Managing Physical Risk in Commercial Real Estate Report

Property and operating losses from physical climate hazards have escalated rapidly over the last several years, reshaping the way the commercial real estate (CRE) industry assesses physical risk. The incidence of billion-dollar weather and climate disasters (such as hurricanes, floods, severe hail, tornadoes and deep freezes) has increased markedly, as have losses from wildfires and smaller-scale severe weather events. As a result, developers and building owners face rising insurance costs, while investors, lenders and tenants are more closely examining the risk of loss from natural hazards when they evaluate a property, particularly in higher-risk areas. The CREDA Research Foundation commissioned this report to examine best practices in assessing, managing and mitigating physical risk. The authors interviewed large corporate tenants, investors, asset managers, developers and architects to evaluate how different segments of the CRE industry currently approach physical risk. Key findings from this research include:

• Institutional investors, lenders and insurers are increasingly integrating forward-looking physical risk analytics into their underwriting processes alongside historically anchored risk data and engineering-based resilience assessments.
• Large occupiers are also actively evaluating physical risk but are most concerned with mitigating potential operational disruptions. As part of the site selection process, they weigh insurance costs in high-risk areas against other locational factors like labor availability, market access and operational efficiency.
• Developers most frequently address physical risk by avoiding portfolio concentration in known high-risk areas or by adopting established engineering practices to mitigate risks for new projects.
• Effective methods to mitigate physical risk range from high-cost design interventions to less expensive operational interventions. For example, developers may raise the elevation of a new building to mitigate flood risk, while owners can maintain effective clearance between a building and adjacent vegetation to mitigate fire risk.
• Developers are most likely to make significant investments in physical risk mitigation if it is required by a tenant, if they plan to hold the property for a long duration, or if they plan to sell it to an institutional investor. In the absence of these factors, developers are reticent to invest in interventions that do not provide a direct return on investment.
• Recent trends, including growing investor and lender scrutiny of physical risk, rising insurance premiums, and evolving local building codes, point toward increased industry adoption of risk mitigation strategies in the coming years.