Those who purchased real estate in Seattle in the late 1990s and held this property have earned a great rate of return as Amazon unexpectedly boomed. When surprise good local news plays out, asset owners are delighted as they earn a windfall. In my 2021 paper, I document that Black home buyers have not been purchasing in such “windfall” tech areas (perhaps because they do not tend to work in these industries and the tech cities —- portland, San Fran, Seattle, Boston) tend not to have a small minority share.
While asset buyers love good news, such asset purchases are often not “a 2 sided coin”. When bad news occurs (such as a natural disaster or a major fire), the U.S government often steps and offers subsidized insurance. Is such a “kind” policy good or bad?
To an economist, this approach generates moral hazard as investors anticipate that their insurance is subsidized. I believe that an even more pernicious effect of this insurance is to crowd out the ability of capitalism to build up a more resilient real estate capital stock in at risk flood zones and fire zones.
Imagine a Libertarian fantasy world where there is no government. A person who builds a home in a flood zone faces the full risks of her investment. She will take pre-cautions (stilts?) to protect her asset. She will seek home construction design and architects who can help to protect the asset. The aggregate demand for flood protection creates a profitable industry for young people to invest their time to acquire the human capital to help real estate investors to build the right property that could handle the next 50 years of climate shocks.
Given the uncertainty about the path of the next 50 years shocks (the life of the home), the owner will build in some redundancy. Improvements in climate science offer local clues about emerging risks. The option value concept will matter here as the home investor will build a home that can be upgraded as new risks materialize. As we have seen with computers, the supply of quality products improves over time. I believe that the quality of adaptation friendly products will sharply improve if this dynamic plays out.
Would lenders lend to such property builders and buyers? The mortgages might be 15 years rather than 30 to make sure the owner has more “skin in the game”. The interest rate may be higher to reflect the climate risk premium. Insurers would risk price to reflect the emerging risks. A competitive market would emerge here. Insurers can sell policies in an area and then diversify the risk by selling some of these loans on the global market. They can also buy catastrophe bonds as a hedging strategy.
An integrated mortgage and insurance firm would have an edge in incentivizing resilience here. The end result would be a more robust real estate sector.
Finally, why are so many Amateur home owners —- home owners? They could be renters and invest in REITS. If high quality REITS manage more properties then we will face less risk as professional managers with the know how, Finances, and data would better handle the climate adaptation.
My new 2021 book Adapting to Climate Change expands on these points. We can adapt if we change the rules of the game so that asset owners are exposed to 2 sides of the coin!