Climate change, a pressing global challenge, has caused severe damage to Earth's ecosystem, but its ramifications extend well beyond the natural world. The US real estate market finds itself in imminent jeopardy, as experts predict that the relentless rise in sea levels alone could imperil over a trillion dollars' worth of properties. In addition to this staggering figure, climate change has unleashed a range of adverse effects, from record-breaking snowfall in California to heightened flooding risks, and more frequent hurricanes in Florida.
It’s important to understand that such changes impact the bottom lines of borrowers in many ways, including limiting their ability to meet operating costs, insurance premiums, and loan payments.
The regulatory environment concerning real estate loans, largely under the purview of the Department of Housing and Urban Development (HUD), has witnessed some changes that now dictate the practices of real estate lenders. Additionally, these changes have a transitional impact on insurance carriers.
The Changing Regulatory Environment
Considering the harm caused by climate change and its impact on the US property industry, the Federal Housing Finance Agency (FHFA) has issued a rule regarding climate change and real estate loans.
It now requires the two government-sponsored enterprises (GSE), Fannie Mae and Freddie Mac, to consider climate change as a risk factor when underwriting real estate loans. Additionally, the GSEs must also assess the likelihood of climate change events impacting borrowers’ ability to repay their loans.
Other federal and state regulations, along with the FHFA rule, also address climate-based financial risk in the real estate lending market. These regulations require banks to meet credit needs for their communities regardless of their income, report findings pertaining to the location of the properties being financed and assess bank climate-related financial risks. Such federal and state regulations include:
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Community Reinvestment Act (CRA), which encourages banks to serve low-income communities.
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The Home Mortgage Disclosure Act (HMDA) mandates mortgage data disclosure.
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Dodd-Frank Wall Street Reform and Consumer Protection Act overhauls financial regulation post-2008 crisis.
How Has Fannie Mae Reacted?
As a result of the evolving regulatory landscape, Fannie Mae has shifted its focus toward understanding climate change's impact on the real estate market. Sharing his thoughts on the matter, Tim Judge, Senior Vice President of Climate Analytics at Fannie Mae, has said:
“We have consulted with a variety of catastrophe and climate risk experts across the modeling spectrum, including firms specializing in emerging climate risk metrics.”
In addition, the GSE has proactively engaged in exploring climate change's impact on the real estate market and assessing the effects of natural disasters, such as Hurricane Ida, on borrowers' performance.
Fannie Mae has also launched an awareness campaign. Their aim for the campaign is to target property owners both inside and outside Federal Emergency Management Agency (FEMA)-designated Special Flood Hazard Areas to create awareness about the risk of flooding.
Through this campaign, “We hope to increase … understanding of flood risk and hazards, as well as educate them on the importance of taking flood risk mitigation measures such as purchasing flood insurance,” says Tim. To limit the risk of damage and their impact on the real estate market, Fannie Mae is also:
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Ensuring that properties are renovated to withstand extreme weather conditions.
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Partnering with Insurance Institute for Business & Home Safety (IIBHS) to highlight current and expected building standards.
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Emphasizing the comprehension of how climate change information impacts the home buyer’s or renter’s journey to help them make informed decisions.
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Partnering with industry partners to strengthen construction resiliency and to ensure climate risks are considered during construction.
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Working to ensure that the impacts of climate change and natural disasters are better integrated into governance and policy decision-making.
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Working with the National Institute of Building Sciences (NIBS) to create a roadmap for investment mitigation to ensure effective responses to climate change.
How Can Insurance Providers Help Property Lenders?
Addressing climate change in the US has historically been challenging. Natural disasters like flooding and wildfires are on the rise, and finding a solution to how these climate change-induced natural disasters impact the property market is now critical. Insurance providers must recognize that these impacts pose a significant risk to all real estate industry stakeholders.
Insurance providers not catering to these challenges can lead to a decline in demand for properties in high-risk regions. In addition, studies have shown that GSEs are more likely to face adverse selection. Therefore, insurance providers should focus on helping GSEs evaluate and improve climate change risk assessments.
Insurance carriers can aid GSEs in creating awareness about flood risks. Speaking about a recent survey pertaining to flood risk, Senior Director of Climate Impact Strategy at Fannie Mae, Saiful Amin, has stated that:
“Flood risk understanding is low for those in high-risk zones even though these [property owners], due to their locale, are more likely to have had direct or indirect experience with flooding and are required to carry flood insurance.”
56% of the respondents have stated that they either “definitely” or “probably” would not move to an area where flood insurance is required. This highlights that consumers currently have a negative perception of moving to areas that have requirements like flood insurance. This negative perception serves as an opportunity for insurance providers to improve their risk communication protocols and ensure customers have a comprehensive understanding of flood insurance.
To further limit the impact of climate change-induced natural disasters, insurance providers should:
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Ensure that properties in high-risk areas adhere to IIBHS base flood elevation guidelines by:
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Collaborating with real estate developers.
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Conducting seminars, live events, and presentations.
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Promoting awareness of BFE guidelines among all market stakeholders.
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Develop new products with risk-adjusted pricing models to incentivize climate-resilient construction and develop advanced risk assessment tools for more precise climate-related risk projections.
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Actively lobby for stricter building codes, share crucial claims data, and lead educational campaigns to promote awareness around mitigation measures and the importance of adequate coverage.
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Align product development with NIBS’s Resilience Incentivization Roadmap 2.0 to incentivize safer construction practices.
Conclusion
Regulatory changes driven by climate change have now led real estate lenders to consider it as a risk factor. GSEs like Fannie Mae are making countless efforts to limit the impact of climate change-based natural disasters on the US property market. However, survey reports have led them to understand that customers have a negative perception of moving to areas with flood insurance requirements.
As the world grapples with the consequences of a changing climate, the role of insurance providers is pivotal. They have a unique opportunity to bridge the gap in understanding, enhance risk communication, and collaborate with property lenders in evaluating climate risks. By rewarding safer construction practices and promoting resilience, insurance providers can play a crucial part in safeguarding the real estate industry against climate change-related risks. Their involvement is not merely beneficial; it's an essential component in securing the future of the property market and the well-being of all those involved.