More than a decade after a U.S. mortgage meltdown threatened to destroy the international financial system, a “Big Short” investor once again sees financial disaster brewing in the real estate market.
Dave Burt, CEO of investment research firm DeltaTerra Capital which aims to help clients manage climate risk, was one of the few skeptics who recognized the housing market was on the brink of collapse in 2007.
He helped two of the protagonists of Michael Lewis’ bestselling book “The Big Short” bet against the mortgage market in the lead-up to the 2008 global financial crisis. As it turned out, they were right and were estimated to have made millions.
Now, Burt believes an overlooked climate risk could see history repeating itself.
“I’m always on the lookout for these big systemic issues and there’s a few reasons for that,” Burt told CNBC via videoconference.
“Professionally, if something is mispriced, then as an investor, which has been my job for most of my career, your main opportunity to add value is to identify something that is either too cheap to purchase for your clients or something that it is too expensive to sell for your client,” he said.
“From a personal perspective, and this is partly based on that professional perspective, I’ve seen when that goes wrong, how impactful that can be on economies and society and our most vulnerable. And I’m really thinking through the post-global financial crisis period here in the U.S. from 2008 to 2012 where there was a huge amount of human suffering.”
Eventually, you are going to hit either a local or national tipping point where there is going to be some type of bubble that bursts.
Jeremy Porter
Head of climate implications at First Street Foundation
Burt said DeltaTerra Capital’s research suggests that 20% of U.S. homes have “meaningful exposure” to a mispricing issue because of flood risk. If realized, he warned the fallout could resemble the extraordinary correction seen during the global financial crisis.
“We think of this repricing issue as maybe a quarter of the size and magnitude of the [global financial crisis] in aggregate, but of course very, very damaging within those exposed communities,” Burt said.
His comments come at a time when the housing market is currently experiencing a major fundamental shift because of higher mortgage rates and as global central banks keep up the fight against inflation by hiking interest rates.
In turn, Burt says some cracks are starting to appear in the terms of the cost of insurance. He noted the recovery in Florida from Hurricane Ian was an issue he’s watching closely, particularly because this storm surge exposed a flood insurance nightmare for homeowners.
“Will they become chasms this year? I’m not sure,” Burt said. “But an observation of the highest frequency fundamental data on home sales and home inventories indicates that things are definitely going south for these exposed properties.”
U.S. housing market overvalued?
While most investors remain skeptical of the impact of climate risks on their portfolios, a recent study warned the U.S. housing market could be overvalued by around $200 billion due to unpriced flood risks.
The analysis was published in mid-February in the journal Nature Climate Change. Authored by researchers from the Environmental Defense Fund, the First Street Foundation and the U.S. Federal Reserve, among others, the study modeled property-level changes in flood risk across the U.S. over the next three decades and warned that low-income households were particularly vulnerable to home value devaluation.
“The biggest reason why it matters from our perspective is that climate risk isn’t being priced into the housing market,” Jeremy Porter, head of climate implications at the First Street Foundation, told CNBC.
“The costs now or the valuations of homes don’t take into account the realization of that actual flood risk, and that’s not taking into account that we have a tremendous amount of overvaluation attached to properties across the country.”
Porter warned that as people continue to lack sufficient climate risk information when purchasing their homes, a danger persists that households could come to lose a significant proportion of their property value overnight.
“It is not that farfetched to say that you hit a tipping point,” Porter said. “It may be community by community. It may be a larger tipping point that you hit across the country in the real estate market. But eventually, you are going to hit either a local or national tipping point where there is going to be some type of bubble that bursts.”
At present, the study said nearly 15 million U.S. properties face a 1% annual likelihood of flooding, with expected annual damages to residential properties forecast to exceed $32 billion.
It also warned the increasing frequency and severity of flooding amid the deepening climate emergency could see the number of U.S. properties exposed to flooding increase by 11% and average annual losses jump by at least 26% by 2050.
“When you buy a home, one of the most important considerations is the cost of maintaining that home and I think so many important decisions are made based on that,” Burt said.
“Ultimately, until people have good information about what these climate-related costs are going to look like, we’re creating new problems every day. I think that’s really the crux of the matter.”
Reflecting on the study’s findings, Jesse Gourevitch, a postdoctoral fellow at the Environmental Defense Fund, told CNBC that the overvaluation was more widespread among lower-income property owners.
He added that “if price deflation were to occur, this very much has the potential to widen wealth gaps in the U.S. and exacerbate inequality.”
Another significant risk, Gourevitch said, was likely to be the potentially detrimental effects on local government tax revenues because the total for municipalities typically relies heavily on property taxes. “And having that tied to a physical asset that is exposed to climate change I think introduces a lot of risks to the stability of that revenue stream,” Gourevitch said.
‘A humanitarian crisis’
Far from a domestic issue, Burt stressed that the climate risks associated with the U.S. housing market posed a major problem for countries worldwide.
“I think when you start thinking about these issues globally, you start thinking about the bigger implications that really the most exposed countries often happen to be the most impoverished as well,” Burt said.
“It is more of a humanitarian crisis when you start looking at this through the global lens.”
Munich Re, the world’s largest reinsurance company, observed steep economic losses in 2022 as the climate crisis drove more extreme weather events, such as Hurricane Ian in the U.S. and apocalyptic flooding in Pakistan. Reinsurance refers to insurance for insurance companies.
It estimated that these losses amounted to $270 billion last year, of which around $120 billion was covered by insurance. The insured loss total continues a trend of high losses in recent years.
“At the end of the day, someone has to pay for these increasing losses,” Ernst Rauch, chief climate and geo scientist at Munich Re, told CNBC. “No matter whether it is insured or not, it is an increasing economic burden.”
One area of particular concern, Rauch said, was flash flooding. This refers to a specific type of flooding in which rain falls so quickly that the underlying ground cannot drain it away fast enough.
He cited the excessive flooding seen in Germany in 2021 which caused overflowing rivers to devastate towns across western Germany, Belgium, Austria, and parts of the Netherlands, Switzerland and Luxembourg.
Rauch said the increasing frequency of these types of extreme local or regional rainfall events was still being underestimated. “It is no matter whether we talk about a typical homeowner in Germany or in other parts of the world,” he added.
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