Insight

Real estate: M&A preparations must address climate risk

ESG is becoming increasingly important in a company’s due diligence process

Liam Kelly

Liam Kelly

Principal, Infrastructure, KPMG US

+1 415-932-9040

Ronan Curran

Ronan Curran

Advisory Managing Director, Financial Due Diligence, KPMG US

+917-603-8913

As climate risk increases, owners, and operators of real estate—which include most companies across most industries— must account for it in their M&A preparations.

The recent severity of climate events such as storms, floods, wildfires, and hurricanes is unprecedented. In 2021, weather and climate-related events caused $329 billion in damages globally1, while the US experienced 20 climate-related disasters whose damages exceeded $1 billion2. CEOs are acutely aware of this: They named climate risk the top threat to growth in the KPMG 2021 CEO Outlook, up from the fourth place in 20203.

Climate risks for real estate: We see three types of climate risk related to real estate assets, namely, the physical risks such as structural damage and rising operating costs; the risks associated with the transition to energy-efficient and low emissions buildings; and regulatory and reputational risks such as penalties for emissions violations or public perception that a company lags on climate issues. Real estate players are using models to forecast the likely effects of physical and transition risks on siting decisions. Estimates of climate risk, for instance, often include relevant real estate costs such as closing a factory due to flooding or the impact of rising temperatures on both carbon emissions and demand for air conditioning. Companies also will need to predict how future climate-related regulatory changes might affect operating expenses as well as costs such as asset write-offs, stranded assets, and lower valuations subject to insurance exclusions.

The right strategy: Evaluate and implement: We recommend a two-phased strategy for buyers, sellers, and institutional investors to prepare for climate change’s potential effects. The first phase involves evaluating climate readiness and the second transforms the company’s business model to better address climate risk.

Evaluating readiness: Assess whether— and to what extent—governance, strategy, risk management, metrics/targets, and reporting enable climate readiness and resilience across the real estate portfolio. Risk reporting should follow the guidance of the Task Force on Climate-Related Financial Disclosures, whose framework is designed to help companies disclose climate risks and perform comprehensive assessments of physical and transition risks and opportunities.

Implementing a new model: Implement a climate-resilient business model that embeds strategic responses to climate risk throughout the organization, encourages pre-emptive analysis and action, and requires ongoing assessments of exposure to those risks across existing real estate portfolios. To drive confidence, it’s important to share the implications of climate risk and the new strategy with stakeholders including investors, employees, and regulators.

Adoption is inevitable: Going forward, we expect the assessment of climate risk to become a mandatory part of the M&A process. Pressure from institutional investors, government entities, and corporate boards likely will raise the heat on dealmakers to incorporate climate risk into their pre-transaction analyses.

For example:

• In October 2021, 733 institutional investors with more than $52 trillion in assets under management signed a statement calling on governments to adopt a number of measures that would help avoid catastrophic temperature rise and manage climate risk4. The measures included requiring climate-risk disclosure, ending fossil fuel subsidies and phasing out thermal coal-based electricity. This is indicative of the importance that private equity investors are placing on these risks while they simultaneously push for greater reporting transparency throughout the M&A process.

• In a keynote address at the 2021 Society for Corporate Governance National Conference, SEC commissioner Allison Herren Lee noted that shareholders and others have ways to hold companies accountable when they don’t meet expectations for climate and environmental, social and governance (ESG) practices—including replacing directors. Lee stated that “Boards that proactively seek to integrate climate and ESG into their decision-making not only mitigate risks, but better position their companies and business models to compete for capital based on good ESG governance.”

Footnotes

  1. Source: “Only 38% of 2021’s Natural Disaster Losses of $343B Were Covered by Insurance: Aon,” insurancejournal.com, January 26, 2022.
  2. Source: “Billion-Dollar Weather and Climate Disasters,” ncdc.noaa.gov.
  3. Source: KPMG 2021 CEO Outlook, kpmg.com, September 2021
  4. Source: “733 investors with more than US$52 trillion issues strongest-ever unified call etc.,” ceres.org, October 27, 2021.