Forget crypto, early warning systems to detect severe weather threats are already calculated to pay back three to 12 times on investment within a one- to three-year period. With science offering up assurance that climate response will be a long-term and intensifying societal need, analysts suggest this could be a lucrative time to get into a surging market.

“It’s not a philanthropic exercise at this point for financial institutions,” contends Michelle Lu, North American banking commercial lead with Climate X, a data analytics firm that projects the probability of severe weather events and their impact of asset values. “Really, it’s about a key business opportunity that is emerging.”

Speaking earlier this summer as part of the Responsible Investor webinar series, she pitched the potential of profits twinned with risk management/mitigation benefits in what the World Economic Forum (WEF) projects will be a USD $2 trillion global market for climate adaptation financing before the end of this decade. That unfolds in sync with the release of a new net-zero standard for financial institutions from the Science Based Targets initiative (SBTi), which recommends more attention be paid to greenhouse gas (GHG) emissions profiles in investing in, lending on, underwriting insurance or raising capital for real estate.

Adaptation Financing

For now, private sector forays into adaptation financing are relatively rare. Total global climate finance input jumped more than fourfold over the past 12 years, from USD $364 billion to USD $1.6 trillion, but the share channelled into adaptation shrank from a high of 10 per cent earlier in that period to just 5 per cent in 2022-23 and 4 per cent in 2023-2024. The private sector’s contribution last year is pegged at about USD $4.7 billion versus USD $500 to $600 billion directed toward decarbonization efforts. That belies WEF’s expectation that the private sector will one day kick in 60 to 70 per cent of required funds.

“There’s a significant gap to be closed by the end of the decade for adaptation finance and we expect the private sector to play a very pivotal role in bridging this financing gap,” Lu maintains.

The rationale for doing so is fairly straightforward. The instruments to better enable it are still a work in progress. Lu underscores opportunities to avoid credit loss, build new lines of business and add pathways to meet green financing targets. Return on investment (ROI) can also surpass that for climate transition measures such as renewable energy generation or electrification and other emissions-reducing retrofits.

Lu cites data from various sources — including WEF, the World Resources Institute (WRI), the Institute for Catastrophic Loss Reduction (ICLR), the Organization for Economic Development and Cooperation (OECD), SwissRe and the global financial services firm, Standard Chartered — indicating:

• 2- to 5-times payback within five to 10 years for floodproofing measures;
• 6-times payback within two to eight years for roof-bracing retrofits;
• 6-times payback within seven to 15 years for fire-resistant construction;
• 2- to 8-times payback within five to 20+ years for a range of resilient infrastructure; and
• 3- to 12-times payback within one to three years for early warning systems.

Nevertheless, the multiplicity of citations also illustrates the lack of a universal metric to quantify loss savings and the flow-through asset value impacts of resilience.

“Typically, adaptation projects are still considered much less bankable compared to other projects because the ROI is measured in avoided losses rather than recurring revenue streams,” Lu acknowledges. “There’s this impression of: there’s only loss savings if a disaster were to happen. But, in reality, because of the nature of the hazards, payoff should be thought of as (reducing) annual expected loss.”

That aligns with the concept of climate value at risk (CVaR). The acute manifestations of physical climate risk — tornadoes; floods; ice storms; forest fires — take form in random destructive events. However, there are also chronic effects — more intense heatwaves; prolonged poor air quality; erratic freeze-thaw cycles — that tax building systems/structures and alter conventional assumptions about operational requirements and equipment/ infrastructure lifespans. All these flow through to asset value.

Standardized metrics for quantifying avoided losses are on Lu’s list of key supports to help de-risk investment. There’s also a need to bolster the creditworthiness of borrowers, particularly for municipal governments that face challenges to climate-proof infrastructure but are constrained in taking on debt or issuing guarantees, as well as a general need for incentives.

“If you are able to adapt or invest in adaptation, that benefit would not just benefit your holding period, but potential future value of the asset or the company, but there’s high uncertainty on ROI timing with potentially a much longer payback horizon,” she observes. “There are definitely regulatory and policy gaps, and not enough incentives in the adaptation space, as previously a lot of the incentives went to the transition risk side.”

Decarbonization guidance

The new SBTi net-zero standard for financial institutions targets scope 3 downstream emissions related to investing (i.e. emissions tied to financial institutions’ clients) and is meant for organizations that derive more than 5 per cent of their global revenue from lending, asset management, insurance underwriting or capital market activities. Like the SBTi corporate net-zero standard, enrollees must quantify their emissions relative to a chosen base year, establish reduction targets that are tied to a verified plan for achieving them, publicly state their commitment and report on their progress.

The initiative is deemed to be science based because targets must be in line with the level of reduction needed to keep global warming within the Paris Agreement’s parameters. Currently 145 Canadian organizations, including seven real estate entities, are among the 11,190 worldwide signatories that have either set targets or made a commitment to do so once their reduction plans are approved through the corporate net-zero standard. (Another 14 Canadian organizations, including four real estate entities, are listed on SBTi’s dashboard as having withdrawn their commitments.)

“The standard empowers institutions to play a catalytic role by enabling and emphasizing portfolio alignment with net-zero, using alignment targets to incentivize them, in the near-term, to support high-emitting sectors, increase the share of climate-aligned financial activities across their portfolio, and leverage their influence to drive real-world decarbonization,” states an SBTi communique, released on the July 22 launch day.

Participating financial institutions will be required to have policies to reduce exposure to fossil fuel and deforestation. A real estate policy is also recommended, but not mandatory. Through that public document, enrollees would:

• commit to restrict the extension of financial services to buildings that are net-zero ready, as of a specified year; and
• state intended measures for increasing financial activities related to retrofitting and decarbonizing existing buildings.

The policy is also expected to include procedures for monitoring, and schedules for reporting, progress on those two objectives.

While SBTi is a voluntary initiative, many industry-watchers argue that decarbonization aligns with the momentum of economic and regulatory trends. Despite recent policy shifts within the United States, those trends could become more discernible in Canada as government and business look to forge a broader range of trading ties.

Looking specifically at real estate, the Real Property Association of Canada (REALPAC) and the Canada Green Building Council (CAGBC) recently launched a joint effort to confer with commercial real estate appraisers on the development of valuation approaches and tools that can more precisely capture sustainability and resilience. A public discussion forum is planned for the fall of 2025.

Green building specialists also stress the importance of industry standards now that there is no longer a consumer carbon price to provide an easy, agreed upon reference point for costs and paybacks.

“The consumer carbon price provided a consensus on the risk for high-carbon buildings. Its cancellation didn’t change the business case for decarbonization; it changed the consensus on the business case. Smart real estate leaders are saying: Okay, now we’re in the wild west of predicting carbon price volatility, escalation and value each year,” submits Eric Chisholm, principal and co-founder of the engineering and sustainability consulting firm, Purpose Building. “Unfortunately, now it will be harder for purchasers, sellers, tenants and landlords to agree on what the threat is, what the value difference is between high-carbon and low-carbon buildings and who should pay what costs and when.”

Speaking at a recent forum for proptech innovators as part of Toronto’s Tech Week, Sheida Shahi, co-founder and chief executive officer of Adaptis, a capital planning tool employing artificial intelligence (AI) to map out low-carbon options for new development, concurred. She defined her company’s product not so much for its sustainability lens, but, rather, as a “vertical platform focused on financially sound investment for building owners”.

“We often get put in the cleantech bucket and I keep trying to take us out of it,” Shahi mused. “We have asset managers in our platform planning for 2050. They are looking at the highest return on investment at the lowest price. We’re talking about energy costs; we’re talking resilience of the building; we’re talking about residual value of the materials. Better decisions mean a more financially stable building over time.”