A bank is planning to finance the purchase of a 300-room hotel by a property development company. The hotel is located near the river in a large European city. The city has not seen much sunny day flooding yet, but the bank is afraid that this may change. While sea level rise is a major threat to the country’s coastal areas, the hotel’s proximity to the river and extreme weather events such as cloud bursts are considered a threat.

As part of its due diligence, the bank now requires property developers to perform a climate risk study. This additional step in the due diligence is not limited to real estate property.

The bank realises that physical climate risk can negatively impact the value of a range of assets. For example, in considering a previous transaction, the bank considered financing of an airport located near the sea. After it performed a thorough climate risk due diligence the bank decided not to lend.

Assessing vulnerability is one step; assessing what the developer can do to mitigate the impact of flooding on the property is equally important. For example, the hotel can erect attractive flood barriers, ensure that critical infrastructure is not located in flood prone basements, and invest in gardens that can function as retention ponds.

Banks have started to recognise the importance of the environmental performance of their real estate lending book in order to better serve their clients and deliver their sustainability goals. Some banks will even refuse to lend if the building does not have a minimum sustainability score.

Response
The property developer engaged our partner, Climate Adaptation Services, who applied climate models to predict the probability of extreme weather events at the property. Current climate models are able to predict such events on the asset level. Furthermore, the report was used to define interventions to make the hotel less vulnerable to climate impact.