Will owning a home lead to wealth or bankruptcy?
In the climate era, it depends what house you buy and where
This past Tuesday, Minneapolis real estate developer Sean Sweeney tweeted this:
The influence of climate resilience (or its absence) on future real estate prices will be significant, and demand for homes in resilient places will increase from here. I recently articulated this idea in stark terms:
[I]n the coming decades real estate in some places will skyrocket in value, while in other places it will experience a crash more extreme than any since the Great Depression, and maybe ever.
But I left something crucial out of this formulation: at some point in the years and decades ahead, home values in climate vulnerable places are going to crash and not bounce back. This is complicated but essential to understand because it’s very different from what we’ve learned to expect.
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Climate change steadily corrodes vulnerable places. Climate change also periodically inflicts severe damage, as Hurricane Ian did to parts of South Florida this week. Over time, both the gradual decay and the devastating events will worsen, until at some point property values start to decline. Crucially – here’s the key point – unlike overbuilding, recessions, and other things that may drive down property values temporarily, climate change is not cyclical.1 Once they start to decline in earnest, most climate vulnerable places won’t ever bounce back.2 At some point, the housing market will internalize this reality and its profound, society-altering implications. At that point the crash of housing prices in climate vulnerable places will be imminent.
One practical implication of this insight is that buying a home now requires a more complex analysis than it did in the past. Previous housing downturns, including the devastating crash of 2007-2009, have always been followed by recoveries, and prices since WWII have experienced shorter-term ups and downs, but on longer timeframes have either risen or held steady.
Even in the regional markets that in 2007 were most overbuilt and overheated, like greater Las Vegas, today’s home prices have surpassed the peak.
So with a few idiosyncratic exceptions, buying a home has reliably been a good investment for decades. So good, in fact, that in looking for a house you could focus on your preferences and price range, secure in the knowledge that any home you bought would be a solid financial decision at worst.3
But not anymore. In the coming decades the housing market will bifurcate, with the fair market value of climate durable homes steadily rising and climate vulnerable homes falling.
This coming bifurcation of the housing market, in which climate resilient areas will thrive and climate vulnerable areas will struggle and decline, is new. It’s a manifestation of the fact that climate change is a discontinuity, a structural change so vast that what has come before is a poor guide to what will come after. Because it’s unfamiliar, let’s think a bit more granularly about how it will happen.
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We can conceptualize every home as having a rating, call it the Home Desirability Index (HDI), that incorporates all the key factors that makes a home more or less appealing. These factors include (but obviously are not limited to):
Size
Condition
Weather
Safety
Community
Taxes
Public school quality
Proximity to jobs
Future appreciation potential
We can think of the individual criteria weights and scores being aggregated in two dimensions. First, by calculating the weighted average of all the criteria scores for each buyer, which generates the person’s overall HDI for that home. And second, by averaging HDIs for a particular home across all buyers, which yields the home’s market HDI. A home’s market HDI is highly correlated with its fair market value. So highly, in fact, that we can treat them as interchangeable. (Another way to think about this is that the market value of a home is a function of its desirability.)
Now that we have a simple conceptual methodology, let’s apply it to some hypothetical homes and see how it will likely operate in a future of growing market understanding of climate realities and implications. If we look at two similar homes, one in the Buffalo, New York metro area on Lake Erie (climate durable) and the other on the Gulf Coast of Louisiana (climate vulnerable), we can model the HDI shifts over time. It starts out looking like this:
In a marketplace that in 2022 has widely variable awareness of climate threats, a critical mass of buyers may assess a home in or around Buffalo and a home with a similar profile along Louisiana’s Gulf Coast as being similarly valuable. In this example, the home in southern Louisiana and the home in greater Buffalo both have market HDIs of 6.4 in 2022. Let’s say this translates to a $640,000 fair market value (on the higher side for both regions).
But as understanding of climate change’s grinding, destructive advance grows in the coming years, more and more buyers will start to recognize that homes on low elevation land in the Gulf Coast are extremely vulnerable to sea level rise and hurricanes, and are therefore likely to lose much of their value in the future. In parallel, as people realize northern, non-coastal cities that have solid infrastructure, ample fresh water, and local food production will be durable in the face of climate change, homes in those places will rise in value. By 2032, it looks like this:
The significant change, highlighted in yellow, is the Future appreciation potential criterion jumps from a weight of 1 percent to a weight of 40 percent between 2022 and 2032. This may seem like a huge increase, but if we consider that hundreds of thousand of dollars are at stake, it’s reasonable for buyers to make preservation of that wealth a primary consideration in what house to buy.4 It's more than reasonable, actually, it's inevitable.
As a result of the increased weight on Future appreciation potential and the proportional reduction in the other criteria weights (plus small shifts in scores for Future appreciation potential and Weather), the Buffalo house went from $640,000 (HDI of 6.4) to $750,000 (HDI of 7.5), while the Gulf Coast house went from $640,000 (HDI of 6.4) to $380,000 (HDI of 3.8). Whoever bought the latter house effectively lost the difference, $370,000, over a period of just 10 years.
These specific dates are not a prediction about timing, which is impossible to know, just a concrete illustration of how it could play out. That said, this is probably understating the gap in terms of financial outcomes between buying a climate durable home vs. a climate vulnerable home. Consider:
It doesn’t take into consideration that homes in those locations will become increasingly expensive to insure, up to the point when eventually no insurance will be available, not even from the state’s insurer of last resort, and homeowners have to bear the considerable risks themselves.
It doesn’t take into consideration that as a result of the wider understanding of climate change and it’s influence on future home values, the overall demand for homes in climate durable places will rise faster than the supply.5
It doesn’t take into consideration that it will eventually become harder to get a mortgage to buy climate vulnerable homes, and the inability of buyers to secure mortgages will depress prices.
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The necessary condition for this bifurcation of the housing market based on climate resiliency to occur is a more widespread understanding of the implications of climate change. But because those implications clash with our mental models of how the world works, and since mental models can be surprisingly resistant to new information, it's difficult to predict when the effectively permanent decline of climate vulnerable housing markets will begin. It could take a while or it could happen sooner than we expect. Caveat emptor.
To be more precise, climate change is not cyclical on any timeline relevant for human lifespans.
It’s not impossible there could be a small handful of places that defy this ecological gravity with manmade defenses like sea walls. But the uncertain effectiveness, implementation challenges, knotty politics, and immense financial cost ensure these exceptions will be few.
Barring, that is, extended unemployment, serious medical issues, divorce, death, or another crisis that leads to foreclosure.
Remember, you can live in a place without buying property there. For those who don’t want leave climate vulnerable areas because their families and communities are there, renting rather than buying is the most important financial decision of their lives. (Is that a tragedy for them? I can understand why some people will see and experience it that way. But in my view renting has plenty of upside even aside from the “preserving your wealth” part.)
Including private equity firms and other investors who recently got into the home rental business, which has an inherent long-term, or at least medium-term, orientation.