Climate change may act as an additional source of pressure on the commercial real estate market. Physical climate risks such as sea level rise (chronic) or wildfires, storms, floods, droughts and subsidence (acute) can cause serious damage to properties. Additionally, energy inefficient buildings may lose value due to their higher energy consumption costs or by not transitioning in time to meet energy performance targets set by regulators (transition risks). Renovating or replacing inefficient buildings also generates additional costs at a time when companies’ profits are already under pressure from higher energy prices, wage increases and rising financing costs.
Since the end of 2022, European banks have reported on a subset of climate risk metrics through their Pillar 3 disclosures. These disclosures cover physical and transition risk indicators for commercial real estate activities and CRE-guaranteed loans. Early revelations are still largely based on estimates, making it difficult to draw valuable conclusions. Furthermore, banks’ physical climate risk assessments are based on a wide variety of assumptions and approaches, sometimes leading to substantial differences in reporting.
Disclosures from Finnish and Estonian banks (almost neighboring countries) form two extremes of reporting in physical climate risks. Finnish banks classify only a few real estate assets as exposed to physical climate risks, while a very high proportion of Estonian commercial real estate assets are assumed to be vulnerable to chronic and acute physical climate risks. Adjusting for high physical risk outliers, real estate assets of German, Spanish and Dutch banks appear to be slightly more sensitive to physical weather risks.