding the baseline scenarios shown in current climate models. Though the probabilities of these events occurring in the near term are presently considered small, the mechanisms of how they occur are not fully understood, thereby making them difficult to project (Ackerman, 2017). To tie back to our earlier point, these sorts of extreme events constitute the types of new facts or evidence that are likely to shift the scientific consensus around the severity of climate change; in these tipping point cases, for the worse.

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Source: Holdren & Lee Keep in mind that the climate has never been stable and, over both short and long-time frames, has always varied and moved in cycles. Rainfall totals and temperatures fluctuate daily and seasonally, and things like ocean circulation and the pattern of the Earth’s rotation around the sun can cause atmospheric shifts over decades, centuries and millennia (Houser, Hsiang, Kopp, Larsen, Delgado, Jina, et al, 2014). The climate’s variability over long timelines is often put forth by climate skeptics as grounds for questioning the validity of the phenomenon outright (though denial of observable temperature increases is rare) or raising doubts about humanity’s responsibility for the phenomenon (a more commonly held position). Another common refrain from the doubtful involves questioning the likelihood of the change continuing, given the uncertainty, which climate scientists grant, around the precision of future climate models. We will address these and other points of skepticism in this chapter, as we discuss what science does and does not know, and why the scientific community holds such strong convictions about its concerns.

A few basic questions need to be addressed to build a foundational understanding of climate science. How does the Earth get warmer? How do we know it is presently warming? How much of this is attributable to anthropogenic (human induced) factors? What is the state of the debate within the scientific community? What are the physical effects that we should expect to see with a warming planet? What can be done to reverse it or at least limit its impact on current and future generations?

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Big Picture: The Climate Challenge

Given the amount of greenhouse gases in the Earth’s atmosphere and oceans, and the various feedback loops already underway (including melting of glaciers, heating and thermal expansion of oceans), the trend towards a hotter future is unlikely to be stopped in the near term. To dramatically lessen the impact of global warming, greenhouse gas emissions (including CO2,

CH4, N2O) need to be drastically reduced. The good news is that public and scientific consensus have galvanized in recent years on the seriousness of this issue, and governments are starting to act. To achieve this measure will take unprecedented global consensus and coordination, given that the United States only accounts for ~15% of global emissions, and that the scientific community believes that past greenhouse gas emissions will continue to warm our climate for centuries to come (Hindlian, Lawson, Banerjee, Duggan, and Hinds, 2019; Lafakis, Ratz, Fazio and Cosma, 2019; Union of Concerned Scientists, 2019; and Hsiang, Kopp, 2018).

Source: Union of Concerned Scientists

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Source: EPA.gov

History of Scientific Research

While today’s scientists use the latest technologies to create increasingly complex computer simulations that model the Earth’s environment, it is worth noting that humanity’s awareness of the link between greenhouse gases and climate change is almost as old as the Industrial Revolution itself. The length of time that we have known about this link is instructive to the subgroup of skeptics who believe the concept of anthropogenic (human caused through GHG emissions) climate change to be a modern-day fiction and conspiracy. By the time of the American Civil War, scientists understood that the Earth is heated by light from the sun and that it had to have mechanisms to lose or remit energy to keep it from continuously warming (Emanuel, 2016).

In 1824, French mathematician Joseph Fourier determined that the surface of the Earth would be colder without an atmosphere (Fourier, 1824). In 1856, Eunice Foote conducted experiments to see how sunlight interacted with different gases; through this she determined that CO2 trapped meaningfully more heat from the sun’s rays more than air, oxygen, or hydrogen (Foote, 1856). In

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1861, Irish physicist John Tyndall discovered that water vapor, CH4 and CO2 trap heat, while other compounds (O2 and N2) do not (Tyndall, 1861). With this, it was now established that the absorption and emission of radiation in the atmosphere is due to certain few gases that account for less than 1% of air. Without these specific gases, the Earth’s temperature would be near freezing and it would be difficult for human life to inhabit the planet (Emanuel, 2016).

Significantly, Swedish scientist Svante Arrhenius found a correlation to atmospheric CO2 and determined that anthropogenic emissions (i.e. resulting from human activity) would cause a warming of the Earth (Arrhenius, 1895). Remarkably, he predicted in 1895 that a doubling of

CO2 in the atmosphere would raise the Earth’s surface temperature by 5 degrees Celsius, which is close to the 2-3 degrees Celsius that scientists have more recently ascribed to this amount of emitted CO2.. He also understood that CO2’s impact causes logarithmic, rather than linear temperature changes along with concentration increases (Arrhenius, 1895). While his prediction was not perfect, it is an impressive feat for a handwritten calculation, and it highlights that our understanding of the problem is evolving but long held and directionally understood (Holdren & Lee, 2019; Emanuel, 2016; Arrhenius, 1895).

After these initial beginnings of climate science, G.S. Callendar estimated in 1938 that CO2 increased 10% in the atmosphere over the previous years and was the cause of warming that he observed at that time (Callendar, 1938). In 1958, Charles David Keeling started time series measurements of CO2 at Mauna Loa in Hawaii (Keeling, 1960).

Source: Holdren & Lee

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In the early 1970’s there was a debate as to whether CO2 induced warming or particulate induced cooling would prevail in the long run, but by 1977 the National Academy of Sciences warned of “potentially catastrophic” increases in temperature in the next century driven by a consensus view that greenhouse gas – from emissions, deforestation and land use change - caused warming would predominate (National Research Council, 1977). Additional research throughout the 1970’s and 1980’s supported this view, won the backing of President Carter and was famously conveyed to the Senate in the testimony of James Hansen of NASA in 1988 when he made it known to Congress that the warming climate was anthropogenic, meaning caused by human activity, and it would likely cause more powerful storms and heat waves in the future (Holdren & Lee, 2019).

Throughout the 1990’s both the science of climate change and the international community’s attempts to resolve it grew, including the creation of the Intergovernmental Panel on Climate Change (typically called the “IPCC”) an intergovernmental body of the United Nations that was established by the World Meteorological Organization and the United Nations Environment Program. Of note, the IPCC’s Assessment Reports include useful detail on modeled future climate states, estimates of warming amounts, and scenarios of what the future looks like under different emissions pathways (Intergovernmental Panel on Climate Change, 2007). In 1997, the Kyoto Protocol was negotiated (took effect in 2005 after being ratified by 140 countries) which promised to reduce emissions 5.2% below 1990 levels of many countries by 2012 (Sample, 2005).

In the 2015 Paris Agreement (signed by almost every country on Earth), the IPCC (Intergovernmental Panel on Climate Change) put forth a goal of keeping global warming to no more than 1.5° C at the end of the century (above pre-industrial levels, deemed as time from 1850-1900), which would mean lowering emissions by 45% in 2030 compared to a 2010 baseline and reaching net zero emissions by 2050. This seems unlikely given the share of fossil fuels in our energy system, the critical role they play in avoiding intermittency issues in the electricity grid, and the pace of growth of developing countries that are still reliant upon fossil fuels. Limiting even to 2.0° C increase by 2100 seems ambitious, as it would require a 25% decline in global emissions by 2030 and net zero emissions by 2070 (Hindlian, Lawson, Banerjee, Duggan, and Hinds, 2019; Lafakis, Ratz, Fazio and Cosma, 2019). The below chart

22 from Climate Action Tracker, an environmental watchdog organization, offers a heavily studied (if somewhat pessimistic) view of where we are today and how bad things could get.

Source: Climate Action Tracker

Given the many and varied observations that we have of the Earth’s behavior, from its surface through the upper atmosphere and down to the ocean depths and given geological understanding of past climates, there is greater confidence than ever that manmade activity is the driving force of the warming climate and environmental destruction that we are witnessing today (Hsiang, Kopp, 2018; Hegerl et al., 2007). According to Moody’s Analytics, the economic consequences of missing these emissions targets are grave, with the IPCC estimating worldwide economic losses of $54 trillion in 2100 under a warming scenario of 1.5°C and $69 trillion under a warming scenario of 2°C; with anything beyond that possibly setting off more severe feedback loops that could trigger substantial and irreversible problems, such as permanent summer ice melt in the Arctic Ocean (Lafakis, Ratz, Fazio and Cosma, 2019).

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Mechanisms and History of a Changing Climate

As defined by Solomon Hsiang (et. al, see reference), climate is “the joint probability distribution describing the state of the atmosphere, ocean, and freshwater systems (including ice).” As all these systems are intricate and multi-faceted, a simple, though not all encompassing, summary metric for understanding their behavior over time is the global mean surface temperature (Hsiang, Kopp, 2018).

There are several ways in which the global climate can change, some are natural processes, and some are anthropogenic (or human caused). Perhaps the most famous force for change, the Greenhouse Effect occurs, as GHGs allow transparent penetration from incoming solar radiation but absorb and reradiate outgoing infrared radiation (Holdren & Lee, 2019). As noted MIT climate scientist Kerry Emanuel has pointed out this effect is not “remotely controversial among scientists, not even those few who express skepticism about global warming” (Emanuel, 2016). In this way, the Earth receives radiant energy from 1) the sun and 2) backradiation from energy unable to return to space through clouds and greenhouse gases (Emanuel, 2016). The planet will have a stable average temperature only if the heat that it takes in from the sun equals that which it radiates back into space; without this the Earth will warm until the amount absorbed and reradiated stabilize. As a result, increasing concentrations of greenhouse gases cause the Earth’s temperature to rise (Houser, Hsiang, Kopp, Larsen, Delgado, Jina, et al, 2014). An interesting aspect of this process has been pointed out by Kerry Emanuel, namely that “on average the Earth’s surface receives almost twice as much radiation from the atmosphere as it does directly from the sun, mostly because the atmosphere radiates 24/7, while the sun shines only part of the time.” (Emanuel, 2016).

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Source: Climate Central

The measure of the influence that a factor, such as greenhouse gases, has on the global balance of incoming and outgoing energy is known as Radiative Forcing. Formally, this is defined as the “change in net flux of energy at the top of the troposphere (incoming sunlight minus outgoing infrared radiation) since pre-industrial times caused by a given human or natural influence” (Holdren & Lee, 2019). As background, the Sun’s energy that reaches the upper Earth’s atmosphere is 342 W/m2. Here, it is important to understand that greater emissions lead to greater radiative forcing, which leads to more warming, though not immediately on the surface, partly because the ocean takes centuries to warm, thereby slowing the process. Significantly, most of the warming occurs within around 20 years of the initial emissions, but can continue to have an impact for millennia, depending on the half-life of the particular greenhouse gas (Hsiang, Kopp, 2018).

Nature can change the global climate through very long term processes that take millennia, including 1) continental drift, 2) variations in Earth’s orbit & tilt (Milankovitch cycles), 3) changes in energy output from the sun, and 4) changes to the percentages of different gases in the Earth’s atmosphere. There are also natural changes that occur over shorter terms, periods of

25 years to decades. These include, 1) changes to interactions of the Earth’s cryosphere (portion covered by ice), biosphere, oceans, and atmosphere; and 2) volcanic eruptions (Holdren & Lee, 2019).

The long term nature of a traditional cycle is typically governed by variations in the amount of heat released from the Sun and in the patterns of the Earth’s orbit around the Sun, a series of effects called the Milankovitch Cycles, which impact the amount of and where solar energy hits our planet but over timescales exponentially longer than that on which we are currently experiencing change (Holdren & Lee, 2019; Houser, Hsiang, Kopp, Larsen, Delgado, Jina, et al, 2014). This phenomenon was discovered in 1912 by Serbian mathematician Milutin Milanković (Emanuel, 2016).

Source: Climate Central

Interestingly, the state of the current Milankovitch cycles should be causing the planet to cool now, which scientists speculate means that the warming impact of greenhouse gases that we are experiencing would be even greater were our orbit around the Sun at a different stage in its eccentricity, obliquity and precession (Emanuel, 2016). Next, we will explore why our actions have caused a shift to a warming period from what should have been a cooling period.

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Humans contribute to climate change in a variety of ways as well and, notably, these changes can have drastic, more immediate impacts on the climate than many of the natural causes of change. These occur on shorter scales measured in years rather than centuries or millennia (as is the case with natural phenomena) and include, 1) greenhouse gas emissions (GHGs) through the Greenhouse Effect (note that different GHGs have different impacts on and half lives in the atmosphere; so impact of methane is different than nitrous oxide or carbon dioxide); 2) land-use changes that impact carbon storage, hydrologic cycles and how reflective the surface is (known as “albedo”); 3) emissions of particulate matter, which depending on circumstances of its materials and release can either cool or warm the surface; and 4) release from urban heat islands (Holdren & Lee, 2019).

Source: Climate Science and Climate Risk: A Primer (Emanuel, 2016)

While the climate has changed dramatically and repeatedly over the history of Earth, the pace of change that we are currently experiencing is truly unprecedented and is tightly correlated to the release of greenhouse gases into the atmosphere through human energy usage. As can be seen in

27 the previous chart, over the past 800,000 years the Earth’s temperature has varied greatly with Antarctic temperatures (arrived at through ice core samples; other resources to understand Earth’s ancient climate include tree rings and sediment cores) with fluctuations nearly 16°C occurring over cyclical periods of around 100,000 years (Houser, Hsiang, Kopp, Larsen, Delgado, Jina, et al, 2014; Emanuel, 2016). After the last ice age nearly 20,000 years ago, the amount of CO2 in the atmosphere increased until it reached around 260 ppm roughly 7,000 years ago (Houser, Hsiang, Kopp, Larsen, Delgado, Jina, et al, 2014; Emanuel, 2016). After staying stable for nearly 6,800 years, the level of CO2 then began to increase with the start of the Industrial Revolution, eventually getting to around the 400 ppm level at which it is today, a level not seen for close to 3 million years when the Earth had substantially higher temperatures and sea levels (Houser, Hsiang, Kopp, Larsen, Delgado, Jina, et al, 2014; Emanuel, 2016).

It is worth noting that carbon sinks offset greenhouse gas emissions, which is why not all emitted greenhouse gases from the start of the Industrial Revolution through today are still in the atmosphere. There are many examples of carbon sinks, from trees to soil to our oceans, these all absorb emitted carbon and are part of the reason why the Earth is not as warm as it would be without them. It is estimated that CO2 concentrations would be ~65 ppm higher than they are today if we did not have carbon sinks (Hsiang, Kopp, 2018).

Source: Global Carbon Project

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The imbalance between causes of carbon in the atmosphere and offsetting sinks is known as the carbon budget. When the carbon budget has a positive imbalance, it means that the planet is poised to get warmer. In recent years, this imbalance has been roughly 1.6 GtCO2/yr. (Global Carbon Project, 2019).

Source: Global Carbon Project

As can be seen in the below graph from the Stern Review, with higher concentrations of carbon comes a higher likelihood of meaningfully warmer temperatures (Stern, 2007).

Source: Stern Review

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While the chart below from Saul Griffith’s The Game Plan, shows the lag between the emission of greenhouse gases into the atmosphere and its fully realized impact on the environment (Griffith, 2008).

Source: Saul Griffith’s “The Game Plan”

The issue with carbon dioxide is not only the lag for it to fully impact the atmosphere, but also its long lifetime in the atmosphere even if we stopped all emissions today. As can be seen in the below charts from Kerry Emanuel, if all emissions ceased concentrations would fall quickly for the first century, but then the rate of change would stagnate and take millennia to get back to preindustrial levels. Compounding matters is that the warming that has occurred of our oceans holds heat for an extended period of time, leads to ocean acidification and contributes to further warming. As we do not currently have scalable, inexpensive technology to remove GHGs from our atmosphere and oceans, we are unlikely – even with a cleaner grid and more environmentally sound energy consumption – to be able to keep our planet from continuing to warm in the decades and centuries ahead (Emanuel, 2016).

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Source: Climate Science and Climate Risk: A Primer (Emanuel, 2016)

The Weather Report: Likely Future States Now that we have explored the basics of climate science, and how we have gotten into our current predicament, we are going to focus on possible outcomes and future states of the climate. Again, with the detail that we discussed in the previous section about the time lag of carbon emissions before its full heating effect is felt in the climate, it is useful to look at the countries that have heated the atmosphere to date and which are likely to contribute a large share going forward. It is worth noting that greenhouse gas emissions are relatively well uniformly dispersed in the atmosphere and very much have a global impact on climate. That is to say, if the United States somehow hits net zero emissions in the next few years, it will suffer from a warming planet if other countries continue to tear down forests and use fossil fuels as their primary energy source (Holdren & Lee, 2019; and Henson, 2019).

In the following chart, we can see that the United States is responsible for roughly 26% of historical emissions through 2014, but only around 15% of current emissions in the last five years. China, on the other hand, has surged, from a mere 12% historically to more than 30% today. In the future, it is expected that China will continue to be the leader, while dramatic

31 growth of emissions is likely in India and other parts of Southeast Asia and Africa (Hsiang, Kopp, 2018; Henson, 2019; Holdren & Lee, 2019).

Source: Hsiang, Kopp 2018 and Boden Marlen & Andres 2017

This chart should help us understand a key point for later discussions in this paper covering everything from political oversight to demographic changes to real estate values. Climate change is a uniquely complicated collective action problem that requires coordinated global effort to fix problems that have widely disparate outcomes on different countries and locations. Flooding in the Pacific Islands may be impossible to stop without eliminating coal burning plants in China, India and Appalachia, but there is no real authority to coordinate this, nor is it necessarily in the immediate best interests of those burning coal to help islanders dealing with sea level rise. The nature of this problem and lack of clear solutions given how the geophysics of carbon and the climate work, and the perverse incentive systems of our politics means that the careful investor should keenly monitor how our future climate will play out.

While there are a variety of climate models that focus on different inputs to and effects on climate change, we will focus on the most widely referenced future scenarios as published by the Intergovernmental Panel on Climate Change (the IPCC), first published in 1992 (Lafakis, Ratz, Fazio and Cosma, 2019). The IPCC reports include four “representative concentration pathways”

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(RCPs) that model possible amounts of anthropogenic impact (through greenhouse gas emissions, deforestation/land use changes, aerosols, etc.) and their likely effects on the planet (in the form of changing temperatures). These different RCPs are labeled based on the amount of net radiative forcing expected in 2100, measured in watts per square meter. Remember that positive radiative forcing is what occurs when the energy absorbed from the sun exceeds the temperature radiated back into space, and when greenhouse gas emissions cause this phenomena, it is also called the Greenhouse Effect (Hsiang, Kopp, 2018; Lafakis, Ratz, Fazio and Cosma, 2019; Henson, 2019; Emanuel, 2016; Holdren & Lee, 2019). Note that the IPCC uses the mean temperature trajectories relative to a base of 1986-2005, which differs from the Paris Agreement’s target based on deviation since the start of industrialization (Lafakis, Ratz, Fazio and Cosma, 2019).

In the charts below, RCP 8.5 represents 8.5 watts per square meter of radiative forcing, and amounts to a pessimistic scenario in which little is done to lessen greenhouse gas emissions and the world’s population continues to grow with twice as many people as now in 2100; as a result, this shows a quadrupling of CO2 levels to ~1,200 ppm. This would truly be a bad case, as it would imply 5–16 °F of global warming over the long term, and be the equivalent GHG ppm to a period not seen since 50 million years ago when the seas where 230 feet higher than they are today. Note that while this chart shows CO2 only, this is meant to be CO2 and its equivalents; thereby, accounting for all greenhouse gases (Lafakis, Ratz, Fazio and Cosma, 2019; Emanuel, 2016).

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Source: Climate Science and Climate Risk: A Primer (Emanuel, 2016)

Note that hitting this level of emissions does not immediately imply that the oceans will rise that high, but it does give some context for how bad things can get with unmitigated warming. The other scenarios offer more hopeful paths based on successful efforts to lessen emissions, and further detail on what each level of emissions means for radiative forcing and temperature change is listed therein. For context, given the goals of the Paris Agreement to limit warming to between 1.5°-2.0° C by 2100, and assuming some level of success by society in meeting this goal, the RCP 2.6 and RCP 4.5 scenarios would be the most likely (Lafakis, Ratz, Fazio and Cosma, 2019).

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Source: Climate Central

Even in these scenarios the economic damages could be substantial, as can be seen in the work of Moody’s and Hsiang et al. shown below, which predict between 0.5-1.25% of GDP lost per year in likely scenarios and possibly >3.5% of GDP lost per year in a true downside case (Lafakis, Ratz, Fazio and Cosma, 2019).

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Source: IPCC, Moody’s Analytics, Hsiang et al (2017)

That said, many countries – including the United States - are presently failing to meet their requirements under the Paris Accord, which could lead to worse than anticipated outcomes (Climate Action Tracker, 2019). Even with declines in the United States and Europe, global greenhouse gas emissions set a record in 2019 (Plumer, 2019) after having set a record in 2018 (Chestney, 2019), and world leaders from Jair Bolsanaro in Brazil to Donald Trump in the United States have put climate goals on the backburner.

Source: Global Carbon Project

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Source: Climate Action Tracker

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Chapter 2 - The Negative Effects of Climate Change

“If it keeps on rainin', levee's goin' to break And all these people have no place to stay.” – Kansas Joe McCoy and Memphis Minnie

Overview

To understand the impacts that climate change will have on the investment community, it is useful to understand its many geophysical manifestations – from increased temperatures to rising seas to more frequent droughts, more intense storms, acidified oceans and endangered water and food supplies – and their potential severity across the globe.

It is important to keep in mind that many of the impacts of climate change will be felt differently in different parts of the planet. Temperature increases have not changed uniformly around the world – with the Arctic warming faster than the rest of the planet -, nor have sea levels – which are rising faster along the Eastern Seaboard and Gulf Coasts. Going forward, climate projections indicate that certain locations will be hit harder by different facets of a changing climate. This will cause varied outcomes for not only the climate, but also the infrastructure, safety, and value of different locations (Emanuel, 2016; Houser, Hsiang, Kopp and Larson, 2015).

Source: NOAA

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As we go through this section it is useful to understand that there are various “tipping points” in the global climate that are significant, non-linear in their time sequencing and nearly impossible to reverse. Once glacier ice starts to melt it has a feedback loop effect and becomes very difficult to slow or stop, causing immediate and continued sea level rise, and atmospheric warming (through change in albedo effect and thermal expansion of water). Much of the permafrost around the world acts as a sink to keep in the ground, greenhouse gases like CO2 and methane. In a warming world, this permafrost could decompose and release these gases into the atmosphere causing a substantial increase in warming (Ackerman, 2017; and Hsiang, Kopp, 2018).

This section provides a brief explanation of the major climate impacts that result from a warming planet, and will help frame later sections in this paper that address how certain regions should have fundamentally different climate risk profiles and, consequently, pricing based on their likely future climatic states. As can be seen in the below chart, several of the negative weather events related to climate change have already started to occur more regularly, become more costly and are projected to become more frequent in the years ahead (Smith, 2017).

Sources: Climate.gov

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Effect: Increased Temperature and Humidity

Perhaps the most obvious effect of global warming is its eponymous impact to cause increased temperatures. Civilizations have developed and thrived largely in temperate climate zones, which are also the regions of the world that have seen the greatest economic success (Emanuel, 2016).

Source: Climate Science and Climate Risk: A Primer (Emanuel, 2016)

As we noted earlier, our planet has seen a roughly 1.0°C increase in temperature since the industrial revolution, and has noticed an increasing pace of warming over the last 40 years (Climate Action Tracker, 2019; Hsiang, Kopp, 2018). Interestingly, though the disbursement of emissions affects all parts of the globe, the Earth’s temperature does not increase in a uniform fashion, with parts of the Arctic warming at twice the pace as that observed in much of the rest of the planet (Holdren & Lee, 2019) and land warming (1.4°C or 2.5°F) meaningfully faster than the oceans (0.6°C or 1.1°F) (Hsiang, Kopp, 2018).

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Source: Holdren & Lee Going forward, the IPCC projects global mean surface temperature to rise by 2080–2100 under a low emissions pathway by 0.9–2.3°C (1.6–4.1°F), under a moderate emissions pathway by 1.7– 3.3°C (3.1–5.9°F), and under a high emissions pathway by 3.2–5.4°C (5.8–9.7°F) (Hsiang, Kopp, 2018; Collins et al., 2013). In the future, summers in Vermont will be like past ones in Maryland, future summers in New Jersey like those of today’s Louisiana, Mexico will be hotter than today’s Iraq, and parts of India and Thailand will be warmer than any current country on the planet (Hsiang, Kopp, 2018; Collins et al., 2013).

While it is a cliché to say that what matters is “not the heat but the humidity”, this holds a lot of truth when it comes to human well-being. Of the 50 nations with today’s highest standard of living, none of them are in humid tropical zones (Emanuel, 2016). The measurement blend of heat and humidity is known as wet-bulb temperature and is defined by Kerry Emanuel as “the lowest temperature a damp surface can achieve in air of a given temperature and humidity”. Once this gauge is above 35 °C (95 °F) the human body runs into a potentially lethal situation, where it cannot transmit heat out of the body fast enough to allow for any cooling, resulting in life threatening body temperatures (Emanuel, 2016). While this dangerous level of temperature is rare today, periodic heat waves occur (one in 2003 in Europe killed 50,000) and it is expected to become common in parts of the Middle East by 2100, severely impacting the habitability of certain areas (Emanuel, 2016). Closer to home in the United States, one study predicts that “dangerously hot and humid days”, those that have a slightly lower wet-bulb temperature peak above 80°F, are expected to increase in frequency in the Southeast from what had been 8 per

41 year from 1981-2010 to 40-70 days per year in 2080-2099 (Houser, Hsiang, Kopp, Larsen, Delgado, Jina, et al, 2014; Hsiang, Kopp, 2018).

The following chart provides an interesting summary of how recent temperatures throughout the United States and world are expected to compare to temperatures at the end of the century in a pessimistic emissions scenario (Hsiang, Kopp, 2018).

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Source: Hsiang & Kopp

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Effect: Sea Level Rise After temperature, sea level rise is perhaps the next most intuitive aspect of global warming. As we reviewed in the previous section melting ice caps - specifically those currently on land, including in West Antarctica and Greenland – cause sea levels to rise. Another, lesser known, phenomon that results in an increase in ocean volumes is the thermal expansion caused by the warming of the waters (as water warms it occupies a larger volume of space), which actually accounts for most of the sea level rise that we have seen in recent years. Interestingly, when relatively reflective (high albedo effect) ice melts, it becomes darker more absorbent water, whose changed albedo (now less able to reflect radiation back into atmosphere and more likely to absorb its heat) exacerbates warming. Other factors, such as currents, winds, plate tectonics, land subsidence or uplifting cause large regional differences in the amount of sea level rise. Land subsidence, for example, is the primary reason why many of the world’s deltas from the Ganges to the Mississippi are seeing greater relative sea levels rise as their ground sinks (Henson, 2019; Emanuel, 2016; and Hsiang, Kopp, 2018).

Source: Holdren & Lee

Again, it is useful to observe how the sea level has progressed on a geologic timescale, then focus on how human behavior has likely changed it and look at what could occur in the future. As is seen in the following chart, the level of the ocean used to be around 130 meters (~400 feet) lower than it is today, but that it has remained steady for the last 7,000 years. This allowed nomadic civilizations to settle down, and for cities and trade routes to flourish along stable coastlines (Emanuel, 2016).

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Source: Emanuel, 2016 and https://commons.wikimedia.org/wiki/File:Post-Glacial_Sea_Level.png

Sea levels have risen on average by 8-9” (not uniform across coastlines, in some places rise is much higher, ex. USA’s East & Gulf coasts) since 1880. Of this, 3.2” has occurred since just 1993 (Lindsey, 2019). This is now happening at an accelerating pace and has more than doubled from 0.06 inches/year for much of the twentieth century to 0.14 inches/year from 2006-2015. Many locations in US have seen frequency of high-tide flooding increase by 300-900% in the last 50 years (Lindsey, 2019). Going forward, projections of future global sea level rise show from 12 inches (assuming large curbs to emissions) to up to 8.2 feet by 2100 (Lindsey, 2019). And the sea level will continue to rise after 2100 even if we hit net zero emissions, given the warming lag of the carbon already in our atmosphere and oceans. For reference, the last time the Earth had the greenhouse gas levels witnessed today was 3 million years ago and the oceans were 25 meters (80 feet) higher. Again, this level will not be reached over night – scientists have widely different predictions on the likely rate of glacier ice melting - but it is an inauspicious sign for the next few centuries and means where we build settlements will look very different in the future (Emanuel, 2016) .

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Source: Holdren & Lee

Now we confront difficult choices and probable econonmic losses as rising seas threaten our coastal communities. According to the United Nations, globally close to 40% of the population lives within 100 kilometers of a coast, and around 10% of the total population lives near a coast and fewer than 10 meters above sea level (Hindlian, Lawson, Banerjee, Duggan, and Hinds, 2019). Higher sea levels have many impacts, including:

 Flooding - increase coastal flooding frequency (Sweet and Park, 2014),  Freshwater Infiltration - can infiltrate freshwater aquifers and destroy potable water reserves,  Stormwater Systems - overload stormwater systems and  Infrastructure Vulnerability - put at risk key infrastructure (roads, coastal powerplants and wastewater treatment facilities, etc.) and population centers.

While some affluent coastal areas, such as Boston or New York, will likely build storm barriers, other cities with fewer resources will face more difficult questions of managed retreat away from the sea (Emanuel, 2016).

The following chart is helpful to understand how much is at stake. Even without including greater hurricane activity, this study estimates that annual property losses from sea level rise alone could exceed $20 billion in 2011 dollars based on a climate model using the IPCC downside RCP 8.5 emissions pathway (Houser, Hsiang, Kopp, Larsen, Delgado, Jina, et al, 2014; Emanuel, 2016).

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Source: Emanuel, 2016

Effect: Harsher Storms, More Droughts, Floods and Wildfires

Global warming will cause more powerful hurricanes in the Atlantic, more overall average rainfall (with more water vapor in the air) and paradoxically (and depending on region) more droughts, floods, and wildfires.

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Source: EPA, 2016

It is likely to cause dryer springs in the Southwest, dryer summers in the Northwest and increased rainfall in the winter and Spring in the Northeast, northern Great Plains and upper Midwest (Hsiang, Kopp, 2018; Houser, Hsiang, Kopp, Larsen, Delgado, Jina, et al, 2014). Flooding around major rivers is worth modeling for anyone buying property inland and those purchasing properties in drought prone areas, should be cautious of increased incidence of wildfires (Holdren & Lee, 2019).

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Sources: Holdren & Lee, 2019 Tropical cyclones, which depending on the region are also called tropical storms, hurricanes, cyclones, or typhoons, cause more than 10,000 deaths and $40 billion in damages every year around the world. There is growing consensus that the strongest storms will become stronger – if not more frequent – because of global warming (Emanuel, 2016).

The following chart is an amplification of the earlier one that showed likely U.S. property losses from sea level rise but adds to that the impact of increased hurricane intensity. Again, this is based on a climate model using the IPCC downside RCP 8.5 emissions pathway. Taken together, this shows roughly double the losses compared to the sea level rise only scenario (Houser, Hsiang, Kopp, Larsen, Delgado, Jina, et al, 2014; Emanuel, 2016).

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Source: Emanuel, 2016 Although there are a host of other factors (especially wind directions and speeds) that influence how powerful a hurricane will become, a warmer ocean and one that is warmer to a deeper depth is likely to create stronger hurricanes. Hurricanes work like heat engines, getting their energy from the warmth of the surface layer of the ocean, and driven by the difference between that and cooler, higher atmospheric temperatures. As the oceans get warmer and down to deeper depths, this makes more available energy for water evaporating from the ocean surface. As water vapor condenses (rains) it heats the atmosphere and the rising heated air lowers the pressure at the ocean’s surface. This then causes air from surrounding areas to flow inward, and Coriolis forces then create a spiraling pattern. Greater available energy allows for more powerful cyclones. Complicating this is that an important limiting factor or “brake” on hurricane power is cold water, which gets churned up less when the ocean warms to continually deeper depths. (Emanuel, 2016).

Further aggravating the potential for damage from hurricanes is the concurrent phenomenon of sea level rise, which when combined with more powerful hurricanes can result in meaningfully worse storm surges (Holdren & Lee, 2019). To illustrate this, the following map shows how much worse flooding will be in Miami and New York in the event of a 1 in 100-year storm (Hsiang, Kopp, 2018).

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Source: Hsiang, Kopp

The following map is based on IPCC’s mid-range scenario of RCP 4.5 and shows another unfortunate wrinkle: changing storm tracks. Hurricane models are showing an increase in hurricanes reaching the Northeast and further inland (Holdren & Lee, 2019; Bhatia& Vecchi, 2018), though these are subject to a host of factors (incl. aerosol releases).

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Sources: Holdren & Lee; Bhatia & Vecchi

Effect: Damaged Ecosystems and a Cloudy Future With a changing climate comes a cascade of effects that impact life for all creatures and plants on Earth. Large scale migrations of animals will occur, as they seek to live in habitats like those in which they presently live. This can already be seen in fish migrations to warmer temperatures (Hsiang, Kopp, 2018). While it will be difficult for many animals and insects to effectively relocate, many natural ecosystems are also in grave danger given the limited time that they have to adapt, the long timescales for tree types that thrive in one region to get to and grow in a new region and even the arability of certain locations. This will be compounded if emissions remain high and the pace of climate change accelerates. A further problem is that in a warmer climate many disease carrying pests will thrive, which could lead to reemergence of various tropical diseases, from dengue fever to malaria (Holdren & Lee, 2019; Henson, 2019; Hsiang, Kopp, 2018). Changes in climate cause great calamity, and many mass extinction events in the planet’s history are thought to have occurred concurrently with substantial changes in the climate (Hsiang, Kopp, 2018; Pilkey, 2016).

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Due to their competing effects, the net impact of clouds on the future climate is an area of uncertainty in current models. Low lying white clouds work to reflect the sun’s radiation back, which reduces the rate of warming, but cirrus clouds, higher in the atmosphere absorb radiation and contribute to warming (Pilkey, 2016). Although, most of the proposed solutions to climate change are inefficient, overly expensive or unproven, one interesting possible remedy is geoengineering (global attempts to reshape the environment), which, in one incarnation, known as solar radiation management or albedo modification involves the use of aerosol sulfates sprayed into the upper atmosphere in a way that mimics how volcanic eruptions cool the planet (Hsiang, Kopp, 2018; and Henson, 2019). This program is a fraction of the cost of other programs and is cheap enough for a rogue billionaire or desperate island nation to singlehandedly attempt (Holdren & Lee, 2019). While this thesis does not detail the strengths and weaknesses of all possible climate solutions (for an in depth review of many solutions, their feasibility and cost, consult Paul Hawken’s work “Drawdown: The Most Comprehensive Plan Ever Proposed To Reverse Global Warming”; Hawken, 2017; or William Nordhaus’ “The Climate Casino: Risk, Uncertainty, and Economics for a Warming World”; Nordhaus, 2013), this type of cloud mimicking will likely have a host of unintended consequences (unclear whether the necessary amount of sulfates is safe), and it does not actually limit the amount of greenhouse gases in the atmosphere, as it merely reflects sunlight back. A major issue with this is if the program were to stop for whatever reason, radiative forcing would quickly revert to correlate to the amount of greenhouse gases in the atmosphere, which could cause catastrophically fast warming that would devastate flora and fauna worldwide (Holdren & Lee, 2019; Henson, 2019).

Effect: Ocean Acidification and Bleaching

While landbound life struggles with climate change, our oceans will also struggle to survive in their current form. With more CO2 in the atmosphere, our oceans end up with more dissolved

CO2 as well. This creates carbonic acid and makes our oceans more acidic. There are currently no viable technologies to combat this effect at a large scale. Lifeforms that have shells, such as mollusks, plankton and coral reefs start to lose their ability to build and maintain themselves (Emanuel, 2016). This could endanger the millions of species that inhabit coral reefs – which also suffer from heat caused bleaching - along with the entire oceanic food chain (Hsiang, Kopp,

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2018). Under a high emissions pathway, ocean acidity around the globe is estimated to increase 100–150% (Hsiang, Kopp, 2018; Jewett, Romanou, 2017).

Source: Climate Central

Effect: Food and Water Insecurity Perhaps the most concerning aspect of climate change is what it portends to food and water security. In a warmer climate rainfall occurs in more concentrated intervals, meaning when it rains it will be more intense, but rainstorms will occur less often. This will also be geographically differentiated with certain regions expected to become wetter, while others become drier. Flash floods and droughts will become more common, and the required steady rain needed for crop production will be scarcer (Emanuel, 2016). When these essentials are scarce, conflict and large-scale migration often follow. We are poised to confront this trend while the

54 world experiences tremendous population growth from roughly 7.7 billion people today to more than 10.9 billion people estimated in 2100 (Cilluffo, Ruiz, 2019).

Source: Pew Research Center

This is set to occur all the while our soil is depleted, and projected crop yields are falling in many parts of the globe. After analyzing USDA data, investment firm GMO has predicted that US corn, wheat, soy and rice crop yields are likely to fall 38% in the next 20 years due to soil erosion alone, but up to 56% when also accounting for the deleterious effects of climate change (Grantham, 2018).

The following projection displays the effect of climate change on losses in U.S. agricultural, relative to a current 1-in-20-year event. By 2100, what would be a 1-in-20-year loss could occur every other year (Emanuel, 2016).

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Source: Emanuel, 2016

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Chapter 3 – Human Activity, Skeptics and Your Bottom Line

“Laws change, people die, the land remains.” - Abraham Lincoln

Reminder: Civilization’s Links To Warming At present, the typical person is responsible for about 5 tons of carbon dioxide (CO2) every year, and roughly 25% of it will stay in the atmosphere for thousands of years (Hsiang, Kopp, 2018; Le Quere, 2018; Archer, 2009). Scientists now have consensus that the changes in our climate are not sufficiently explained by natural variations and are confident that they are the result of human behavior (Hsiang, Kopp, 2018; Molina et al., 2014; National Research Council, 2010). Now the concentration of carbon dioxide is greater than any time in the last 800,000 years (Emanuel, 2016). In the continental United States, the mean temperature has increased roughly 1.5°F over the past century and of this an estimated 80% has been observed in the last 30 years (Houser, Hsiang, Kopp, Larsen, Delgado, Jina, et al, 2014; Menne, Williams, & Palecki, 2010; Walsh et al., 2014). Globally, each of the last three decades has been successively warmer than its predecessor (Hsiang, Kopp, 2018).

As we touched on earlier in this chapter, on its own the climate of the Earth changes over very long-time scales in the thousands to millions of years. What we have witnessed since the beginning of the Industrial Revolution has been a large-scale experiment in carbon dioxide and other greenhouse gases’ impact on our environment. The results of this experiment are rather bleak and a valid cause for self-reflection, our planet has stopped a 7,000 year period of relative stability and warmed at an increasingly fast rate in reaction to greater concentrations of CO2 and its equivalents in our atmosphere and oceans. The following chart shows CO2 emissions levels on a geological scale, you will note that it shows a dramatic uptick in CO2 concentrations after the start of the Industrial Revolution, with a dramatic acceleration after the wide adoption of the car, growth in the commercial airline industry and fossil fuel dependent electricity grids (Union of Concerned Scientists; NASA).

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Sources: Union of Concerned Scientists & NASA

Source: Emanuel, 2016

The below chart shows in detail various causes of positive and negative radiative forcing and their overall impact on the carbon budget and global temperatures. As this indicates, human activity is responsible for the bulk of the observed warming (Holdren & Lee, 2019).

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Source: Holdren & Lee

What Are The Positions Of Climate Skeptics?

We will briefly discuss the most common questions raised by skeptics, but for more thorough answers to their concerns and research on the very real threat of the climate change, visit www.skepticalscience.com.

Though there is a long, detailed history of our scientific understanding of the forces that drive the climate and overwhelming consensus – on the order of 90%+ - from publishing climate scientists that global warming is real and driven by human behavior, there still persists a sizeable (though shrinking) percentage of the American population that questions whether climate change is in fact occurring (this is an extreme and now uncommon position) and, if so, whether it is caused by human behavior (this is the more common form of skepticism). These questions range from the reasonable and well intentioned ruminations of the curious to the less wholesome spin of fossil fuel funded researchers and lobbyists (for more on some prominent deniers, including Fred Seitz and Fred Singer, read Naomi Oreskes and Erik Conway’s “Merchants of Doubt”).

Here are some of the more common arguments:

 “The Earth Isn’t Getting Warmer” – This claim has been effectively refuted and is not commonly made today, but was periodically made until the 1990’s. The main contention was based on an apparent lack of warming in the upper air temperatures, but this has been

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repeatedly measured by satellites and radiosondes and shown to be heating at the same pace as the land surface (Henson, 2019).  “Natural Variation Causes Warming” – As we discussed earlier in this chapter, there are many natural causes of climate change, from Earth’s orbit around the sun to the amount of energy emitted from the sun to natural processes like El Niño. However, the pace of warming has been much faster than the timescale of these natural processes, has actually counteracted what should by all accounts have been a period of cooling, and is tightly correlated on the timescale of human fossil fuel emissions (Holdren & Lee, 2019).  “Solar Output Is Causing It” – Some have speculated without substantiation that perhaps a big change in solar output has caused the temperature increase. There is evidence in the record that past fluctuations in solar output resulted in climate change. Unfortunately, this is not currently occurring. Since the early 1980’s scientists have used satellites to measure in detail the amount of energy emitted by the sun and have recorded a slight decrease in solar output (Emanuel, 2016).  Some Form Of Irrational Optimism – The final type of argument that is put forth by skeptics amounts to irrational optimism, and typically takes the form of something like “a few degrees won’t be that bad”, “there will be technological solutions so why worry or hurt the economy”. While the precise amount of warming is unknown, we have explored in detail the catastrophic impacts that even a small amount can wreak, especially given anticipated tipping points estimated to occur between 2-3°C of warming. While there are promising technologies, including next generation nuclear facilities and carbon capture technology, they are currently inefficient, prohibitively expensive, or unproven. Further, there are substantial upfront coordination issues to get the political will and funding to get these technologies working. Further complicating matters is that even if we cut emissions to zero, the amount of carbon in the atmosphere and dissolved in the oceans (carbon capture technology has been focused on air thus far, and no viable technology to remedy ocean acidification) will still cause warming for potentially thousands of years to come (Henson, 2019).

While we have countered these arguments above and throughout this chapter, it is worth noting the non-scientific but strategically oriented groups that are taking action to plan for a warming climate.

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How Are Self Interested Parties Reacting?

For skeptics’ case to be supportable it would help to have more scientific evidence that refutes that global warming is occurring (for the rare few that deny it outright), offers hope that it will reverse on its own in the near term (this knowledge would be helpful for planning), and explains why it is not anthropogenic (so we can understand what mechanisms actually govern it). Without further back up to support global warming being a non-issue, we face a rapidly heating world and the attendant consequences of this fact.

Of great interest in the examination of global warming’s validity is the behavior of certain prepared, self-interested parties, namely: The United States Military, China, Russia, and the major oil companies. These entities are all known to pursue their own interests and have little reason to plan for climate change unless they believe it to be a grave and real issue.

 The United States Military – All branches of the United States Military recognize and are planning for the eventualities of a worsening climate, as they consider it an “urgent and growing threat to our national security” that will likely drive people and countries to have conflicts over dwindling resources. The following table shows military installations that have been deemed by our government to be at risk due to climate change. These include severely threatened places like the Naval Academy in Annapolis and the Navy base in Norfolk, Virginia (Department of Defense, 2015). Recently, the Navy added two levels to the docks at its Norfolk base in an attempt to cope with sea level rise (Pilkey, 2016). In the words of the United States Department of Defense from July 2015 (Department of Defense, 2015): “The Department of Defense sees climate change as a present security threat, not strictly a long-term risk. We are already observing the impacts of climate change in shocks and stressors to vulnerable nations and communities, including in the United States, and in the Arctic, Middle East, Africa, Asia, and South America. Case studies have demonstrated measurable impacts on areas vulnerable to the impacts of climate change and in specific cases significant interaction between conflict dynamics and sensitivity to climate changes. Although climate-related stress will disproportionately affect fragile and conflict-affected states, even resilient, well-developed countries are subject to the effects of climate change in significant and consequential ways.”

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Per the Department of Defense, the United States military has property in all 50 states, along with 7 overseas territories and 40 foreign countries, that total 300,000 buildings worth nearly $590 billion. Just the US Army owns over 14 million acres.

Source: Department of Defense

 China, Russia(and almost every other country on the planet) - While most of the world has claimed climate change to be an issue and nearly every country on the planet ratified the Paris Agreement, what is truly telling are the actions of some of our global competitors: China and Russia. China has invested billions of dollars in renewables and clean energy businesses (incl. nuclear fission) with expectations that those sectors will be drivers of their economy going forward. Further, both China and Russia are beginning to capitalize on warming in the Arctic by sending military to secure natural resources and shipping lanes. China is preparing for an ice free arctic as soon as 2050, and is at work on solidifying the means for a trading route along the “Polar Silk Road”, a route that dramatically cuts trading distance and time from China’s east coast to Europe (Bennett, 2019).

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Source: Maritime Executive

 Energy Companies – As was detailed in Mackenzie Funk’s “Windfall”, which tells the stories of different groups trying to profiteer on the backs of climate change, many major oil companies, including Shell, have spent significant amounts of time and money prospecting for oil and gas reserves in the Arctic and buying concessions for extraction (Funk, 2015).

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 Large Companies and Unions – On December 2, 2019, “United For The Paris Agreement”, a consortium made up of large labor interests (incl. the AFL-CIO) and large company CEOs (many Fortune 500’s incl. Google, Apple, Goldman Sachs) sent a letter to President Trump asking him to reinstate the United State’s commitment to the Paris Agreement. Their group represents over 12.5 million union laborers and 2 million private workers (Applebaum, 2019).

Why Does Climate Change Matter For The Economy And The Real Estate Community?

While the following chapters discuss this in greater detail, to begin to understand the gravity that this phenomenon will have on the overall economy, it is helpful to visualize how our world will change. The following chart shows which countries have the largest populations at risk to one of the more quantifiable and clearly harmful impacts of climate change, namely sea level rise (CIESIN, 2007), and another graph from Moody’s Analytics that shows the economic impact of sea level rise in specific locations, Hong Kong and Croatia (Lafakis, Ratz, Fazio and Cosma, 2019).

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As we have discussed, there are various possible future states from climate change, each will have an impact of differing severity on our climate. As part of a broader study that we will explore for context the credit rating agency Moody’s came up with the following impacts on annual GDP growth, including by location to show high level the likely winners and losers of our coming atmospheric state (Lafakis, Ratz, Fazio and Cosma, 2019).

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In the coming chapters, we will delve into case studies of how climate change has been handled so far by modern societies and how it will likely play out going forward. As part of this, we will analyze and review the economic literature that has studied the topic from an empirical perspective and have a specific focus for how real estate markets have performed to date. All of this is with an eye to developing a framework for how to incorporate the phenomenon of climate change into real estate underwriting, development, and ownership. With more knowledge on the magnitude and effects of this trend, we can hopefully make wiser investment decisions.

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Chapter 4 – The Road Ahead: Challenges and Case Studies

“All I want to know is where I'm going to die so I'll never go there.” - Charlie Munger

While scientists tell us that the condition of our planet will likely be different in 100 years from any time in recent human history (Emanuel, 2016), there are useful analogs of nations and cities dealing with similar environmental conditions, economic collapses, wars and extreme weather events that illustrate components of our coming reality. By examining these cases, we can understand some generalizable truths that will be useful to our adaptation measures and learn why certain cases are exceptional and unlikely to have educational value writ large. From this, the hope is for the reader to internalize the historical context of how dramatic atmospheric changes and environmental destruction can lead to dramatic economic losses, and to provide some lessons that we can incorporate into future underwriting.

This chapter begins with a look at the costs of extreme weather, the challenges confronting the insurance industry and the monumental task of trying to find infrastructure solutions to maintain the status quo. We will then review specific cases, with a summary of the Dutch’s successful experience fighting the sea, an edge case that offers hope for humanity, but for a variety of reasons that we will explore, is unlikely to be an example that the rest of the world can successfully emulate. Thereafter, we will briefly look at areas condemned - for economic or topographic reasons - to suffer in a warming climate, with a focus on the domestic examples of Miami and New Orleans.

In closing, this chapter will review the ever expanding economic, legal, and demographic research analyzing climate change’s impacts to date and what it will likely cause in the future. Taken together, this information will provide useful insights that will inform how we approach underwriting a real estate investment in a time where climate change, with a specific focus on sea level rise, is poised to impact property values.

Insurance and Ensured Extreme Weather As described in the first two chapters, there are countless negative externalities to climate change with extreme weather incidents and sea level rise as among the most consequential.

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Unfortunately, there are many indications that storm intensity is likely to increase. NASA recently used satellite temperature data to estimate that every Celsius degree increase to ocean surface temperature raises the probability of severe storms by 20% (Min, 2020). As the power of a storm is proportional to the cube of its wind speed, a 150 mph Category 4 hurricane would have 8 times as much power as a 75 mph Category 1 hurricane (Ackerman, 2017). This is worrying because US hurricane damages have been estimated - by Nobel Prize winning climate economist William Nordhaus - to be roughly proportional to the 9th power of wind speed, so that 150 mph storm would cause 500 times the damage of the 75 mph storm as damages rapidly increase after certain buildings reach structural breaking points (Ackerman, 2017). While it is tempting to hope that new technologies, large scale engineering projects and well-designed insurance policies will mitigate these impacts, the sheer scale of the problem makes coping with it an expensive and difficult task.

The main concern of this paper, sea level rise, creates a serious threat to all flood insurance regimes. As mentioned in the first chapter, the world has averaged ~8-9 inches of sea level rise since 1880, with some places along the East Coast experiencing faster rising oceans (Lindsey, 2019). Globally, close to 40% of the population lives within 100 kilometers of a coast, and around 10% of the total population lives near a coast and fewer than 10 meters above sea level (Hindlian, Lawson, Banerjee, Duggan, and Hinds, 2019). With large population growth and development along the coasts, the cost of coastal storms, flooding and beach erosion is increasing. It is estimated that a rise by 2100 of two feet beyond today’s sea level would threaten more than $1 trillion of property in the United States, and half of it in Florida, with risk of continual inundation (Neumann et al., 2010). Unfortunately, projections of future global sea level rise show from 12 inches (assuming large curbs to emissions) to up to 8.2 feet by 2100, and this could even surpass the higher end of that range if glacier melting accelerates (Lindsey, 2019). For context, it is estimated that a sea level rise of 39 inches would move North Carolina’s coastline, depending upon your location in the state, inland by 2-4 miles (Pilkey, 2016).

This is occurring at a time when more people are moving into increasingly expensive coastal communities, which puts precious lives and investments at risk. Per the U.S. Census Bureau, counties along the Atlantic, Pacific and Gulf Coasts saw consistent population growth of 5 to 10

68 million people each decade, from 47 million in 1960 to 87 million in 2008, which resulted in a doubling of population density (Cleetus, 2013). By 2012, the insured value of residential and commercial property in 18 Atlantic and Gulf Coast states reached $10.6 trillion, and in five states (Connecticut, Florida, Maine, Massachusetts & New York) the insured value of coastal property was more than half of the state’s total insured property value (Cleetus, 2013). Considering ongoing sea level rise, this high density of people and expensive property along the coast not only risks individual homeowners’ economic well-being, but it also imperils the tax coffers and credit ratings of many coastal communities and states. As an example, the State of Florida had a $78 billion budget in 2016, with roughly half of it paid for by state tax collections (largely sales tax) and half of it financed through debt (Ballotpedia, 2020). With significant storm damage and possibly fewer coastal attractions (both inundation and seawalls ruin sandy beaches), Florida would likely experience a massive loss in sales tax (from declining tourism which hits state coffers) and property tax (from lower property values which hits municipal revenues), which would endanger state and city revenue sources, their credit ratings and their ability to raise debt (Pilkey, 2016).

At present, the human and economic cost of extreme weather events is quite large, and – if scientific predictions are at least directionally correct – poised to become more costly in the years to come. In the last 40 years, the United States has seen an uptick in both the cost and frequency of extreme weather events. Since 1980, NOAA has tracked over 254 events that caused a billion dollars or more in damages, for a total of $1.7 trillion and 13,244 lives lost (see following maps and charts for detail; Smith, Lott, Houston, Shein, Crouch and Enloe, 2019). Hurricane Harvey alone caused $125 billion worth of damage in August 2017 when 60 inches of rain, combined with flooding and high winds to devastate Texas and Louisiana, where 70% of those hit by the storm were uninsured (Min, 2020). The charts on the following pages show that the frequency and cost of these events has increased in recent years (Smith, Lott, Houston, Shein, Crouch and Enloe, 2019).

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Source: NOAA

Source: NOAA

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Source: NOAA

Source: NOAA

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At the same time, the insurance industry thrives when risk is uncertain with respect to a specific outcome but bounded with respect to total loss severity. This allows insurers to understand their probable losses and gain comfort that ongoing premiums from clients are sufficient to keep their businesses solvent over time. When an event’s probable loss increases, it becomes more expensive to insure. When an event’s likelihood becomes a certainty, it is no longer insurable (Kunreuther, 2007). The increasing likelihood of greater damage caused by climate change creates underwriting and profitability problems for private insurers – who struggle to make money in the face of more probable and more damaging events - and moral hazard for government backed insurance programs – who risk increasing loss of property and life by filling in as an insurer in areas that private markets refuse to back (Smith, Lott, Houston, Shein, Crouch and Enloe, 2019).

Historically, private insurers have been wary of insuring property in exposed areas and policies were too expensive for people living there to get coverage (Kunreuther, 2007). For this reason, the Federal government created the National Flood Insurance Program (NFIP) in 1968 and Florida created the Citizens Property Insurance Corporation, both of which struggle financially and require government assistance to remain operational (Pilkey, 2016). As climate change increases the frequency of dangerous high tides, rainy day flooding and intense storms, private insurers are pulling back even more in issuing flood insurance (Cleetus, 2013). Recently one of the world’s largest insurers, Allianz, sold its US subsidiary’s retail insurance business after worrying about the increasing risk of insuring coastal houses in Florida and California, and industry giant SwissRe has “adopted more conservative loss assumptions” to prepare for more likely and costly extreme weather events (Min, 2020). Without readily available and reasonably priced private flood and wind insurance, coastal and other high-risk homeowners look to government insurance policies that create moral hazard by backstopping losses in areas that are meaningfully and increasingly exposed to rising seas (Pilkey, 2016).

Of specific concern for this paper are the government funded insurance markets that back single- family housing and small scale commercial properties, most notably the National Flood Insurance Program (NFIP), which is managed by the Federal Emergency Management Agency (FEMA). NFIP is practically the only provider of affordable flood insurance for homeowners and small businesses, with an estimated 5 million policies ensuring property valued at $1.6 trillion

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(Min, 2020). Through this program, homeowners living in flood-prone areas are able to obtain flood insurance coverage of up to $250,000 for single family homeowners (more detail in following chart). In the 100-year floodplain (meaning there is a 1% chance of flooding in any year, though this equates to a 26% chance over the course of a 30 year mortgage), which is formally called the Special Flood Hazard Area (SFHA), homeowners with government backed loans are technically required to purchase flood insurance if they have a mortgage from a regulated or government backed lender. However, only 49% of those living in SFHA’s have the necessary insurance in place (Cleetus, 2013). Overall, only 15% of all homeowners have NFIP coverage even though many are in areas that are now exposed to sea level rise inundation and greater storm intensity (Min, 2020). Further complicating matters, the flood insurance maps used by FEMA are based on historical sea levels and storm patterns (areas that had a 1% chance when the maps were drafted, may actually have a much higher probability of being inundated going forward), and do not include any projections of rising seas, greater shoreline erosion, stronger storms, or deeper storm surge penetrations. This dynamic holds true around all bodies of water, as rivers along with oceans are particularly exposed to greater flood risk (Cleetus, 2013).

Source: FEMA.gov The NFIP suffers as homeowners are given subsidized rates that encourage moral hazard of living in dangerous areas and paying inflated property prices. Without this insurance, many developers would be less likely to build in at risk areas and focus instead on areas with better long-term prospects, and, as a result, there would be fewer, less expensive houses along the coast (Pilkey, 2016). The program itself has seen its expenses increase by a factor of seven to an annual $3.5 billion, but its premiums have lagged as many homeowners in increasingly unstable areas are grandfathered into both the coverage and the low premiums of their previous risk

73 assessment (Min, 2020). Repetitive loss properties or buildings with multiple claims over the years account for only 1.3% of all policies but represent close to 25% of all claim payments made since 1978 (Cleetus, 2013). This has caused the insolvent program to repeatedly request bailout funds from the US Treasury. Even after having $16 billion of debt forgiven by the Treasury in 2017, the NFIP is still in the red by over $20 billion (Min, 2020).

Unfortunately, even efforts to create better maps are often met with opposition. In 2010, FEMA gave North Carolina a $5 million grant to map the flood prone northeastern corner of the state and to do this with projections of storm surges and future sea level rise. After seeing the results and fearing an impact on real estate values and the economy, the government of North Carolina prohibited the publication of these updated flood and storm surge maps (Pilkey, 2016). After Hurricane Sandy hit New York City in 2012, FEMA attempted to redraw its flood maps for the city to include more of the at risk zones, but was met with push back not only from the construction industry but also from New York City itself (Slowey, 2015).

In brief, the NFIP dramatically subsidizes high risk properties in floodplains at great cost to the federal budget, severely undercounts the number of properties that are exposed to climate change and sea level rise and incentivizes development in high risk areas. Without continued government support for the program, borrowers would be unable to satisfy loan insurance requirements, would be forced to either pay exorbitant private flood and wind insurance costs (if it is even available for their property) or go uninsured (which would likely lead to a dramatic fall in mortgage availability), all of which would likely lead to substantial falls in the value of coastal property and in the creditworthiness of waterfront cities and towns. A 2015 study from the University of North Carolina Wilmington found that oceanfront property values could drop across beachfront property in the United States if federal subsidies were eliminated. In New Jersey, this study estimated that values would fall up to 34 percent without a subsidy (McNamara, 2015). With increased storm intensity and greater losses likely, it is reasonable for an investor to budget meaningfully higher flood and wind insurance costs, either through a rerated public program with higher premiums or private insurance, and to make more conservative exit assumptions about properties in at-risk areas (Kunreuther, 2007).

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Engineering Complexities and Costs While flood and wind insurance regimes face financial hardship that will likely make coastal property less valuable, by either greatly increasing flood insurance premiums or making certain properties uninsurable, the hope that engineering solutions will somehow solve the problem of sea level rise is also fraught with economic, political, environmental and technological challenges. Apart from the cost issue, which we will discuss further, it is worth noting that a solution for one area could mean inundation or environmental catastrophe for its neighbors, as redirected water causes even higher water levels for those poorly positioned relative to a seawall. Further, any dike, levee, seawall, dam, or jetty is designed to very specific tolerances, beyond which it is exposed to catastrophic failure. If a seawall is built to accommodate three feet of sea level rise, but it turns out that we see three and a half feet of sea level rise then this large-scale investment will fail catastrophically, and endanger people and property in the area (Pilkey, 2016).

Complicating matters beyond the engineering precision and the complexities of trying to build solutions to an escalating, dynamic problem like sea level rise is the expensive price tag and often lengthy timescale of these projects. As an example, in Venice, land subsidence has long exposed the city to high levels of flooding, but in 1966 after record storms the Italian government recruited engineers to design infrastructure to protect the city. It was not until 2003 that construction commenced on a sea defense system, Mose, that consists of 78 mobile barriers submerged in water that are activated and rise above the surface during storm events and high tides. This project was expected to complete in 2011 at a cost of 1.6 billion euros but is now expected to complete in 2021 and cost at least 5.5 billion euros. Worse still, the project has already seen key components rust and degrade, it is estimated to cost more than 100 million euros/year to maintain, and questions abound over whether it will actually protect Venice with accelerating sea level rise (Balmer, 2019).

Throughout the United States, exposed cities and states are starting to grapple with the necessary engineering projects and associated costs that are required to maintain their existence. Boston has planned a series of seawalls, berms and other barriers to protect the Seaport District, but still needs to raise another $1 billion to finance its construction (Gopal, 2019). New York City

75 recently raised $20 billion for sewage improvements and a Staten Island seawall but is still more than $10 billion short for necessary protections including a 500-foot extension of lower Manhattan into the East River (Gopal, 2019). Beyond the large price tags, projects like these also face significant legal hurdles, as lawsuits from environmental organizations concerned about ecosystem impacts, and neighboring communities that could be damaged by displaced water, which could cause significant construction delays and result in dramatic cost escalations (Pilkey, 2016).

When you consider, in addition to new coastal protection systems, the high expense that our governments face to retrofit and protect existing, exposed infrastructure, such as highways, public transportation, sewage systems, waste treatment facilities and nuclear power plants, it becomes clear that the engineering and economic scale of this problem requires proactive investments to minimize cost and risk. During Hurricane Sandy, sewage plants – which are often gravity fed and situated in low lying areas directly on the coast - in nine different states were inundated and forced to release an estimated 11 billion gallons of untreated or partially treated sewage into neighboring streets and bodies of water (Pilkey, 2016). In Florida alone, the Turkey Point and St. Lucie Nuclear power plants sit on low lying barrier islands and are the sources of much of Southeast Florida’s electricity. In 2012, Climate Central mapped the location of energy facilities in the continental United States and found 300 facilities (130 natural gas, 96 electric, 56 oil and 4 nuclear powerplants) that were fewer than 4 feet above the mean high tide line. Retrofitting these plants would cost billions of dollars, but the cost of not protecting or moving them could also approach that level if a large storm were to cause a Fukushima like meltdown or if chronic inundation led to severe environmental degradation (Pilkey, 2016).

A recent report by Resilient Analytics titled “High Tide Tax: The Price to Protect Coastal Communities from Rising Seas” set about to estimate the cost to build a bare bones seawall around much of the United States (their model included 50,000 miles in 22 states) and determined that it will cost at least $400 billion over the next 20 years to protect coastal communities from sea level rise, but that this amount would only be around 1/10th of the total adaptation costs that local and state governments will have to finance over the next two decades. Further, this study assumed relatively optimistic scenarios where there are moderate reductions

76 in carbon emissions (used models based on emissions pathway RCP 4.5, which implies only 14- 28 inches of rise by 2100, below many estimates that show >3 feet as probable) and with the surge from only a 1 year storm event (the Army Corps of Engineers typically designs coastal infrastructure to withstand a 100 year storm). On top of this, they assume that this system could be built in half the time it took to build the original interstate highway system. To prevent seawall failure in a more intense scenario, the costs would increase significantly (Leroy, 2019). It is important to note that a seawall of this scale would have negative environmental and ecological impacts, by destroying sandy beaches and altering marine ecosystems. Of significant concern is the extreme cost that falls on specific counties and communities, as this analysis estimated that 14 states would see expenses of $10 billion or greater, more than 130 counties would have at least $1 billion in costs and 19 towns would have costs exceeding $1,000,000 per person. Florida alone is shown as having to pay $76 billion for this infrastructure, which roughly equates to the state’s entire 2016 budget (Leroy, 2019).

Not only are the cost, political will, environmental impacts, engineering capacity and timing of this in question, but importantly it is unclear what would be the revenue source for these expensive projects that could bankrupt certain municipalities and counties without federal or private support (Leroy, 2019). This means that many homeowners and communities may be forced overtime to abandon exposed properties and neighborhoods and explore ways to manage retreat to safer locations. Though managed retreat of some kind is likely, even it could prove costly to local governments as there have been recent court rulings stating that governments that fail to protect private property may owe homeowners compensation for the value of their abandoned properties (Leroy, 2019). Since 1989, Americans have voluntarily sold 44,000 properties in high risk areas to the federal government through FEMA’s Hazard Mitigation Grant Program, but these payouts are often on less expensive properties and will be exorbitantly expensive to try to replicate on even a small percentage of the more than 49 million housing units in at-risk areas in the United States (Roston, 2019).

Centuries Below Sea Level: Dutch Exceptionalism As we discussed in the previous section, the engineering expertise and cost of projects required to protect the status quo along all of America’s coasts are enormous. Many commentators point

77 to Holland as a hopeful example that the United States and the rest of the world can try to emulate as they adapt to the problems of global warming. Much has been written about the Netherlands’ tremendous ability to adapt its society to thrive despite constant threat of inundation. Unfortunately, close examination of the Netherlands’ centuries long fight with the sea reveals that their success has depended on extensive engineering skills, uniquely beneficial topography, massive government spending, a lack of land to which to relocate, unanimous political will and an elongated timeline that will be difficult to replicate in other parts of the world. To understand how the Dutch have succeeded against all odds requires a brief history of the country and its impressive waterworks programs.

Situated in the North Sea at an average elevation of ~90’, with a third of its land mass below sea level and two thirds of it prone to flooding, the Netherlands is a low lying country that largely occupies the delta formed by three major rivers (the Rhine, the Meuse and the Scheldt). Its very existence relies upon protecting itself against flooding from the sea and its rivers and, as such, it has an 1,100-year history of water engineering with dikes protecting villages even in the 9th century (Iovenko, 2018). Powerful, transregional water control boards, dating back to the 13th century, are independent from the national government and have their own ability to levy taxes. These entities have facilitated many large engineering projects that would create jurisdictional and legal nightmares in the United States (Pilkey, 2016).

Apart from continual and large scale land reclamations that date back to the nation’s founding, the two most famous Dutch water protection measures are the more recent Zuiderzee Works and Delta Works projects of the 19th and 20th centuries, which taken together are listed by the American Society of Civil Engineers on its list of Seven Wonders of the Modern World (ASCE, 2010). The Zuiderzee (means “Southern Sea”) was a shallow bay that ran 60 miles inland from the North Sea and was about 30 miles wide (Bergsma, 2019). Though this facilitated shipping and trade, it frequently exposed inland populations to floods that killed hundreds or thousands of people. Prominent Dutch politician and civil engineer, Cornelis Lely, hatched a plan in the late 1800’s to wall off the outside of the sea and turn it into a lake, but had trouble winning political support for it until a large storm hit in 1916 (Bos, 2017). In 1918, the Zuiderzee act was approved by the government with hopes to tame the sea and create farmland. Thankfully, the topography allowed the Netherlands to do this inexpensively by building a 19-mile dam known

78 as the Aflsuitdijk (ASCE, 2010). After its construction completed in 1932 for a relatively low cost of 700 million euros (2004 equivalent), this allowed for reclamation of close to 900 square miles of land (called polders) that completed in 1967 (Bergsma, 2019).

The second famous project, the Delta Works, was approved after a large storm hit the area of the Netherlands unprotected by the Aflsuitdijk dam in 1953, causing the death of roughly 2,000 people. This large-scale project consists of dams, locks, dykes, sluices, and levees that protect the south of the Netherlands (Fleming, 2018). Though partially financed by the Marshall Plan, it ended up costing the Dutch $7 billion upon its completion in 1997, over 40 years after its commencement (Bergsma, 2019; Pilkey, 2016).

While these projects have helped the Netherlands to thrive in spite of its low lying elevation, they have come at an enormous cost of up to 7% of annual GDP (Bos, 2017), were possible given the nation’s relatively short coastline and long construction timeframe, and were driven by a nation with a long legacy of civil engineering, powerful transregional governing bodies, and no additional land to which to retreat (Fleming, 2018). Replicating this success on a large scale in the United States is highly unlikely given the price tag and much larger scale of the problem here. For comparison, the Netherlands’ three main cities and economic engines, Amsterdam, Rotterdam, and the Hague, are within 620 miles of each other along the coast, and are all at least partially below sea level (Fleming, 2018). This compares to the United States’ 100,000 miles of coastline with ample interior land to which managed retreat is possible and cheap (Fleming, 2018). Further, the current pace of sea level rise means that the United States will not be able to spend the multiple decades it took the Dutch to build its coastal infrastructure and, even if that time were available, the delegation of authority to city and state governments in the United States would make it, under current jurisdictional conditions, impossible to have the regional planning and approval coordination that was afforded to the Dutch by its powerful water boards (Fleming, 2018; Pilkey, 2016).

From Sea to Shining Sea: America at Risk As is the case around the globe, the impacts of climate change will not be uniform in the United States. There will be losers and winners, or maybe just losers and slightly better off losers. Regardless, not all geographies of the United States are equally well positioned to survive future projections. Among the easier to understand and model impacts of climate change is sea level

79 rise. While wildfire likelihood and severity and even storm surges can be hard to predict, it is relatively discrete to determine how much land situated glaciers are melting, the thermal expansion of ocean water and the pace of subsidence (land sinking; often occurs at deltas or in areas with large amounts of water or mineral extraction) will affect an area’s sea level. While all coastal cities from Boston to San Diego and Juneau to New York are exposed, much of the Southeastern United States and particularly Miami and New Orleans are in even greater peril due to their topography, geology and exposure to tropical storms (Pilkey, 2016; Wanless, 2019).

Delta Blues: Sinking New Orleans

Positioned low in the Mississippi Delta, New Orleans is one of the country’s most endangered places when it comes to climate change. With over 344,000 people in the city limits and 1.2 million in surrounding communities (as of 2010), the low-lying city is exposed as its average elevation is 2 feet below sea level (highest elevations are only ~20 ft above sea level - on a natural levee - with its lowest portions 6 ft below sea level - in the eastern portion of town) and it currently is sinking an average of 2 inches per decade (Pilkey, 2016). In addition to a large population, an economic engine of the United States is also at risk, as the Port Of New Orleans is the country’s 16th largest port and, via the Mississippi River, a key trading post linking the Gulf Coast to America’s heartland (Harvard Business Publishing, 2017). Having already been ravaged

80 by a continued loss of wetlands, dangerously high temperatures, increasingly powerful storms, including 1,577 deaths and a large portion of the $150 billion of damage caused by Hurricane Katrina in 2005, land subsidence and rising seas, the long term future of New Orleans is in doubt and substantial adaptation measures need to be undertaken to preserve The Crescent City (Pilkey, 2016).

Source: City of New Orleans, “Climate Action for a Resilient New Orleans”

One of the most pressing impacts of climate change on New Orleans has been the sinking of the city due to the complementary (but still negative) climatological impacts of sea level rise and land subsidence. This trend is expected to accelerate into the future causing massive damage to the city and permanently altering its landscape. NOAA expects the sea level in the area to rise by at least 3 feet by the end of the century, while the USGS expects that New Orleans will sink by 3 feet in this same period, causing – in aggregate - the city to drop a further 6 feet below its already low-lying location relative to the ocean (Pilkey, 2016). Under this pressure, the city risks catastrophic failure of its levee system and inundation of many of its neighborhoods.

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Source: “Climate Change and the Resilience of New Orleans”

That is what happened during Hurricane Katrina after 53 different levee breaks occurred, allowing stormwaters to flood 80% of New Orleans (Pilkey, 2016). This led to an exodus of 800,000 residents out of greater New Orleans, many of whom never returned even after the city was rebuilt. Eight years after Hurricane Katrina, New Orleans’ population was still 25% lower than it had been before the storm (Deryugina, 2014). The Federal government spent $14.5 billion to enlist Dutch engineers and the Army Corps of Engineers to rebuild the city’s damaged infrastructure, including building large gates at three drainage canals, repairing a 350 mile system of connected levees, fixing 73 pumping stations and 4 gated outlets. These infrastructure improvements were built to withstand a once in a 100-year storm, meaning a storm with a 1% chance of occurring in any given year (Pilkey, 2016).

Unfortunately, scientists believe that hurricanes are gaining strength and storms of the intensity of the past once in a 100-year designation will now become more common. Scientists at MIT and Princeton published research in Nature Climate Change showing that today’s once in a 100-year storm could start to occur every 3 to 20 years, so 5 to 33 times more likely in any given year.

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They also predicted that once in 500-year storms that would stress New Orleans’ infrastructure may occur every 25 to 240 years, so 2 to 20 times more likely in any given year (Pilkey, 2016).

Urgent measures need to be taken to guarantee New Orleans’ future. To effectively adapt to such a large problem will mean deploying several concurrent measures to improve building standards, raise portions of the city, protect wetlands, keep the water out, redirect storms and pump out any floodwater that intrudes (City of New Orleans, 2017). One way to help is to buyout landowners in flood zones, as this creates a market for houses that may otherwise be difficult to sell and facilitates managed retreat to safer areas that also have better long-term investment potential.

A particularly pernicious problem in low lying coastal areas is the use of flood insurance and other disaster relief programs to rebuild properties in the same place that are damaged by hurricanes and other forms of flooding. While the desire to preserve neighborhoods is well intended, it can often prove foolhardy when these areas are likely to be destroyed again in the near term. The Biggert-Waters Flood Insurance Reform Act of 2012 sought to address the problems of the NFIP program by phasing out subsidized rates for properties in low lying areas (Pilkey, 2016) and would have been a powerful way of pushing owners to think about the risks of living in dangerous areas. Unfortunately, this act was repealed and means that other programs will have to be relied upon to incentivize people to leave low lying areas. Fortunately, there are other ways to try to buy out at-risk homeowners and landlords and get them to move to higher ground before they suffer destruction of their properties (and attendant hit to their balance sheets), including three FEMA programs that offer buyouts that do not depend on disasters, including 1) the Flood Mitigation Assistance Program, 2) the Pre-Disaster Mitigation Program and 3) the Severe Repetitive Loss Program (Pilkey, 2016). If focused, this program should have particular efficacy as Orrin Pilkey points out “78.8% of subsidized policies are in counties that rank in the top 30% of home values, while fewer than 1% are in counties that rank in the bottom 30%” (Pilkey, 2016). Acquiring and removing houses and infrastructure that are exposed to sea level rise makes sense as it protects lives, creates larger land barriers to buffer future storms and keeps taxpayers from having to continually backstop the cost of natural disasters.

That said, given its unfortunate location in the Mississippi Delta, any future for New Orleans will involve a city with a smaller footprint and population. In the interim, exposed property is likely

83 to lose value, tax rates may increase to compensate for lost revenue, and some inhabitants may move to nearby cities that are more well positioned to withstand a changing climate.

Atlantis in America: Underwater in Miami Miami, like New Orleans, faces several unique challenges as it confronts a future of rising oceans. The city has grown rapidly over the last 60 years from 350,000 housing units and 935,000 people in 1960 to 2.6 million people and around 1 million housing units in 2010 (Sullivan Sealey, 2018). Unfortunately, close to 60% of Miami-Dade County is less than six feet above sea level and is already vulnerable to tropical storms (Cox, 2015). The urban population is primarily along a coastal ridge that slopes down seaward to the ocean and landward to the large wetlands of the Everglades, which means that Miami is at risk of flooding an inundation from both the west and the east (Wanless, 2019). As mentioned earlier, it is estimated that a rise by 2100 of two feet beyond today’s sea level would cause continual inundation of roughly $500 billion of property in Florida (Neumann et al., 2010). Despite this, there is still lots of building ongoing in South Florida (over 200 condominium units under construction in Miami), including on barrier islands, throughout downtown Miami and in low lying areas adjacent to the Everglades (Wanless, 2019).

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Many scientists suspect that Miami-Dade County will face faster than average sea level rise in the years ahead. After 2006, the rate of annual sea rise tripled in along Florida’s coastline (SE Florida Regional, 2012). Miami-Dade and Southeast Florida may also experience a slowing Florida Current and Gulf Stream, which is projected to drive an additional 0.7 to 1.3 feet of sea level rise above and beyond current projections (Wanless, 2019). Exacerbating the situation, much of Miami-Dade County sits atop limestone bedrock that is porous and allows salt water to flow through its formation (Pilkey, 2016). As a result, any sea level rise also increases the saltwater table relative to the fresh water in the Biscayne Aquifer. This not only threatens Miami’s primary source of drinking water, but also increases pressure on the region’s storm water drainage system, making it harder for floodwaters to drain. In a storm event, this currently causes parts of Miami Beach and downtown Miami to have up to three feet of standing water and, with increasing sea levels and larger storms, could lead to widespread damage and more regular inundation (SE Florida Regional, 2015). Additionally, this means that hardened protections like a seawall would do nothing to stop the water flowing in from the Everglades and up from the water table underneath Miami-Dade, which makes the region uniquely poorly positioned to deal with seal level rise (Pilkey, 2016).

Source: Hal Wanless, University of Miami and Peter Harlem, Florida International University

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Unfortunately, almost none of South Florida’s infrastructure was built to anticipate sea level rise, causing the existing sewage system to lose drainage capacity in recent years, leading to flooded streets and may soon result in possible expensive violations of the Clean Water Act if the state is unable to properly dispose of sewage in the future. As with the nearby Turkey Point nuclear powerplant, the county’s three wastewater treatment plants are located along the coast and face billions of dollars of costs to be retrofitted or moved to safer locations (Pilkey, 2016).

Given Miami’s increased exposure to the risk of sea level rise, it has been one of the first markets to have climate change’s pricing impact studied empirically and has shown some interesting property value trends that are likely to continue in South Florida and spread to other at-risk markets. Local developers have started to focus on the safety of higher ground, with formerly overlooked submarkets seeing interest and, according to CoreLogic Inc, neighborhoods like Little Haiti experiencing home price appreciation at nearly double the rate of Miami overall. Harvard professor Jesse Keenan and his colleagues did a detailed study of home values (sampled over 100,000 properties) throughout greater Miami and tracked neighborhood prices against their elevations. This research revealed that home prices are beginning to increase more slowly near sea level than in higher elevations with properties between 2-4 meters of elevation seeing faster appreciation than properties in the 0-2 meters of elevation cohort. The authors concluded that this likely demonstrates a consumer preference for higher elevation properties, where buyers are less concerned about flooding, and postulated that this may lead to large scale migrations that cause gentrification of higher elevation communities (Keenan, 2018). With a similar focus, Steven McAlpine and Jeremy Porter, published similar research that analyzed the real estate value lost in Miami-Dade County due to recurring tidal flooding resulting from sea level rise compared to what property values would have been had the coastal conditions of the recent past persisted. To do this they looked at property values, elevations, flooding events and storm activity in 2005 and in 2016, observed all sales in from 2005 to 2016 and ran regressions to see relative property value changes by indicators of future property flooding (using climate model projections). This work showed that increased tidal and flooding risk over that period caused a total loss of $465 million of real estate value in Miami-Dade between 2005 and 2016 (McAlpine, 2018).

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Chapter 5 – By the Numbers: The Economic Literature on Property Values and Climate Change

“A bank is a place where they lend you an umbrella in fair weather and ask for it back when it begins to rain.” - Robert Frost

In this section, we will continue the review of sea level rise’s impact on property pricing that we began in the Miami section but with a focus on the country as a whole, and consider how this will change going forward and impact where people want to live, work and own property. While scientists predict that the worst impacts of climate change are still to come, there is a growing body of empirical research proving that certain property values are already being negatively impacted by this phenomenon. There are many luminaries in the field, including Nobel prize winner William Nordhaus, Nicholas Stern, Matt Kahn, Frances Sussman, Solomon Hsiang & Marshall Burke, Jesse Keenan, Frank Ackerman, Robert Pindyck, Asaf Bernstein and Melissa Dell. Their work has shown that climate factors already play an important role in the economic decision making of property owners and are poised to see faster rates of change as the climate warms and seas rise. Going beyond pricing, noted demographers, such as Mat Hauer, Katherine Curtis and Annemarie Schneider have contributed valuable insights about how human births, deaths and migratory patterns are likely to evolve to cope with climate change.

The Cost of Sea Level Rise The First Street Foundation is a non-profit research and technology group that now employs the aforementioned Steven McAlpine and Jeremy Porter, along with other climatologists and data scientists, to define America’s flood risk and analyze sea level rise’s impact on property values. Helpfully, they have put together a free online tool called Flood Factor (https://floodfactor.com/) that allows investors to analyze their properties’ risk of flooding, see whether it has previously flooded and see how their local area will be impacted by climate change. This tool should be a compulsory due diligence item for any real estate investor. Separately, the First Street Foundation conducts cutting edge research, using similar methodologies to McAlpine and Porter’s study of Miami’s property market. After analyzing 11 million real estate transactions and looking at how those trends would impact 22.5 million properties in 14 states, they found a $15 billion loss in home value in the United States due to increased sea level and flood risk. With

87 an ability to look at granular, property level detail, they also found that a triplex on Marginal Street in Boston was worth only half of what it would have been had it not been for increased flood risk (Costello, 2019).

Interesting research is also underway to show how frequent flooding can impact local economic activity. While this paper’s focus is on how residential properties are impacted by sea level rise, there are also studies being conducted on the impact to retail trade areas, which will be instructive to both retail tenants and landlords looking to business plan in a time of climate change. Scientists and economists analyzed how high-tide flooding has reduced visits to Annapolis, Maryland’s historic downtown and measured the impact that this reduction has had on local trade. In 2017, downtown Annapolis had 63 days with at least nuisance flooding (often occurs without rain and just a function of a high tide), a level that causes minor street flooding and submerges several parking spots in the town’s main commercial parking lot. Researchers analyzed drops in visitors to the parking lots on nuisance flooding days and found that the downtown already has lost 1.7% of its visitor base, another 3 inches of sea level rise are expected to reduce visits by 3.6%, while 12 inches of sea level rise would eliminate 24% of the retail areas visitors. The study also estimated that every 1% loss in visitors would drive a 0.4% to 0.8% loss in revenue for the local businesses, meaning that retailers today are missing out on 0.7% to 1.4% of their revenue, with 3 inches of rise could lose 1.4% to 2.9% of their revenue and with a foot of sea level rise would lose 9.6% to 19.2% of their revenue (Hino, 2019). This analysis is worth considering, as other flood prone locations may exhibit similar dynamics that hurt government sales and property tax collections, retailer profitability, landlord rent receipts and, ultimately, investors’ property values.

A groundbreaking work by Asaf Bernstein, Ryan Lewis and Matthew Gustafson titled “Disaster On the Horizon: The Price Effect of Sea Level Rise” analyzed the impact of sea level rise on property prices and found that more than 6 million houses in the United States worth over $1 trillion are at risk. While predictions of sea level rise heights vary depending on local effects there is relative consensus that by 2100 coasts are generally likely to have mean high tides that are 3 to 6 feet higher than they are today. After layering on sea level rise maps created by the National Oceanic and Atmospheric Administration (NOAA) to Zillow’s residential pricing data,

88 this study examined data for more than 1.7 million homes to see how sea level rise impacted their values with a focus on 460,000 sales occurring in areas between 0-6 feet above sea level and less than ¼ mile from the coast. In summary, they found that these houses are already trading at a substantial discount – on average 7% - when compared to houses that are not exposed to sea level rise, and they found that institutional investors and those that believe in climate change are taking greater discounts and that the amount of the discount has increased in recent years (Bernstein, 2018).

This research is interesting not only because it shows that a discount for forthcoming sea level rise is already being underwritten, it also indicates that larger future discounts are likely as the effects of sea level rise come to pass and cause currently sanguine investors to become more cautious. As an example, this study found that so far, rental rates are unimpacted by sea level rise, which means short term renters are willing to pay the same amount, as they are not focused on future inundation that will happen long after their leases end. This happens while non-owner- occupied properties trade at a greater 10% average discount. This means that savvy investors are starting to discount properties faster than their less aware peers (Bernstein, 2018).

Source: Bernstein, 2018

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Based on largely the coastal topography and underwater bathymetry in the United States the study found significant property exposure to sea level rise in the Gulf of Mexico, Florida, up the East Coast to Maine and in the Pacific Northwest. Not only did it find the average 7% overall discount at properties exposed to sea level rise, it also found, as you would expect, greater discounts on lower lying properties. This reflects the fact that lower lying properties will be affected by sea level rise sooner, in certain cases within the next decade. Specifically, the study found properties up to 1 foot above sea level discounted by 15%, from 2-3 feet above sea level discounted by 14%, from 4-5 feet above sea level at an 8% discount and those up to 6 feet above sea level at only a 4% discount – as they are unlikely to flood for many decades (Bernstein, 2018).

Going forward, this affirms the likelihood that certain areas will see greater falls in property values even if rental conditions hold. What is not studied in this paper is a likely effect that is beginning to be studied in other academic research: that certain well positioned areas are likely to see outsized appreciation in the years to come (Bernstein, 2018).

Other Price Drivers: Hurricane and Wildfire Risk

While much of the research done to date has focused on sea level rise, there are also some interesting economic studies showing the impact that hurricanes and wildfires have on property values. The research firm Attom Data has already begun to study and quantify these differences (Flavelle, 2018). In its work, Attom analyzed home prices in 3,397 cities across the United States and found that from 2007 to 2017, average home prices grew much faster in areas with a low likelihood of being damaged by flooding, wildfires, or hurricanes. Overall, they found that average home prices, for all stock, increased 7.3% in this time period, but the houses most exposed to flood risk were worth 4.8% less in 2017 than they were in 2007, and those most at risk of a hurricane storm surge where worth 9.1% less in 2017 than in 2007. Homes most at risk of wildfires saw appreciation over the period, but at 2.2% it was still 5.1% lower than the value increase experienced at the average home (Flavelle, 2018). This indicates that homeowners are more cognizant of the variety of risks posed by climate change and are adjusting their bids accordingly.

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A Crystal Thermometer: Temperature and Forward-Looking Pricing While the previous analyses show how climate change has already hurt property prices, the real issue is how different will future prices be in markets that realize dramatically different climate outcomes. To put it simply, how much better off will the winners be than the losers?

Although this is still an emergent subject of research, there are useful studies that are starting to cover this topic. Several studies (incl. Hoch and Drake, 1974; Cropper and Arriaga-Salinas, 1980; Cropper, 1981; Roback, 1982; Clark and Cosgrove, 1990, 1991; Gyourko and Tracy, 1991; Koirala and Bohara, 2014; Albouy et al., 2013; Sinha and Cropper, 2013; and Sussman et al., 2014) show climate’s significant impact on residential real estate and labor markets, and indicate that as Sussman et al. summarize “people prefer warmer average weather, higher winter temperatures, lower summer temperatures, and less precipitation. The evidence also suggests that the relationship is nonlinear so that extreme temperatures are less preferred.” (Sussman et al., 2014)

Of note, the seminal 2014 article from Climate Change Economics titled “Estimates of Changes In County-Level Housing Prices In The United States Under Scenarios Of Future Climate Change” offers a helpful analysis of how differently real estate markets throughout the United States could be effected by a changing climate. It is worth noting when looking at the outcomes of this work that it did not factor in sea level rise (this paper’s focus) or other extreme weather, including hurricane impacts. This means that the results of a similar project that is expanded to include these variables could produce even more disparate outcomes by geography.

In this work, its authors analyzed the relationship between housing prices and climate variables – such as temperature, precipitation and humidity - to try to determine climate’s impact on values. They pulled information from a dataset of 1.3 million households on owner-occupied houses in small and large cities (excluded rural areas) to develop a hedonic regression model to show how different natural factors have impacted pricing. They then applied their results to future climate states based two models (primary and alternate) that rely on four scenarios using General Circulation Models (which are future climate simulations that cover the entire planet) and Regional Climate Models (which are downscaled simulations that focus on smaller geographies

91 to capture localized changes) of future climates taken from the North American Regional Climate Change Assessment Program (prepared in 2007 and 2009). The primary model includes seasonal temperature variability (with inputs for January and July) to show how these extremes affect prices while the alternate model is based on an annual average temperature. With this, they were able to look at how temperature and precipitation overlaid with other data tracked by the US Census, including city size (Sussman et al, 2014).

The results of their hedonic regressions reflect that historically there has been a pricing premium placed on locations with warmer winters and cooler summers. On average, there is a preference and premium for warmer average year-round temperatures up until a point (around average annual temperature of 80°F) at which they become too warm and function as a drawback that requires a discount to entice homebuyers. Interestingly, their regressions did not indicate consumer preferences for certain precipitation levels (Sussman et al, 2014).

The forward-looking results of their study are based on taking the relationships derived from regressions based on historical climate (from the 1990’s) and then applying the results of these regressions to future climates that the varying scenarios predict for 2041 to 2050. The future climates vary from today’s current conditions with several changes, an example of which is an increase from today’s average 57.4 °F to up to 61.5°F in their CS1 model. Depending on which of the four scenarios is reviewed, they showed losses in home values over a normal climate on average between 3% to 12%, but that there is high variability among regions with certain scenarios showing some counties losing up to 45% of their home values while other counties are up to 12% better off. These scenarios also produce different results within the regions, but generally show the Southeastern United States as more likely to suffer, while states that are currently colder or less humid show greater resilience and in some cases home price appreciation in a future climate state over what they would otherwise be worth if the climate of the 1990’s persisted. Again, this study did not include either sea level rise or hurricane impact, which when taken together means that negative outcomes are likely to occur along the Gulf and East Coasts, with Florida being particularly exposed (Sussman et al, 2014).

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Where To? Demographic Research and Possible Migration Patterns As real estate investors seek to own property in regions with strong economic fundamentals, which are often characterized by job and population growth, a key question posed by climate change and specifically sea level rise is whether populations will cluster in different cities in the future. While the research on this topic is in its early stages, it is an area of increasing focus for demographers, scientists, and economists alike. While the state of research is likely too speculative to serve as the focus for a real estate investment business plan, it still facilitates a useful thought exercise for investors who should keep this likely future trend in mind as a topic to consider in due diligence.

While island bound nations are seeing large out migration and climate refugees are likely to become a big source in the years to come of international immigration to the United States (Koerth-Baker, 2019), it is also likely to be a predominant driver of domestic migration within the United States, a country where 40% of the population lives in a coastal area. The press has started to seize on the topic as one that will drive future home purchase decisions with the New York Times highlighting millennials who are buying climate change proof homes (Krueger, 2018) to even recommending Duluth, Minnesota as a possible climate haven (Pierre-Louis, 2019). Other publications have argued that Michigan’s Upper Peninsula is the best place to relocate in a warming world (Koerth-Baker, 2019), and many of these northern cities (including Duluth, Buffalo and Cincinnati) are actively being marketed by their city officials as climate havens to potentially relocating businesses and citizens (Rossi, 2019). The increase in interest in the topic may reflect growing consciousness that could lead to a tipping point in homebuyer and real estate investor behavior.

Early academic work on the topic by Annemarie Schneider and Katherine Curtis at the University of Wisconsin estimated that close to 20 million people in the United States will be affected and dislocated by sea level rise by 2030. Their research linked population growth predictions with climate models at the county-level spatially and temporally over 5 to 30-year forecasts. By taking sea level rise (1 meter inundation) and storm surge (4 meter) projections, comparing them with maps showing the extent of building land cover, and layering on population growth projections for the United States overall and also with a focus on four areas likely to be heavily affected by climate change (California, Florida, New Jersey and South Carolina), this study estimated how many people may have to leave a location for higher ground.

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Apart from the 19.3 million people they estimate will be dislocated by 2030 on a national level, they also estimate that 9.9 million Floridians, 5.3 million Californians, 3.3 million New Jerseyans and 722 thousand South Carolinians will need to find new homes (Curtis, 2011).

A team led by MIT engineers and urban planners analyzed the Boston metro area to see how transportation use and citizens’ reliance upon it will impact where people move considering sea level rise. Using a land use-transport model to forecast the short and long term impacts of a 4 foot sea level rise over the time period out to 2030, they found that in the short term transit dependent users suffer as travel speeds are cut in half by flooding related delays. They also projected that this would cause ridership to fall by 66%. Over the longer term, they project that parts of the subway system are inundated as roughly ten square miles of land disappear, that residential centers would shift to the periphery, mainly the inner loop suburbs likely driving up property prices, increasing walking trips, bus (more flexible than subways and trains) and passenger car usage (Han, 2017). While this study did not factor in the impact on supply chains and industrial real estate, it is likely that a similar dynamic will occur causing logistics firms to reroute shipping as coastal roads and ports flood, and populations move. Although this analysis does not offer precise historical measures or future predictions of real estate price movements, it does offer useful context to developers and property owners on the possible population shift to nearby areas, and the importance and changing role of transportation in investment underwriting.

After looking at sea level rise projections, demographer Mat Hauer began to study how climate change may impact where populations decide to settle. He astutely noted that sea level rise is an environmental phenomenon that will cause unique migration trends (when compared to the Dust Bowl or even a hurricane), as it takes land that was inhabitable and makes it permanently uninhabitable, eliminating any chance of return as previously occupied areas are inundated. In his work, he found that environmental migration often occurs after a press (longer term, think extended drought or sea level rise) or pulse (one off event, think hurricanes) that over time combine to drive large scale migration. After reviewing county-to-county migrations of people from 1990 to 2013 using tax returns from the IRS, he was able to observe past patterns to determine likely future movements. He found that migration destination decisions are often influenced by established networks, including work opportunities, friend and family locations, but are also influenced by both natural and economic amenities (Hauer, 2016). With this he

94 looked at different amounts of sea level rise (base case used 1.8 meters or ~6 feet) and future population projections to understand to which areas people are likely to move. This was one of the first attempts to determine not only who is at risk, but also their likely destination. Through his work Hauer estimated that 13.1 million people will be displaced by 2100 by rising sea levels, identified plausible destinations and areas likely to be left behind (Hauer, 2016). In additional research, he has found that Austin, Orlando and Atlanta are likely to be top climate destinations with each expecting net migration of more than 250,000, while Miami is likely to experience an exodus with more than 2.5 million projected to leave the city (Hauer, 2017).

Source: The Guardian and Mathew Hauer

Going forward it is likely that climate factors like protection from flooding and storms, availability of potable water, arable land and pleasant temperatures will be considered climate amenities and, as a result, facilitate greater economic activity, faster population growth and increasing real estate prices in areas that have them. At a minimum, it is worth noting that certain exposed regions, like Southeast Florida, face substantial habitability challenges and are likely to

95 see this impact real estate pricing. As real estate investors research which markets they find attractive for investment, they should consider environmental factors and how these could impact future migration and population trends.

Money Talks: Institutional Investor Awareness While the topic of climate change has not always been a focus of institutional investors, there has recently been growing consensus of its reality and likely severity and increasing interest by large financial organizations in how to profit from or at least protect against it. Commercial banks and regulators (including EU mandate of pension funds in 2016) have begun to look at weather damage to assess borrower creditworthiness (Min, 2020). The California Public Employees’ Retirement System (CalPERS) recently stated that climate change poses an increased financial risk on $36 billion of its $180 billion portfolio, while its neighbor the California State Teachers’ Retirement System (CalSTRS) mandated that its employees consider climate change in all investments (Min, 2020). The Florida State Board of Administration (SBA) has diversified its portfolio with only 10% of its investments in real estate and the vast majority of those properties located outside of hurricane prone Florida (Min, 2020).

Meanwhile institutional groups - from investment banks including Goldman Sachs to consultancies including McKinsey to real estate firms including Heitman and Clarion Partners - have begun to publish lengthy research pieces and white papers that offer their investors and clients background on the topic, their concerns for the future and business plans to capitalize on the trend. Even large hedge fund managers, such as Jeremy Grantham of GMO, have offered that climate change will create investment opportunities, as it changes where we choose to live, our forms of transportation and the energy systems that we use (Barron, 2019). If climate projections and price trends continue on their current trajectories then it is likely that real estate industry standard investment behavior could quickly change with greater attention paid to flooding, inundation, storm and other climate risks, and lead to the proliferation of large price discounts on exposed coastal property.

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Conclusion – Takeaways and Next Steps to Underwrite Real Estate

“Buy land, they’re not making it anymore.” – Mark Twain

Takeaways As we have reviewed, the science of climate change is based on certain long held understandings of the chemical and physical interactions of our planet’s ecosystems with themselves and the Sun. The Greenhouse Effect has been understood since the start of the Industrial Revolution, and the science linking human activity to climate change dates to the 1800’s. We have seen increasing temperatures (1.5°F over the past century) and sea levels (have risen on average by 8- 9”) consistent with or in excess of the climate models that have been digitized and refined over the last few decades, and that show signs of accelerating. Certain intractable tipping points from the melting from disintegration of the West Antarctic and Greenland ice sheets to coral reef die- off are underway and action is needed to curb them before they result in discontinuous, dramatic, and irreversible changes.

From a geopolitical perspective, it is difficult to enact effective responses to fix a problem of collective action, but that relies on the coordination of disparate groups with diverging interests. The United States accounts for only 15% of global greenhouse gas emissions and cannot solve the problem independently. Past treaties have met with mixed compliance from nations (including the United States) whose self-interest and economic goals caused them to fail to meet targeted emission levels. As with many things in life, the most effective remedies to climate change will occur when individual incentives can be aligned with group goals. We have observed how groups like the United States military and oil majors, along with nations such as Russia (who is positioned to benefit) and China (who is trying to position themselves to benefit) have made statements and display behavior that shows they understand the gravity of climate change as both an existential threat, but also as an opportunity to first movers.

While optimism is often helpful, many of the things that we have typically relied upon to protect ourselves from nature are either going to run into engineering challenges, political opposition, lawsuits, and/or excessive costs that make them untenable. Current flood insurance programs rely on government assistance and are functionally bankrupt, and private insurance solutions are

97 either non-existent or exorbitantly priced. Without an ability to purchase an insurance policy against disaster, many coastal property owners will have to self-insure and be personally responsible to repair and rebuild any damage caused by storms or inundation. The effect of this will be to lower the value of coastal property and, over time, to limit the number and expense of buildings constructed in high risk areas.

Though they may help affluent locations with large tax revenues (such as New York or Boston), engineering solutions to this problem are unlikely to bear fruit on a large scale given the dynamic nature of sea level rise (hard to know to what height to build), the cost (could be several % of GDP to protect the entirety of our coastline; many cities and towns face costs that exceed their tax revenues), the timescale (some larger infrastructure projects take decades to design, approve and build, while climate change will continue apace in the interim), and political barriers (environmental infrastructure can help some and hurt others). Even arguably the most hopeful case from history, the Netherlands’ success against the sea, provides little solace given the unique factors that have allowed the Dutch to thrive and that are not replicable in areas with unique challenges like Bangladesh, Miami or New Orleans. More environmentally friendly buildings and more durable construction of homes may help, but in certain communities managed retreat away from flood zones is inevitable and saving time and money by proactively anticipating and effecting it is desirable.

While many of the worst aspects of climate change are accelerating, the economic data already displays empirical evidence of how a changing climate is lowering GDP and hurting human well-being globally. Sunny day flooding is limiting commerce, hurting consumers, retailers, and landlords alike. While sea level rise and increasing storm intensity is causing property damage and costing lives. Since 1980, over 254 events caused a billion dollars or more in damages, totaling $1.7 trillion and 13,244 lives lost, with the last few years responsible for a disproportionate amount of the damage.

A changing climate touches all sectors of the economy, but real estate, especially coastal real estate is exposed, in a direct way. With chronic inundation, over time certain places will be permanently uninhabitable. This will increase the 7% discount hitting sellers of exposed coastal property, and further the already $15 billion loss in home value due to increased sea level and flood risk. While Mark Twain coined the aphorism “buy land, they’re not making it anymore”, if

98 he were alive today, he would be more likely to say, “buy land, some of it is disappearing.” As with any market, lowering the supply of a good without lessening its demand leads to an increase in the price of that good. This is the dynamic facing well positioned land today. Fortunately, real estate investors respond to the profit motive and if the consequences of climate change are well understood, that profit motive should serve to help long term oriented investors to understand the currently mispriced risk of owning and developing buildings in vulnerable areas like flood zones.

Next Steps The purpose of this thesis is not to provide a list of cities that are most likely to outperform their peers in a world of climate change, nor is it to attempt to perfectly predict future real estate price changes. An obvious opportunity for highly useful research exists for climate scientists, urban planners, demographers, economists and investors to work together to do a deep dive on what different climate scenarios mean for regional habitability, what the current carrying capacities are of different cities, taken together what these suggest for possible migratory trends and, as a consequence of the aforementioned analyses, offer rigorous recommendations of how cities should rezone, governments should invest in infrastructure and supply chains and property markets should adapt. While the aforementioned tasks are worthwhile, they are impossible to do accurately at present given the number of variables, timescale involved and scope of this thesis.

Instead, the goal of this thesis is to inform homeowners, real estate developers and the investment community generally that climate change is rapidly occurring, largely intractable, and likely to cause massive movements of people to more well positioned cities. The logical result of these changes, which is already showing up in transactions, is that certain coastal and flood prone locations will experience large drops in property value, while areas with better climate amenities will experience outsized buyer interest and appreciation. The tangible question then becomes what steps real estate developers and owners can take today to limit their downside risk and exposure to climate change.

Tomorrow’s Climate, Today’s Underwriting: Climate Due Diligence For Real Estate Given the lack of clarity about the timescale and magnitude of future climatic shifts, their regional variability, and the potential implications to real estate values, it is important for investors to reconsider their approach to finding and underwriting investments. To this end, investors should consider climate related aspects that are often not included in traditional

99 investment memorandum. Environmental and political factors beyond inundation from sea level rise, will influence population migrations and the economic viability of different neighborhoods and cities.

Investors should consider items that are critical to growth, including water availability (already an issue in certain cities like Las Vegas with recent droughts at Lake Mead and subject to interjurisdictional disputes like the tri-state water war between Georgia, Alabama and Florida), the sources of tax revenue for different jurisdictions and how exposed these may be to climate dependent factors (example, importance of beaches to Miami-Dade tourism and sales tax, and the proportion of Florida’s property taxes from coastal homes). An excellent overall source for understanding climate change and how it could impact any region in the country is the U.S. Climate Resilience Toolkit, which can be found here: https://toolkit.climate.gov/.

To prepare for climate change, property investors should include the following ten items with their typical due diligence packages and underwriting materials.

1. Flood Maps – Of primary importance to investors in coastal property, elevation and flood maps offer useful indications of a property’s risk. As described previously, FEMA’s flood maps do not factor in future sea level rise or storm surge potential, so it is worth consulting other, forward looking resources. While the best resources may change, the First Street Foundation’s Flood Factor is a free, intuitive and detailed application that allows you to look at a property’s flood history, understand its current exposure and analyze its future risks. It can be found here: https://floodfactor.com/. While Flood Factor works well for the property itself Climate Central’s Risk Finder and the website Sea Level Rise are useful tools to understand specific city and town exposure to sea level rise. They can be found here: https://riskfinder.climatecentral.org/ and here: https://sealevelrise.org/. 2. Climate Models – While climate models are extremely detailed and difficult for the uninitiated to audit or interpret, their outputs are often summarized in detailed, accessible papers by organizations like the IPCC. Although they may not be as immediately useful as flood maps, they provide additional information around likely temperature changes and regional weather predictions (including impact on possible heat islands and proximity to forest fire zones) that can prove informative for underwriting. A good initial resource for

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these are the assessment reports prepared by the IPCC, which are continually updated and can be found here: https://www.ipcc.ch/reports/ 3. Neighborhood and Regional Infrastructure Viability – The value of a property can be materially harmed if the local infrastructure or regional supply chains upon which it relies are damaged. Local infrastructure conditions and vulnerability should be analyzed in due diligence. This should include detail on the sources and availability of access (roads, bridges, tunnels, etc.), fresh water and electricity, and the capacity of storm drains and wastewater treatment systems. This should include mapping of their locations relative to the property, to include a review of the infrastructure’s exposure to sea level rise. 4. In vs. Out Migration Dynamics – When underwriting real estate, it is useful to look at whether an area is gaining or losing population and the inclusion of demographic trends is standard in many investors’ processes. Going forward, investors may benefit by understanding not only the ages, incomes and number of people that are moving to or leaving an area, but also understanding from where they are coming or to where they are going. As the research of demographers has showed, people tend to move to places where they either have social networks (often called chain migration) or where there is greater economic opportunity. Certain climate amenities, such as pleasant temperatures and protection from storms and rising seas, may also play a role in how people decide to move in the future. 5. Carrying Capacity – For very long-term investments in regions that seem poised to be destinations for climate migrants, it would be useful to understand the carrying capacity of an investment’s neighborhood, town, city, state or region. It is great if an investment is attractive today, but if its local government and utilities are later unable to provide water, electricity, reasonable commute times and land for a likely larger population then this could impact a developer or property owner’s business plan. 6. Government Creditworthiness Now and In Future – As certain municipalities and states face climate change, revenue shortfalls from diminishing property and sales tax could lead to budget holes that either make it more expensive for a state to borrow in public markets, more likely for them to increase taxes or cut the budgets of other key services, and, in some cases, possible that they even file for bankruptcy. As part of the due diligence process, it is worthwhile to review an investment’s state, county, and municipal finances by reviewing the credit scores, budgets, tax sources and the susceptibility of those tax sources to climate

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change before investing in a property. This work is often ignored by real estate investors focused on a property’s cash flows but it will become more important as governments grapple with how to pay for climate change adaptation. 7. Political Will and Property Rights – For real estate investment to occur efficiently and predictably, it is important for communities to respect property rights and enforce the laws that establish them. To deal with climate change, it will be helpful for local governments to prepare for the inevitability by making strategic transportation and zoning plans, accounting for climate impacts in their budgets and trying to determine likely sources of funds to mitigate these impacts. When looking at new markets, real estate investors should analyze the stances of politicians to see whether they are supportive of investment in a time of climate change. Positions opposed to property rights (an example may be if they support extreme rent control measures) or unresponsive to climate change (example, support for zoning that encourages development in flood zones) may indicate that a municipality is not poised to thrive as a place for investment in a time of climate change. As is the case with Boston, certain cities have detailed plans that lay out much of this information. See Resilient Boston here: https://www.boston.gov/environment-and-energy/resilient-boston-harbor. 8. Building Design and Sustainability – Apart from things like LEED certification or passive house (PHIUS), it is important to analyze how capable any building will be in the decades to come. Will the foundation stand up to a rising water table, or the façade and roof to more intense storm winds? Are there ways to make the building more habitable in warmer weather? This is a typical component of real estate diligence and underwriting, but a focus on the ability of the building to thrive in a future climate will be increasingly important. 9. Operating Expense Review – Central to any property underwriting, operating expenses can fluctuate greatly depending on things like mill rates for property taxes, supply/demand dynamics with respect to different utilities and insurance rate variability based on past loss histories and estimates of future loss probabilities. While these are often budgeted using one number per line item and a different growth rate, it may be worth thinking through scenarios whereby utilities or taxes could increase meaningfully and at once, rather than slowly and over time with a growth rate. When determining future scenarios, consideration should be made to a municipality’s tax base’s exposure to climate change and the possibility that large capital expenditures may be required of local utilities to maintain the same level of service.

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10. Real Options Approach and Monte Carlo Simulations – Property is typically underwritten using relatively short-term discounted cash flows, but by utilizing a longer timeline with more simulations of different scenarios it is possible to highlight current market mispricing of assets based on widely divergent upside and downside skews given likely future climates. Expanding traditional underwriting models to include a real options approach and Monte Carlo simulations should help investors avoid overpaying for property in coastal areas like Miami and help them to understand the potentially unrealized value of climate amenities at properties in more resilient locations.

The Usefulness of a Real Options Approach and Monte Carlo Simulations In the previous list of items to add to the diligence process, the one that is probably least intuitive to the uninitiated is the tenth and final item, updating underwriting models to include a real options approach and Monte Carlo simulations. Given the already observed differences in climate amenities between markets and the likelihood that the related disparity in pricing grows, it is advisable to include in new property underwriting a longer timescale with additional simulations to account for the uncertainties associated with climate change. This approach is critical to quantifying and articulating the underlying risk that investors miss when they underwrite property based on the assumption of a stable future climate that matches today’s climate.

As the actual work of building a full model to do this is quite involved, we focus here on the flaws of traditional property valuation methods, give background on real options and Monte Carlo simulations, and explain why using these to underwrite property in conjunction with traditional methods is preferable. While there are many good books on the topic, for detailed background and practical instruction on how to build Monte Carlo simulations in Excel, please consult David Geltner and Richard de Neufville’s work “Flexibility and Real Estate Valuation under Uncertainty: A Practical Guide for Developers”. For more information on how real options is shaping and applied to environmental policy, consult Benoit Morel’s “Real Option Analysis and Climate Change: A New Framework For Environmental Policy Analysis.”

When underwriting new property investments, most real estate investors rely on some mix of Microsoft Excel and a real estate software package called Argus to produce net present values (NPV) and deterministic, relatively short-term (typically up to 10 years) discounted cash flows

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(DCF). In a DCF, the investor models all future cash flows in a pro forma, which includes income from rent, property expenses and an expected future sales price. The model then applies a risk adjusted discount rate to the cash flows to determine the present value of the property. Or if they know the purchase price up front this will be included in the cash flows and they instead will calculate an internal rate of return (IRR), which is functionally the same as the discount rate that would make the NPV of the future cash flows equal zero (Geltner, 2014). While these analyses can be comprehensive and include important information like current and future financing, tenant rents and occupancies, and growth rates for different line items, they still have many limitations. Perhaps the biggest limitation of traditional analyses is that they cannot value uncertainty well because these models assume static, one off decision making, which fails to consider changes in market conditions and, in response, an owner’s flexibility to switch course as appropriate. Another of their failings is that they are traditionally run using a single discount rate to account for an investment’s risk, which fails to consider the different components of risk in a project, and the asymmetric payoffs and risks experienced between upside and downside scenarios. This is important because many investors worry more about losing money in a downside case than making an incremental profit in an upside case (Geltner, 2018). As the investor Warren Buffett famously said, “Rule number 1, never lose money. Rule number 2, never forget rule number 1.”

In this context, options are useful because they allow investors to mitigate downside risk and profit from uncertainty. A financial option is defined as the right without the obligation to obtain something of value upon payment or trading something else of value. It is designed to let investors hedge against uncertainty, as it lets them gather more information about realistic outcomes before deciding whether to exercise their option. A call option is the right to purchase an underlying asset at a predetermined price and a put option is the right to sell an asset at a predetermined price. A real option is like a financial option, except it refers to physical assets, such as land or a building (Geltner, 2014). In the real estate context, the real option often is in many ways analogous to an American call option, in that any value add decision can be made at the owner’s discretion up until the time that she sells her property. This means that if the value of an improvement is more than its exercise cost then the residual difference is the option’s value. If a call option is in the money then the developer can realize this value, but if it is out of the money then the developer can maintain the status quo without worsening her financial situation.

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With existing property, this relates to future infrastructure upgrades, renovations, tear downs and rebuilds. With vacant land, this deals with constructing a new building.

Source: Martinson, 2009 and Mun, 2006

Compared to a real options model (here a property’s DCF model where the property has an embedded call right), a traditional DCF model will show higher risk, as represented by a standard deviation (σ), and a lower overall return distribution. The above graph compares these two approaches, and shows the benefit of using real options, namely the downside is mitigated as it reflects the investor’s ability to make the positive decision to call an option along the way, thereby lessening risk, and leading to higher overall expected returns (Martinson, 2009).

Monte Carlo simulation is a tool, often used by engineers but increasingly by financial analysts, for evaluating models based on probabilistic or stochastic inputs rather than from a DCF’s more traditional deterministic or static inputs. While there are software packages that specialize in it, Microsoft Excel is fully capable of being set up to run these scenario simulations for real estate projects (Martinson, 2009). By assigning probabilities to different inputs, often based on empirical analysis and regression analyses, it is possible to take the base case cash flows in the original DCF and randomly simulate thousands of outcomes to determine a net present value that more completely factors in a wide range of future scenarios. The output of the Monte Carlo simulation will then feature summary statistics of its simulations to show the outcomes’ mean (average), maximum and minimum results (Geltner, 2018).

As climate change is a highly complicated problem with many uncertainties, its impact on real estate investments creates a reasonable opportunity to employ Monte Carlo simulations and a

105 real options approach to investing. It should be particularly useful to show the value of covered land plays, which are existing, cash flowing assets that generate sufficient returns to justify purchasing today based on their current cash flows, but that have future redevelopment potential to a higher and better use, thereby creating additional option value. The most difficult aspect of this is determining the probabilities of different future climate scenarios, their specific correlations to future real estate rents and cap rates, and, as a result, the pricing factors to use in a Monte Carlo simulation. Fortunately, this is a topic of active academic research and there are several new consultancies (427 Advisors, Attom, Jupiter Intelligence) who are focused on refining this understanding.

With progress in the accuracy of future climate models and greater clarity on how they have previously impacted the economy and real estate prices, it should be possible to have climate amenities as inputs that correlate to future real estate variables, such as rental rates, occupancies, insurance costs, property taxes and exit cap rates. Doing this correctly, which will become easier as research progresses, will not only help to articulate the intrinsic value of a covered land play in a market that is poised to withstand sea level rise and undergo net in-migration, but it will also help to illuminate the potential downside of owning properties in areas exposed to meaningful climate risks and where the future option value would be negative.

Most importantly, this type of analysis helps investors reorient their underwriting to contextualize and consider the range of scenarios that could play out as we face uncertain timing and magnitude of inevitable climate change. It is this mindset shift that is critical for real estate developers and investors to internalize. Our world is getting warmer and, in many ways, including rising seas, more unstable. This significant challenge will influence all aspects of society and reshape where and how we live. The undertaking now for the astute investor is to take the lessons of this thesis and use them to determine how to deploy capital to properties and regions that have the competitive advantage of increasingly valuable climate amenities. Fundamentally, a profit motive recalibrated to account for climate change, should allow for more efficient uses of resources and capital, and lead to a smoother, safer future for society at large. With any luck, a private market reaction focused on doing good for a developer’s investors and bottom line, will also facilitate a public market good by constructing buildings and neighborhoods in resilient locations.

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