Climate Risk for Coastal Commercial Real Estate in the Language of Modern Portfolio Theory

Real estate owners face the impact of climate change on both expected risk and returns across property types and geography. This article provides a road map to estimating the risk-return characteristics of coastal real estate properties incorporating the effect of rising sea levels. The approach uses two inputs—a model of real estate risk in the absence of any climate impact, and, separately, a model for the probability of flooding due to proximity to the shoreline. The authors employ a risk model provided by Northfield Information Services to satisfy the first condition and data from FEMA and NOAA combined with a simple, effective, and intuitive flood probability model to satisfy the second condition. Specific examples are shown to illustrate the impact on commercial real estate (CRE) asset returns and risk, which is an essential input for the CRE investor portfolio management process.