Climate Change Is Going to Transform Where and How We Build
Homes, offices, factories, and other valuable structures in the U.S. are increasingly threatened by climate change. Coastal areas where economic activity is concentrated is at particular risk of flooding from rising sea levels. But few Americans are thinking seriously about how to build resilience in areas threatened by a changing climate. My research indicates that there are five basic choices in investing in climate resilience: reinforce (for example, by building higher sea walls to protect against sea rise); rebuild after disaster; rebound (by, for example, introducing building features designed to be flooded without major damage to the overall structure); restrict through strict zoning laws; and retreat (by moving assets and people away from climate-endangered areas). Together, they can be used as a decision-support tool for what to do with assets exposed to climate risk.
As fires, floods, and droughts increasingly threaten homes, businesses, and other institutions, climate risk has become financial risk. A National Bureau of Economic Research paper recently concluded that mortgages written on homes in exposed locations are being shed by banks and absorbed by Fannie Mae and Freddie Mac, government-backed mortgage guarantors. This implies that homeowners and investors have been making location decisions without properly pricing the cost of potential peril, and that the government has been enabling the oversight. Some are even warning that this market failure could lead to a repeat of the 2008 financial crisis, which was also triggered by bad mortgages.
It’s not just homeowners investing recklessly — many businesses have been equally short-sighted in where they place new assets, such as factories, and what to do with existing assets in once-safe areas now threatened by these perils. While laudatory efforts continue to mitigate climate change at the international level, it’s long past time to accept that the climate is already irreversibly changing, and we must adjust our mindset accordingly. We can’t just keep piling sandbags, pumping basements, dousing flames, and expecting government bailouts forever; a methodology is needed for homeowners, businesses, mortgage holders, governments — all of society — to figure out which assets to reinforce and what other courses of action are available.
Alas, we seem to be headed in the wrong direction. While virtually no private insurance companies retain residential flood risk in Florida, Virginia, and other coastal states due to sea rise, government-subsidized programs such as NFIP continue to keep residences insured. Making things even worse is a general lack of restrictions on where one can build and what can be built. A society that prides itself on free will and self-determination is loath to say what a property owner can and cannot build on their own land as long as it meets rudimentary building and zoning codes: So more and more people move into harm’s way in flood plains, low-lying coastal areas, and tinder dry western landscapes.
Why this dysfunction? To begin with, all three of these factors — mortgages, insurance, and land development policies — are by design backward-looking. They rely on history of lending defaults, history of insurance claims, and history of floods and fires to make determinations. This is logical; there is plenty of hard empirical data to draw from, and a switch to looking forward would risk becoming a matter of speculation over the merits of one modeling method or another. There is also plenty of market incentive to keep housing prices high. But the look-backward approach seems overwhelmed today as climate events — and follow-on effects on the ground — are moving so fast.
There is a better way. My research and that of others indicate that there are five basic choices in investing in resilience: reinforce, rebuild, rebound, restrict, and retreat. Together, they can be used as a decision-support tool for what to do with assets exposed to climate risk.
Reinforce: This is often the default recommendation in the face of climate-related perils. But only in some circumstances is it is the right reaction. A good example is Texas Medical Center (TMC) in Houston. Following severe damages from Hurricane Allison in 2001, TMC invested hundreds of millions of dollars in resilience improvements, including flood bulkheads, sky bridges, elevation of electrical equipment, and more. When Hurricane Harvey hit in 2017, Houston was soaked by unthinkable amounts of rain and the regional flooding persisted for weeks — but with its resilience interventions in place, Texas Medical Center hardly missed a beat. Investing in reinforcement made sense in this instance because, first, the direct and indirect costs of being hit were huge; the hospital had the ability to raise the capital even though the investments in resilience were not sure to pay off (since there might have never been another big storm). And second, because the incremental capital spending relative to the entire balance sheet was manageable. But not every potential investment in resilience makes economic sense. We can’t pay for a blanket policy to resist sea rise and rainfall and fire in every situation forever, regardless of cost/benefit. When should a different route be taken?
Retreat: Consider the opposite scenario. After several consecutive years of being overwhelmed by riverine flooding, multiple small shopkeepers and restaurants in Ellicott City, Maryland, collectively abandoned the historic downtown for higher, dryer land. This was the right course of action for them: the cumulative flooding had a substantial cost relative to their balance sheets; the price to reinforce (by raising floors or building sea walls) was too high, and resources were thin.
Rebound: In Miami and Miami Beach, most new commercial or condo buildings on the water are built with extra-high first floor elevations (“freeboard”), with expensive equipment located out of harm’s way on the second floor or higher, and with furnishings and materials at ground level and in the basement that can survive temporary sea-water inundation, be pumped out, be quickly cleaned, and then put back in service. The famous wooden plank walkways on St. Mark’s Square in Venice are similar: They embrace neither reinforcement or retreat, but rather are focused on “living with water” — how to rebound in a cost-effective way.
Rebuild: This is essentially the path chosen by the homeowners in Houston, Texas or the Hampton Roads area in Virginia, where FEMA has paid to rebuild thousands of homes multiple times each. Rebuilding is a great choice — particularly if you are rich or if you can use someone else’s money. The long-term questions, though, are: Will there always be that money available? Will it go to those who are most in need or to help higher income individuals, as reported by U.S. News and World Report? And, of course, how long will the other taxpayers support aiding those in danger zones? In recent years, Congress has authorized about $200 billion per year for disaster relief in California, Iowa, Texas, Florida, New York, Puerto Rico, and elsewhere (on top of subsidizing the NFIP). It’s not clear that, in a time of deficits, this largesse will be perpetual.
Restrict: This is a strategy that the private sector mortgage and insurance companies appear to already be following — they are not investing in harm’s way and, based on press reports, they are drawing back. Some other large asset owners such as REITs or retailers thinking about store locations are avoiding purchasing or building properties in high-risk areas. But there is a public policy angle, as well: Recently the utility PG&E was forced to pick up the cost of property damage from California wildfires. A strong argument could be made that the local government should have restricted these structures from being built in the first place.
In the coming years, growth pressures for sure will increase in many attractive locations (such as coastal cities and western states). Americans will be forced to make some tough decisions. Subsidized mortgages and artificially cheap insurance have let us put off the hard reckonings a little longer, but if a severe price correction (and subsequent economic shock) is to be avoided, all asset owners in potentially exposed locations will need to pick one of five paths outlined above. The right choice in each situation depends on circumstances, the level of exposure, the cost of potential damages, the cost to reinforce, and resources available. The challenge for homeowners, investors, mayors, and all of us is to look ahead, not behind, and to make these choices with intent — before circumstances take the choices out of our hands.
via Harvard Business Review http://hbr.org
October 16, 2019 at 11:49AM