The impact of climate change could lead to unpredictable shocks to the value of commercial real estate, as well as the availability and cost of buildings insurance, the Bank of England (BoE) has warned.

Sarah Breeden, deputy governor for financial stability at the Bank of England

The bank’s deputy governor for financial stability, Sarah Breeden, issued the warning yesterday (10 July) in a speech to the property sector – the annual Chapman Barrigan lecture, given in memory of industry figures Honor Chapman and Trish Barrigan.

“There is evidence that climate risk is starting to be priced in assets such as corporate and sovereign bonds, but our analysis suggests that current prices fully account for neither the transition risks […] nor the physical risks,” Breeden told guests at the event in London’s Guildhall.

She continued: “These are risks that could materialise and, in some cases, already are materialising.

“Rapid repricing could occur if markets start pricing in severe physical climate risks or a disorderly transition, perhaps following acute physical disasters. This repricing could affect a wide range of assets.”

Breeden described potential outcomes explored in the BoE’s scenario planning, including a loss of up to 20% in the value of long-duration G7 sovereign bonds, with knock-on losses felt across other assets.

“We are already seeing evidence of a ‘green premium’ [in real estate],” Breeden noted. “That suggests that some climate risks are already priced in. However, a sharp reassessment of physical risks or the likelihood of a sharp and disorderly transition [could lead to] a heavier discount.”

She added: “As flood risks intensify, insurers may withdraw coverage or increase price. This is already happening in the US, where policy non-renewals correlate with regional climate risks.”

Breeden acknowledged that the costs of climate-adapting and retrofitting buildings “will be substantial” and that “without the necessary funding, we risk stranded or ‘zombie’ properties”.

She cited the latest Bayes UK Commercial Real Estate Lending Report, which found that almost 70% of all outstanding debt – around £100bn in total – is due for repayment by 2027. “Around 10% of debt matured in 2024, with a small minority in default and the rest restructured or extended,” she observed, adding that the transition from low to high base rates “is far from over”.

She continued: “But reassuringly, compared with before the financial crisis, bank lending standards have been much more conservative and our stress tests show that the UK banking system is resilient to very large falls in CRE [commercial real estate] prices.”

But she warned that the prevalence of higher-rated non-bank finance across commercial real estate raised “the potential for increased risks” if values were to tumble.

Responding to an audience question from Peter Cosmetatos, chief executive of trade finance association CREFC Europe, about constraints in available capital, Breeden said: “The worst outcome [would be] to get decarbonisation on paper and just divestment of [less attractive] assets. That’s kidding ourselves that we’re managing the systemic risk.”

She said the BoE’s job was to “highlight the important role that banks have in pointing capital at the problem”, adding that it could prove disastrous if “everybody tried to divest at the same time”.

“That just doesn’t work. So we’re doing our best to shine a light on it, [to] make sure that people are focused on the genuine systemic risk, which is the need to decarbonise and to try to ensure that what we talk about is the need for transition finance.”