ClimanomicsMarket ViewA market-level blueprint for assessing climate-related financial risk in real estate.

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About the Authors

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Foreword

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Introduction

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Module 1: Municipal Adaptation

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Module 2: Building-Level Adaptation

Table of Contents

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Module 3: Insurability

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Module 4: Rental Market Growth

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Module 5: Liquidity

About the Authors

Tory Grieves is VP of Analytics for The Climate Service, where sheutilizes her technical expertise in both environmental science andbusiness to accelerate climate adaptation and resilience. Her prior workincludes structuring green infrastructure credit markets with NatureVest(the investment unit of The Nature Conservancy) and advancing socialand environmental outcomes in Nepal through private equityinvestments while working with Dolma Impact Fund, an impactinvestment firm based in Kathmandu.

Tory Grieves - VP of Analytics, The Climate Service

Katherine Taylor is Senior Climate Risk Analyst for The Climate Serviceand brings an immensely strong background in quantitative finance andrisk management. Prior to TCS, Katie worked at SAS Institute developingrisk management software solutions for the financial services sector.Katie enjoys problem-solving and connecting technology to the realchallenges businesses face. She sees climate risk as the mostinteresting problem to solve and is excited for the opportunity to be partof the solution through her work at TCS.

Katherine Taylor - Senior Climate Risk Analyst, The Climate Service

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The Climate Service

Trusted by clients including the world’s largest banks, asset managers, real estate investors,Fortune 500 firms, and public bodies, including the US Federal Government, the Climanomics®platform from The Climate Service enables climate risk assessment and reporting consistentwith the TCFD framework. Providing asset and portfolio-level analysis, evaluating assetsanywhere in the world, the platform models risks and opportunities decades into the future.Our mission is to embed climate risk data into every decision on the planet to accelerate anequitable transition to a low-carbon economy.

About the Authors

Abigail Dean is the Global Head of Strategic Insights for Nuveen RealEstate. She is responsible for the organization’s global research,sustainability and proptech and innovation functions. She overseesNuveen Real Estate’s Tomorrow’s World Strategy which future-proofsthe investment strategy in light of global megatrends and integratesESG across fund and asset management. This strategy ensures that thebusiness delivers on its mission to invest in the urban fabric ofTomorrow’s World for the enduring benefit of our clients and society.Working alongside our Product Development team, Abigail is alsoresponsible for ensuring that new product and the growth of thebusiness are underpinned by solid research and sustainabilityconsiderations overseeing the global research team.

Abigail Dean - Global Head of Strategic Insights, Nuveen Real Estate

Jessica is the Head of Sustainability for Nuveen’s U.S. Real EstatePortfolio. She is responsible for the implementation of Nuveen RealEstate's Tomorrow World sustainability platform, focusing on climaterisk and meeting carbon reduction targets throughout Nuveen’s U.S. realestate portfolio. She manages a team of internal sustainabilityprofessionals as well as external consultants that engage at the assetlevel to achieve the firms' sustainability goals.

Jessica Long - Head of Sustainability, Americas, Nuveen Real Estate

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Nuveen Real Estate

Nuveen has supported the financial futures of millions of people for over 120 years. Under theleadership of TIAA, we invest in the growth of businesses, real estate, farmland, forests, andinfrastructure while building lifetime relationships with clients from all over the globe. Withexpertise across income and alternatives, and as one of the first in the industry to practiceresponsible investing, we’ve been able to adapt to a rapidly changing world while maintainingour legacy as a leading asset manager.

Assessing climate risk in real estate, and quantifying the link between climate and the value ofreal estate investments, is incredibly complex. The work goes beyond a single metric or set ofmetrics, extending into the interwoven nature of building valuations and the market in whichthey reside. It moves us beyond the bottom-up climate risk analysis (direct property impactssuch as increased cooling and repair costs) toward considerations such as resilienceinvestments made by cities, the future desirability and livability of certain locations, theavailability and affordability of insurance, and the impact on liquidity.

These market-level impacts are beginning to change investment decisions as they willcontribute significantly to the value of properties and investors’ ability to sell a given property atan expected price, and within an expected period. The framework described in this report — aproduct of extensive work by The Climate Service, members of our team at Nuveen, and others— unlocks the ability to systematically assess market-level impacts in various cities around theworld. The goal is to inform investment strategies and guide the assessment of the relativemateriality of indirect impacts within these markets.

With this framework and in partnership with our investment teams, Nuveen invests using our“Tomorrow Cities” approach, which includes a process for screening cities for an array of factorsthat will impact real asset values. Market impact studies will be used to assess potentialinvestments, build comfort in “high risk” locations, and reinforce decision-making where we seean opportunity for strong growth. It is a systematic process for assessing the risk exacerbationand/or reduction potential of market-level impacts on real estate investments, and it can beembedded into investment strategy, due diligence, and property management processes.

As climate risk assessment and reporting become mandatory and mainstream, the ability tounderstand and assess climate risk accurately and comprehensively will be critical and willconfer a significant strategic advantage. We believe that the only way to do this work is througha framework such as that described in this report — capturing the full picture of market impacts.

Foreword "For investors, there has been a sizable gap inthe climate risk conversation: the right raw dataand a practical framework to make informeddecisions on a market level. With the insightsfrom this study, investors can really begin topredict how specific real estate markets willrespond to climate change."

- Abigail Dean, Head of Sustainability, NuveenReal Estate

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Climanomics® Market View

Forward-thinking real estate investors, working to understand the risk held in their portfolios,have begun considering “market-level” impacts as a way to fully measure the impacts fromclimate change. But until now, there has not been a comprehensive framework and toolkitenabling this work.

Building on the foundational work of Heitman and the Urban Land Institute, presented in theirjoint report entitled Climate Risk and Real Estate: Emerging Practices for Market Assessment(2020), the TCS Market View seeks to address a key gap identified within the report: that there isa dearth of resources to guide investors in assessing the financial implications of market-levelimpacts. As one investment manager quoted in the report expressed, “We have never found[any tools or frameworks] that cut to the chase and say, first, is this city impacted by climatechange? And second, is the city’s reaction appropriate and sufficient given the risk?”

The following abbreviated version of the full Market View (120+ pages in total) provides a high-level overview of the Market View Framework and key insights into how these indirect measurescan be assessed. While the study does not offer specific answers to such complex questions,the framework goes beyond existing research to provide a structured approach to analyzing therelationship between projected physical climate hazards, policy, economics, and demographicson five different factors: 1) Municipal Adaptation, 2) Insurability, 3) Rental Market Growth, 4)Liquidity and 5) Building-Level Adaptation.

We hope that industry leaders will find this study useful in augmenting and informing decision-making when it comes to climate risk in real estate. The full framework, which includes toolssuch as guidance on integrating the Climanomics® property-level outputs with market impactsand acquisition checklists to employ during due diligence, is available to purchase through TCS.Please reach out to us for more information or to comment.

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2021Climanomics® Market View

Introduction

MunicipalAdaptation

"A municipality can materially impact how insurers view resilience tonatural peril loss by working to quantify and optimally represent resilienceto natural perils. Capturing the characteristics of the assets at risk, and anyengineering investments that may have been made to increase resiliencewill result in lower loss forecasts generated when physical events aresimulated."

- Ben Miliauskas | Reinsurance Solutions, Aon

Definition:

Municipal Adaptation is defined as the suite of

interventions undertaken by a municipal government to

reduce the risk of and to promote recovery from climate-

related hazards at the neighborhood and community

scales (as opposed to building-level adaptation, which is

asset-specific). Measures can include both tangible

investments (e.g. sea walls) and policies (e.g. adaptation

plans and zoning laws).

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2021Climanomics® Market View

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Municipal Adaptation

I. Overview

Municipal adaptation measures for climate change can play a significant role in the durabilityand resilience — and therefore, value — of real estate investments. However, it is difficult toknow how adaptation investments made today will protect investors in the face of evolvingclimate risk in decades to come. Similarly, it is not certain that city governments that havedeveloped resilience plans will have the political will and financing capacity to implement themin the coming years.

The Municipal Adaptation module of TCS’ Real Estate Market View study serves as a globalframework for assessing the potential risk mitigation effects of municipal-level adaptationmeasures on the projected climate risks facing real estate assets from the perspective of aninvestor-owner, in addition to assessing the likelihood that a municipality will have the politicalwill and economic means to invest in such measures now and in the future. The informationprovided by the framework is useful for sustainability or investment teams assessing acquisitionrisk, making a case for mitigating the effects of climate risks for potential acquisitions, orinforming the investment decision process. In addition, we note that municipal bond investorslike Nuveen are beginning to consider the climate adaptation capacity of municipalities from acredit quality perspective. While this framework is not designed specifically to assess the impactof climate adaptation on a municipality’s ability to repay debt, many of the same assessmentcomponents may apply across asset classes.

While this framework is not intended to provide all of the answers when it comes to municipaladaptation, its purpose is to create a structured guide for the assessment of the likelihood,extent, and efficacy of municipal adaptation measures that currently exist or are planned. Theframework is not intended as investment advice; instead, it serves as a guide for research anddiscussion. We encourage users to modify the tools and templates based on their assumptionsand investment strategies.

II. Process

The TCS Market View study Municipal Adaptation Module is intended to be used in conjunctionwith four other modules in the report: Insurability, Liquidity, Rental Market Growth, and Building-level Adaptation. As indicated below, municipal adaptation interventions, if implemented andeffective, can keep insurance policies available and relatively affordable, retain rental marketgrowth, and promote liquidity — particularly if the city’s interventions are expected to beeffective well past a potential buyer’s hold period.

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While coastal flooding can be extremely destructive to properties and infrastructure, it ismore geographically isolated (at the coast) than other climate-related hazards liketemperature, which affect broader areas. The ability of municipalities to mitigate coastalflooding risk is, in many ways, dictated by local topographic and hydrologic considerations.For example, Florida’s porous limestone bedrock renders some coastal flooding protectionsimpossible to implement.

The National Flood Insurance Program (NFIP) offers a voluntary incentive program known asthe Community Rating System, which enables cities and communities to reduce their floodinsurance premiums by investing in floodplain management activities.

Municipal adaptation to wildfire must have a strong emphasis on proactive and preventivemeasures to be both practical and cost-effective. Before a wildfire occurs, municipalities candevelop robust planning efforts to reduce the impacts of a wildfire once it hits. For example,over 10 years, the town of Silverthorne, Colorado, invested a few million dollars in fire breaksand prescribed fires (which reduce the volume of fuel available to burn at any given time).When a wildfire hit in 2018, the town successfully protected 1,400 homes, totaling almost $1billion in property value. Overall, it is estimated that the benefits of proactive wildfiremitigation outweigh reactive approaches by a factor of more than four times.

Protecting green space in urban municipalities can significantly reduce the risk of extreme

III. Did You Know?

Figure 1: Municipal Adaptation Measures and suggested assessment components

Type of hazard

Location's degree of exposure

to hazard

Time horizon and pace of

change in hazard exposure

Market strength

Availability of financing

Political will

1

Key Assessments:

2

Design and specs of the

adaptation measure vs.

nature/timeline of hazard

Scope of the adaptation

measures and location of

asset within that scope

Efficacy and sustainability of the

adaptation measures for given

time period

Rental market growth

Insurability

Liquidity

Asset's vulnerability to direct financial

impacts within holding period x 2

Market's vulnerability to impacts

within holding x 2 +

3

Range of existing/potential

measures

Feasibility/affordability of

the measures

Market's adaptive capacity

Implementation stage: Already

in place, planned, or not

planned?

Indicators to research: Effects and Conclusions:

Municipal Adaptation Measures

Assessment Components

Loops back to impact market strength, financing

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10

heat. Studies have found that the greatest degrees of cooling effect distance and intensityoccur with large urban parks greater than 10 hectares in size. However, natural elementsalso drive the degree to which a park will effectively cool the surrounding area. Large parkscan yield up to 1–2 °C temperature reduction that extends over 350 meters from the parkboundary.

IV. Conclusion

The City of Boston, Massachusetts, provides a stark example of why assessing municipaladaptation as part of an individual property’s climate risk assessment is so crucial. By the 2050s,absent municipal adaptation intervention, the physical climate hazard-related losses for anaverage office building in the downtown area are expected to be around 6% of the building’svalue; a $500 million building would lose $30 million each year from physical damage, businessinterruption, and other impacts. However, Boston is investing heavily in adaptation measures,particularly for coastal flooding, which is one of the hazards of greatest concern for the city. Thecity’s strong economy lends extra confidence that it will continue to be able to invest in on-shore adaptations, including zoning, sea walls, and natural sea barriers to reduce risk to much ofthe city’s flooding-exposed areas.

Such measures depend upon a municipality’s access to capital, and as creditors and bondmarkets deepen their investigation into climate impacts on localities, credit ratings may beimpacted. This may cause a knock-on erosion of a municipality’s ability to adapt — a vicious andcomplex cycle, which in turn will negatively impact businesses residing and operating in thatjurisdiction. Success depends upon a collaborative approach between business and communityleaders if municipalities are to adapt to climate change. And because the fate of businesses istied to the fate of their communities, the same is true for business.

This work begins with an approach to climate risk assessment that takes into account thisinterrelatedness, and this is the goal of the TCS Market View study: to broaden the real estateindustry’s lens and approach to climate risk analytics. To help investors with this task, the studyincludes tools such as a suggested sequence for municipal adaptation research and anacquisition checklist for municipal adaptation considerations, among other things.

Building-levelAdaptation

“Armed with the right data, buildings and communities can adapt to risk.Examples abound, from building-level energy efficiency technologies tothe Thames and Oosterscheldekering Flood Barriers in London and theNetherlands. The work of resilience to meet new risks is ongoing anditerative."

- Peter Cheesman, CCRMP | Head of APAC Analytics, Reinsurance Solutions,Aon

Definition:

The United Nations Framework Convention on

Climate Change (UNFCCC) uses two significant terms:

mitigation, which is aimed at reducing emissions to

minimize global warming or “avoiding the

unmanageable,” and adaptation, which is “managing

the unavoidable.” Mitigation relates more closely to

carbon transition risks, and adaptation relates to

managing the impacts of physical risks. Sometimes,

mitigation is also informally used to refer to lessening

the impacts of physical risks on assets. Resilience is

another buzzword that emerges when talking about

how vulnerable assets and communities are to

climate risks, particularly to physical risks. Resilient

design can be used for new construction or applied to

existing buildings via adaptation measures.

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Building-level Adaptation

I. Overview

Globally, cities are responsible for 70% of greenhouse gas emissions. In New York City, forexample, buildings account for 75% of the city’s greenhouse gas emissions. Regulations, such asNew York City's 2019 Building Emissions Law, which requires 40% citywide emissions reductionsby 2030, are becoming increasingly common and are expected to increase globally, renderinggreenhouse gas intensity reductions imperative. Building adaptation will therefore play a centralrole in meeting emissions reduction mandates.

This Building-Level Adaptation module of the TCS Market View provides a high-level overviewof investor-owned considerations for building-level adaptation and resilience to climate risks incommercial real estate properties. It also discusses approaches to assessing building-levelresilience at the due diligence phase, as well as program-wide processes for documentingresilience for reporting purposes and action plans. We provide a high-level “starter kit” ofadaptation and resilience measures by hazard; an overview of cost-benefit analysis foradaptation measures, as performed by the Climanomics® platform; and more.

While adaptations implemented at the property level are asset-specific, market-level factorsinfluence investors’ decisions regarding the cost-benefit analysis of investing in such property-level adaptation measures. For example, near-term investments made by the City of Boston,such as robust coastal flooding protections in South Boston as outlined in the Climate ReadySouth Boston plan, coupled with a high degree of confidence that the city will have the financialmeans and political will to continue to invest, change the calculus regarding the cost-benefit ofinvesting in property-level floodproofing. If the area is likely to be protected, the additionalbenefit of site-specific floodproofing measures is reduced, and tenants and future buyers alikeare less likely to place a premium on building-level protection in the future.

As with the other modules in this study, this information is not exhaustive and should beemployed alongside the other modules for full context. It is also not meant to replace the on-site engineering assessment necessary to fully assess vulnerabilities and adaptationopportunities.

II. Process

In the Hazard-Vulnerability-Risk framework that is the backbone of the Climanomics® platform,adaptation or resilience can be thought of as changing the vulnerability of an asset to the hazardexposure it faces. Since Hazard and Vulnerability combine to produce a Risk result, reducing

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Building-level Adaptation

Assign a monetary value to the costs: Costs may include the costs for physicalresources needed, cost of the human effort involved in all phases of a project, as well asany quantifiable social, environmental, or economic disbenefits. The costs occurring inthe future should be discounted to today’s value ("present value") using a discount rate.

Assign a monetary value to the benefits: Quantifying benefits can be lessstraightforward, but the Climanomics® platform can greatly help. It is often more difficultto predict benefits accurately, especially for new, innovative options. Benefits mayinclude not only reducing the direct losses from climate hazards but also protecting thevalue of the building, greater ease of sale (reducing liquidity risk), improved tenantengagement and leasing velocity, etc.

Vulnerability should reduce the overall Risk an asset faces. We recommend that customers usethis module to arrive at a relative comparison of the materiality of the risk exposure of assets intheir portfolios, and use this as an indicator of where deeper analysis (either desktop or on-site)is needed.

When it comes to cost-benefit analysis for adaptation measures, a highly simplified example ofanalysis could be performed using the Modeled Average Annual Losses associated with aparticular hazard. Through this, you would arrive at a payback period for the expense of theadaptation measure, assuming the adaptation measure eliminates all or some known portion ofthe losses. However, there are many nuances to consider in this process, outlined in the fullreport. The following suggested steps for cost-benefit analysis of adaptation measures(adapted from The European Climate Adaptation Platform Climate-ADAPT tool, developed bythe European Commission) might be useful in developing a strategy:

1. Define the objective of building adaptation (e.g., to mitigate the impact of frequent flooding)and identify adaptation options to be assessed that will contribute to this objective.

2. Define the baseline to enable comparing scenarios "with" and "without" the specific adaptationaction.

3. Identify all costs and benefits over a set timeline (presumably holding period and exit valueimpacts).

a.

a.

4. Compare costs and benefits: Finally, compare the value of costs to the value of benefits, anduse this analysis to decide the course of action.

The full Market View study provides more detail on the above, in particular on how to establish abaseline “without adaptation” scenario leveraging the Climanomics® platform, how to broadly

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Building-level Adaptation

1450 Brickell Avenue in Miami is a 35-story, 586,000-square-foot Class A office tower thatfeatures views of the city and Biscayne Bay. This building was constructed with resiliencemeasures to protect against cyclones and other storms, including impact-resistant glass,desalination units, and backup power supplies, which collectively added 6-8% toconstruction costs for the building, with the resilient glass adding roughly $13 million to theconstruction costs. Notably, the builder reported that these costs had been recoupedseveral-fold.

A 2018 study by Headwaters Economics on the cost of constructing a wildfire-resistanthome showed that construction costs were roughly the same as those for building aconventional home. While some differences may apply to commercial buildings, thisindicates that the cost of adapting to wildfire may not be as significant as other hazards thatpose similarly devastating levels of risk.

ENR2, a recently constructed building at the University of Arizona in Tuscon, incorporatedmany adaptation investments to increase resilience to extreme temperatures (as well asincrease water efficiency). This building cost a total of $75 million, with resilienceinvestments adding 2% to overall construction costs. Notably, the building is realizing aroughly 30% reduction in annual energy costs due to these adaptations.

think about indirect losses, modeling “with adaptation” scenarios, resilience measures commonacross hazards, and more.

III. Did You Know?

IV. Conclusion

By 2070, $35 trillion in real estate assets will be at risk if the world does not change its currentcarbon emissions trajectory, according to the United Nations Framework Convention on ClimateChange (UNFCCC). Protecting many of these assets simply will not be possible, but in the caseof others, resilience and adaptation investments will pay off.

The process of understanding where to invest is complex, dependent upon both on-the-groundclimate and resilience assessments, as well as scenario analysis of future risks andopportunities. This asset-level quantitative modeling is a first step in identifying the assets mostat risk and in need of additional and/or on-the-ground scrutiny. And, in the course of our work,we find the majority of the users of the Climanomics® platform uncover that most of their

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Building-level Adaptation

climate risk resides in a small number of assets (see Figure 2 below). This may be due to thevulnerability of their location, asset type, or the asset’s lack of adaptive capacity.

Locating assets that are most at risk from the physical impacts of climate change enablesdecision-making vis-a-vis resilience efforts. It empowers companies to prioritize assets for whichinvestments in adaptation will have the greatest risk mitigation benefits. However, as investorunderstanding of overall market-level impacts becomes more sophisticated, considerationsregarding municipal adaptation, insurability, rental market growth, and liquidity will also factor inand will play an increasingly important role in climate risk analysis for real estate.

Figure 2: An example of the 80/20 rule in climate risk

“Real estate ESG due diligence questionnaires are beginning to askinsurance-related questions; this indicates that investors are beginning tobuild insurability concerns into their analysis.”

- Jessica Long, Head of Sustainability, Americas, Nuveen Real Estate

Insurability

Definition:

Uninsurability occurs when insurance coverage

becomes either unavailable or unaffordable to those

seeking coverage. While availability and affordability

are two distinct concepts and drivers of uninsurability,

they are interlinked. An insurer’s assessment of

affordability can also influence their determination of

whether or not to offer coverage in a given market.

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Insurability

I. Overview

With increasing public awareness of climate change, concerns about the cost and availability ofinsurance coverage for perils such as flooding and wildfire have grown for residential homesand commercial properties. Although insurance companies and re-insurers started flaggingclimate change as a risk to their business decades ago, there is still much uncertainty about howthis will unfold for them and their policyholders. Since policies are generally set for a single yearat a time (with some differentiation by region), it is difficult for policyholders to gauge how theirinsurance costs will change over the holding period of an investment property, and if/when aninsurer will refuse to provide insurance for a particular property or market because annualaverage losses become too great.

Insurability is most critical to consider in markets where acute hazards, such as wildfire, coastalflooding, fluvial flooding, and tropical cyclones are projected to drastically increase in the future.These hazards have the potential to escalate uncertainty — and thus, volatility — for insurers.With insurability, interacting effects and feedback loops between other aspects of the MarketImpact Framework are critical to consider. For example, while the implementation of effectivemunicipal adaptation measures has the potential to reduce the risk of uninsurability (particularlyif adaptation measures address a hazard that is flagged as a high risk for that location), if aninsurer determines that it is not feasible to offer insurance in a particular area, building-leveladaptations are unlikely to guard against uninsurability. Uninsurability, or the imminent threat ofit in coming decades, can in turn significantly decrease liquidity.

Insights such as these, drawn from our work and the Climanomics® Platform, are presented inmore detail in the Insurability Module of the TCS Real Estate Market View study. The moduleserves as a framework for property investors to assess the likely future affordability andavailability of insurance coverage for a property as climate hazards change over time, and isparticularly useful to real estate investment managers in the due diligence process. The modulereveals insurance trends across physical hazards, market and asset-level criteria thresholds fortriggering an insurability review, and more. While not an exhaustive resource for all of thenuances of commercial property insurance, the module provides a focused inquiry into theavailability and affordability of insurance, with much of the decision-critical information comingfrom the insurance provider.

II. Process

TCS recommends the following approach when assessing whether insurability is a concern for

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Insurability

potential property acquisition. We would encourage users of this guide to adapt the process totheir investment strategies and internal processes. The overall approach is depicted in Figure 2and consists of three principal stages covering Indicators, Key Assessments, and Effects. Moredetailed information is available in the full Market View study.

North America

Europe

APAC

Norms for insuring this

hazard

Time horizon and pace of

change in hazard exposure

Regional considerations and norms

Nature of hazard

1

Key Assessments:

2

Pooling structure - sufficient

confidence?

Backstops or government -

provided

insurance/assistance?

Self-insurance -

possible/desirable?

Building-level adaptation

measures - can this reduce

average annual losses and

secure insurance?

Other Considerations:

Cost of insurance

Loss of insurance

Liquidity

Cost of insurance

Rental market growth

Liquidity

Asset's vulnerability to insurance

concerns within holding period X 2

Potential impact to the other

properties in the insurance pool

Market's vulnerability to insurance

concerns within holding period X 2

3

Climanomics: How are

hazard exposure and

modeled average annual

losses expected to change

over time?

What would insurance cost

for this asset be if it were

NOT in insurance pool?

Assess hazard exposure,

modeled average annual

losses, premiums

Indicators to research: Effects and Conclusions:

Insurability

Assessment Components

Figure 3: Suggested components of Insurability Assessment

A general rule of thumb used to assess insurability is that once annual premiums exceed1% of a property’s value, insurance is considered unaffordable. In an analysis of insurabilityin Australia, the firm Climate Risk determined that 1 in 20 addresses in the country couldbecome uninsurable without interventions to account for climate-related hazards. Thesame report projected that, in many areas throughout Australia, insurance premiumswould double or triple within the next several decades

III. Did You Know?

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2021Climanomics® Market View

Insurability

From the insurer’s perspective, volatility — or the difference between an expected result andits standard deviation — is an essential factor in determining whether to make insurancecoverage available and at what price, as it in large part determines the degree of risk forwhich the insurer must be compensated via insurance premiums. Thus, it is one of the mostimportant drivers of (un)insurability. Climate change is increasing the volatility of acuteclimate hazards like wildfire events, which are occurring with less predictability and withgreater severity than backward-looking catastrophe risk models indicate. Thus, volatilityserves as one of the key links between climate risk and insurability concerns.

Due to the availability and affordability of FEMA flood insurance in the U.S., there have beenno major, significant instances of uninsurability for coastal and fluvial flooding. However,impending changes to the FEMA flood insurance program may lead to cases ofuninsurability in the near future. This may also impact how lenders approach financingproperties in flood plains that currently require federal flood insurance.

What does the Climanomics® Platform tell us about changes in hazard exposure andchanges in modeled annual average losses?

What (if anything) does the insurance provider say the annual premiums and deductibleswould be for this asset individually if not part of an insurance pool?

What would this asset’s deductibles and premiums be if they were part of an insurancepool?

IV. Conclusion

As the insurance industry comes to terms with the disruption from climate change, it willreshape and alter operating models used for decades to understand catastrophic risk, weather,and other events. While these changes will enhance risk management and mitigation strategiesfor these companies, they will undoubtedly impact insurers in a multitude of ways.

Real estate investors should embed consideration of these potential changes into due diligenceprocesses to more accurately capture the risks associated with climate change. To assess aproperty’s insurability concerns at the due diligence phase, the Market View study makesrecommendations for a sequence of considerations paired with scenario analysis using theClimanomics® Platform that includes the following:

It is also important to keep in mind the consequences of loss of insurance coverage for a

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Insurability

commercial investment property if the ability or willingness to insure the property (or themarket’s perception of its future insurability) is lost during the holding period.

20

Rental marketgrowth

“We see the raw climate data, but we don’t know how people are goingto react. That is the missing piece.”

- Abigail Dean, Global Head of Strategic Insights, Nuveen Real Estate

Definition:

For the purpose of this study, our view of Rental

Market Growth will encompass the economic growth

of a particular city or region, and more specifically, the

rental demand growth in that city or region, which

could differ by property type.

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Rental Market Growth

I. Overview

Climate change is predicted to have a significant impact on rental markets. Factors determiningoutcomes are multifaceted, including regional job availability, physical impacts (sea level rise,extreme heat, etc.), rent and operating expenses, municipal adaptation measures, voluntary andforced migration, and more.

The Rental Market Growth Module of the TCS Market View provides a high-level overview of theclimate change-related factors that can influence rental market growth and the best availablestudies estimating their impacts. The Module lays the conceptual groundwork for assessingmarket-level economic vulnerability to climate change impacts, specifically related to rentalmarkets, and we will build upon this work over time.

Moving beyond standard macro-level indicators of economic growth, this Module looks moreclosely at the impact of climate risks (physical and transition) on tenants and residents at themicro-level, and how they might behave in the face of these risks. It includes a framework togauge the traits and considerations that might influence how tenants or residents are impactedand thus react to increasing hazards, e.g., which business sectors are more sensitive than othersto a given hazard or a new carbon pricing regulation, which populations of residents mightleave, and so on.

Take coastal flooding and extreme temperature, for example. An increase in coastal flooding islikely to trigger migration within a market, from low-lying coastal areas to those that are moreelevated. In a report published by Milliman in 2019, the authors theorized that in Miami, this islikely to cause climate-related gentrification. They posit that those who can afford to move tohigher elevation areas to escape sea level rise will leave behind those who don’t have themeans to flee high-risk zones, and potentially price out lower-income people from higherelevation zones. Conversely, extreme temperature is either tolerated or, if very extreme,prompts outmigration to much farther destinations, since temperature is a more geographicallywidespread hazard than flooding. In the case of either flooding or temperature, those with moreresources will have more options when it comes to staying and adapting to the climate hazardor migrating away from it.

II. Process

Drivers for consideration in this module include physical risks (the full report contains anoverview of the most materially impacted sectors by physical hazard), transition and other risks;

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Rental Market Growth

market impacts to jobs, wealth, and more as well as micro impacts including insurance, lifestyleconsiderations, rent, and more. Considerations also include economic sensitivities, municipaladaptation, population wealth and mobility, and more.

Overall, the data and tables in the full report provide a structure for thinking through potentialclimate risk impacts to businesses and residents in a market, which could affect the overalleconomy and potentially the investment performance of commercial properties in certainregions.

Floods, storms, wildfires,

heat stress, etc.

Carbon pricing,

technology, market shifts,

regulations, etc.

Tech innovation,

demographics,

geopolitics, pandemic,

etc.

Climate: Physical Risks

Climate: Transition Risks

Other Trends and Risks*

Rental Market Growth

Assessment Components

Sensitivity, existing adaptation

and adaptive capacity (incl.

resilience & recovery), and

diversity (re: carbon-intensity)

Property type, diversity of

tenants, sensitivity of the

sector(s), adaptive capacity,

wedded to place(?), mobility,

wealth

Nature of the hazard

Economy

Property, Tenants, Residents

Interruptions, damages,

safety/health, workforce,

rent/OpEx, sales

Insurance, employment,

expenses, safety/health,

nuisance, lifestyle

Micro

Businesses

Residents (homeowners and

renters):

1

Market Impacts

2

Stay and adapt, stay and

accept risk (bankruptcy),

relocate

Rent growth, occupancy,

market value, liquidity

Tenant/Resident Response

Impact to asset's investment

performance

4

Jobs, population, GDP,

income/wealth, etc.

Macro

Drivers Effects/OutcomesConsiderations

3

Innovations such as high-speed transportation predicted for certain regions may lead torental growth in suburban areas as commuting times reduce.

Demographic shifts could impact rental market growth in fundamental ways. For example,increasing urbanization could dramatically increase growth in certain urban markets.

III. Did You Know?

1.

Figure 4: Suggested components of Rental Market Growth Assessment

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Rental Market Growth

A landmark study titled, “Spatial Empirical Adaptive Global to-Local Assessment System(SEAGLAS)” — Hsiang et al (2017) — the combined value of U.S. market and nonmarketdamage across analyzed sectors — agriculture, crime, coastal storms, energy, humanmortality, and labor — increases quadratically in global mean temperature, costing roughly1.2% of gross domestic product per +1 degree on average. Importantly, risk is distributedunequally across locations, generating a large transfer to value northward and westwardthat increases economic inequality. By the late 21st century, the poorest third of counties areprojected to experience a loss of between 2 and 20% of county income (90% chance) underthe “business-as-usual” emissions scenario (RCP 8.5).

Occupancy: impacted by hazard frequencies, lease length, and timing of expirations

Rent collection: impacted by economic factors, wealth, cash flow

Rental growth: impacted by rental property supply and demand and perceptions of value

However, slower overall population growth and a continued rise in teleworking couldcounterbalance this effect.

IV. Conclusion

The degree to which the income streams of investment performance of a property is affectedby climate change can be considered through several possible pathways which are notmutually exclusive. These include:

Property values and liquidity are impacted by perceptions of future risk. If property buyers feeluncomfortable with the rental growth projections, they may hold off or walk away, and the poolof willing buyers may dwindle.

Property owners will need to consider how climate impacts and adaptations may impactaffordability for renters. While most operating costs are passed on to tenants in commercialbuildings as costs to adapt and recover from increasing climate hazards, tenants may not bewilling to absorb increases impacting the net rent to the owner. In the case of renter-occupiedhousing, which represents a significant portion of inventory — more than 30% in the UnitedStates — the majority are low-income and/or students and young people. A recent report fromthe Joint Center for Housing Studies of Harvard University calculates that 10.9 million rentersspent more than 50% of their income on housing in 2018. That equates to one in four renters.Moreover, there were 6 million more cost-burdened renters in 2018 than in 2001 (that is, they are

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Rental Market Growth

spending more than 30% of their income on housing). The feasibility of owners passingadaptation and recovery costs along to renters will depend upon many factors, but is asignificant consideration, especially as income level can profoundly influence overallresilience.

Liquidity

“Obsolescence is becoming a concern for assets facing physical andtransition risks from climate change. The question at the heart of theequation for property owners is: will there still be bidders when weneed/want to sell, and what will they be willing to pay?”

- Tory Grieves | VP of Analytics, The Climate Service

Definition:

Liquidity in financial markets relates to whether assets

such as commercial properties can be sold quickly or

slowly (which may be defined differently for different

asset types). Liquidity is also related to whether the

price of an asset will vary significantly from its market

value when it is sold. At the core of liquidity risk is the

inability to be able to immediately transform assets

into cash at current market prices without a loss in

value (and vice versa). Liquidity breakdowns produce

situations where there are no buyers as investors

attempt to exit a sector or market.

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Liquidity

I. Overview

TCS views this Liquidity Module as informing the methodology for incorporating climate risk intovaluation models. The module is focused on laying the conceptual groundwork forunderstanding liquidity, pricing, valuation, and cap rates in the context of climate risk. It is anarea that is rapidly changing and developing over time.

The module breaks down the liquidity concerns for real estate investments first in generalterms, and then in the context of climate risk. It includes perspectives on physical and transitionrisks, and market-level and property-level, to the extent distinguishable at this point. Weexamine ways liquidity can be defined and measured, and we look at obsolescence.

To date, the impact of climate-related hazards on liquidity within a given market has beendifficult to measure and track, as only a portion of buyers price in climate risk when purchasingnew assets. In turn, this disguises the influence of those buyers who did price in this additionalrisk, thus presumably bidding lower prices that were ultimately outcompeted by bids thatignored future climate risk.

In an article in PERE News in April 2020 titled, “Deep Dive: Is private real estate short-sighted onclimate risk?”, BentallGreenOak president Sonny Kalsi discusses their ongoing acquisitions ofproperties in Miami:

“The office property that the firm recently committed to buying in Miami, for example, is locatedin the city’s downtown, rather than on the beach, making it less exposed to sea-level rise. Theexpected exit pricing was also a factor: ‘We basically put a premium on the cap rate, on theasset on the going-in and, actually, on the going-out, because we felt that whoever is going tobuy this asset is going to want a premium to what they would want if that asset was located in [acity like] Austin and Nashville.’”

Thus, outstanding questions for a property owner concerned about liquidity issues include:Should we be willing to discount this property when we put it on the market to anticipatebuyers’ risk perception and to facilitate a faster sale? There is some anecdotal evidencesuggesting that these dynamics are emerging in high-risk markets, as indicated above.

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Liquidity

II. Process

As we explore liquidity concerns in the context of climate risk, clarity is only likely to come withtime. In turn, this requires investors to develop points of view based on their risk tolerance andthe best available information. Today, uncertainty remains about how properties will respond todirect physical hazards, how building- and municipal-level adaptation will protect assets andcities, how markets will react to climate stresses, whether insurance (and therefore credit) willremain available, and so on.

Uncertainty in valuation is also very much related to current and future capitalization rates. Caprates should, theoretically, capture the perceived risk to future income streams of an investmentproperty. If the market is expected to yield future increases in rental rates, investors should paya higher price for the current income stream, pushing the cap rate down. If the market projects aweak outlook, investors will want to pay less, and cap rates will rise. What “tipping points” willlead to more climate risk-adjusted, bid-winning deals, and how many of those deals need tohappen to move pricing and cap rates for comparable properties?

Obsolescence is becoming a concern for assets facing physical and transition risks from climatechange. In this module, we explore obsolescence in the context of climate risk, andsustainability more broadly. The question at the heart of the equation for property owners is: willthere still be bidders when we need/want to sell, and what will they be willing to pay? Weaddress this question with “corrective” information and metrics to watch in this module.

Liquidity Spectrum

Liquid Illiquid

Liquidity Spectrum

Easier to sell Harder to sell

Obsolescence?

Price vs "value"?

Time to sale?

Figure 5: A visual representation of the likely liquidity spectrum for real estate assets, TCS

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Liquidity

One of the few available studies connecting climate risks to liquidity hinges entirely on theprinciple of uncertainty. In a 2019 study, Rehse et al. reported the effects of uncertainty onmarket liquidity by comparing the market reactions of REITs with and without property in thewidely published evacuation zone of New York City before landfall. They found relativelyless trading and wider bid-ask spreads in affected REITs. The results confirm the theory onthe detrimental effects of uncertainty on market functioning.

There have been several studies in recent years showing a connection between flood riskand property values in the residential housing market, and now there are emerging studiesincorporating liquidity impacts using transaction volume. In one study, housing sales in high-risk and low-risk areas grew and fell at a similar rate for years, but began to diverge in 2013.Volume started to fall in high-risk areas, and a few years later, in 2017, prices began todiverge in a similar way. This research highlights a lead-lag relationship between reducedsales volume (liquidity) and pricing of climate risk in the Florida housing market. In thismodule, we ask whether commercial properties follow the same pattern and suggest thatmarket-level indicators such as transaction volume (liquidity scores) and cap rates bemonitored for signs of tightening liquidity or pricing-in of climate risk.

III. Did You Know?

1.

Figure 6: A flow chart representing the questions Nuveen typicallyasks during the investment process

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Liquidity

The National Resources Defense Council (NRDC) reported in 2019 that rising sea levels willbe a significant driving force in displacing populations globally. In fact, the NRDC estimatesthat between 4.2 and 13.1 million Americans could be forced to move due to climate changeby the end of the 21st century. Taking into consideration other impacts, such as extremeheat, wildfire, riverine flooding, and more, countless miles of land in the United States willbecome unlivable within the next 80 years.

How and when individual properties will have eventual “expiration dates” versus those thatwill continue to operate remains challenging. Future scenarios and outcomes are extremelydependent on human decision-making (emissions scenarios, adaptation investments, etc.).But, as the Market View study addresses, certain hazards and scenarios will makeobsolescence more likely. The issue of liquidity impacts from climate change is becoming akey concern for real estate investors across the country.

IV. Conclusion

1.

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