Wall Street Is Masking the True Cost of Climate Change for Coastal Homes

(Bloomberg Markets) -- Last November, less than a month after someone paid more than $1 million for an oceanfront house on New York’s Fire Island, a narrow strip of land dividing Long Island’s Great South Bay from the Atlantic Ocean, a storm surge destroyed the pool. “It’s certainly a very vulnerable place for storm and water damage,” says Vincent Petrarca, a broker who specializes in Fire Island Pines real estate. “You just have to look at the beach [to see] that there’s been erosion. But these houses are incredible, it’s a luxury item, and people want it.”

Extreme weather events are getting worse, and so is their impact on coastal real estate. “Any property that’s close to sea level is going to have an increase in the frequency of damaging events,” says Peter Thornton, a senior research scientist specializing in Earth-system modeling at Oak Ridge National Laboratory. “The same storm as 20 years ago has a more damaging impact today, just because it’s starting off at a higher baseline.”

But even as coastal housing becomes more vulnerable, the cost of living in that housing has stayed relatively stable, and the price of that housing has continued to rise. In North Carolina’s Outer Banks, the average sales price was up 11.5 percent over the last three years. Luxury real estate in Miami Beach was up more than 60 percent year over year during the fourth quarter of 2018. In 2018, Nantucket island saw a 161 percent increase in the total number of sales over the prior year. In contrast, annual National Flood Insurance premiums were raised by an average of about 8 percent on April 1, 2018, from an annual average of $866 to $935 per policy.

It’s not that homebuyers are ignoring the growing threat of climate-related damage; Petrarca says his clients are increasingly concerned about the climate threat. It’s just that currently there are too few financial repercussions for coastal homeowners, says John Rollins, an actuary at Milliman who specializes in catastrophe-exposed property and flood insurance. “People are moving into harm’s way, and there are multiple threats associated with living near the coast,” he says, “but there’s been a tremendous abundance of capital that has become available to insure property risks.”

The investment capital that has gone into insurers and reinsurers has increased competition in the industry and held premiums down. That, in turn, has artificially suppressed the cost of coastal homeownership. “The consumer got the benefit of the disconnect between the flood of available capital that came into the reinsurance market and the voices of scientists indicating higher client risk,” says Rollins.

Simultaneously, “the national flood insurance program is artificially subsidized due to a lot of political pressure,” says Howard Mills, the global insurance regulatory leader at Deloitte. “Currently, people who live in areas of the country that will never, ever flood are subsidizing those who live in risky areas.”

But all this could change as climate-related damage incidents rise and insurance companies improve their climate models, which may make them demand higher premiums. “With the greater frequency and severity of storms, will it be more expensive going forward to live in coastal areas?” asks Mills. “Yes. And frankly, it should be.”

That, of course, will be bad news for homeowners on coasts. “It would impact the real estate market, because that market is about the cost of ownership, not just the cost of purchase,” Rollins says. A higher cost of ownership would hit home values.

The trillion-dollar question, then, is when will coastal real estate begin to show signs of pressure? For now, Petrarca says, the dream of living on the ocean outweighs everything else. “People are approaching it like a piece of jewelry or a painting,” he says. “You can’t really justify it in a practical way. It’s emotional.”

To contact the editor responsible for this story: Pat Regnier at pregnier3@bloomberg.net

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