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Commercial properties increasingly vulnerable to climate risks

Wildfire damaga in Santa Rosa, California

Commercial real estate owners, developers and investors face growing challenges in managing California wildfires and other climate risks, even if many have yet to see marked changes in insurance availability and costs, according to industry observers.

As the number and intensity of severe weather-related events increases, the risks associated with climate change can have financial impacts for real estate, according to a report published Feb. 12 by real estate management firm Heitman and the Urban Land Institute.

“It is an urgent and complex challenge which must be addressed, but for which the industry does not yet have a clear strategy,” the report said.

While some real estate players investing in areas with potential climate risks have found that insurance premiums have gone up or availability of coverage has contracted in markets affected by extreme weather, the majority have not yet seen a significant impact on insurance premiums or coverage, said the report.

“The impact is still low for now. We haven’t yet seen insurance premiums going up massively or buildings not being insurable,” said Lisette van Doorn, CEO of ULI Europe based in London.

“But we see owners realizing that it won’t take long,” said Ms. van Doorn.

As a result, real estate investors and investment managers are exploring new approaches to better price climate risk into their future investment strategies, she said.

“What they are doing is really trying to understand their exposures in their existing portfolios by doing a lot of mapping exercises, using big data,” said Ms. van Doorn. They are also looking to develop new tools to include climate risk in their due diligence, she said.

As estimates of losses from the 2018 California wildfires continue to increase, the insurance market for commercial property compared to the market for residential property is very different, say industry experts.

In the excess and surplus lines market, rates for commercial property in brush-exposed areas in California are starting to harden, but not as drastically as for personal lines, said Rich Gobler, corporate vice president and managing director at Burns & Wilcox in San Francisco.

“In commercial property, prices are no longer dropping, they are firming or going up in the higher brush areas in the higher protection classes,” said Mr. Gobler.

In contrast, the excess and surplus lines personal lines market is seeing rates increases from 20% to 100%, said Tom Carvalho, underwriting manager for personal insurance with Burns & Wilcox in San Francisco.

“It’s become what we would call a hard market,” said Mr. Carvalho.

While the commercial property market has been flat, buyers have seen prices start firming or rising in the past couple of years, according to Eric Schake, real estate & hospitality leader, corporate risk and broking, Willis Towers Watson PLC.

“It’s a function of if you’ve had losses and how the portfolio is exposed, if it’s exposed to California earthquake or has California wildfire losses or wind exposure,” said Mr. Schake.

When it comes to risk mitigation for real estate owners and developers, carriers typically want to see a certain distance from the buildings to the brush, he said. Some builders and owners are also looking at different construction materials that are not as susceptible to fire, while others are looking into the potential benefits of having water cannons on the properties, said Mr. Schake.

In terms of managing the risk of wildfire, the idea of creating a defensible space around a building is as important for commercial property owners as it is for homeowners, according to Daniel Gorham, research engineer at the Insurance Institute for Business and Home Safety in Richburg, South Carolina.

“The idea is you do some management of that space, whether it’s vegetation management and landscaping that reduces the potential for high intensity fire and severe exposure,” said Mr. Gorham.

While there are many examples of parking lots being called defensible space, there can be combustible items in these areas that could trigger fires, Mr. Gorham said. “A parking lot near a commercial building might have cars parked 15 feet to 20 feet away from the building. If one of the cars ignites, that might be a severe fire exposure,” he said.

That’s why defensible space must be coupled with hardening the building structure and using noncombustible building materials and construction techniques that make it wildfire resistant, said Mr. Gorham.

“Up to this point, the assumption might have been that commercial isn’t vulnerable to wildfire exposure, but I think we are learning that it is, and I think that will lead to reconsideration and potential changes in the building code requirements not just for residential, but potentially also for commercial,” said Mr. Gorham.