Can coastal property values weather climate change

A reader of mine asked the following question in a recent email: If climate change is such a threat, how come U.S. coastal properties continue to rise in value? This seems like a conundrum unless you know what is actually driving the trend. And, it’s worth noting that coastal home prices in certain instances have suddenly collapsed along with the shoreline next to those homes due to coastal erosion—which, not surprisingly, increases with rising sea level. A Nantucket seaside home assessed for tax purposes just this year at $1.9 million recently sold for $200,000. Expect more stories like this one to start appearing in the news.

So, what about other homes that continue to hold their value and even rise in value? Here are some of the drivers of what will some day be considered an insane bubble in coastal real estate prices:

1. 1. The National Flood Insurance Program was created by the U.S. Congress in 1968. Seen as something that helped homeowners and small businesses which were having trouble getting flood insurance, it has ballooned into a vast federal subsidy of below-market insurance rates for those wishing to build in risky places prone to flooding including developments of high-end coastal properties. Private insurance companies have shied away from flood insurance because of the high risks which are getting higher with the more extreme and frequent floods that are accompanying climate change and the increasingly dangerous storm surges accompanying ocean storms.

1. 1. Disaster recovery in the United States has long featured large amounts of federal money to aid people in situations where local resources would never be adequate. That approach to policy is entirely consistent with the notion that we are one nation committed to helping our fellow citizens when, through no fault of their own, disaster strikes—which means that we will be helped should a disaster happen to us. However, the reassurance that even those without private (non-subsidized) insurance will be compensated and able to rebuild creates what in financial parlance is called “moral hazard.” In short, we are conducting disaster recovery in ways that encourage people to rebuild in the same risky places affected by disasters such as hurricanes that are entirely foreseeable.

1. 1. Local, state and federal governments continue to build, rebuild and upgrade public infrastructure to facilitate coastal development in risky places. For example, Ocean City, New Jersey got the Army Corp of Engineers to pump more than 1.8 million cubic yards of sand to restore its beaches after Hurricane Sandy washed them away. The city paid $4 million for the sand pumping while the federal government paid $14 million. The process is repeated (sometimes, again and again) along many of America’s beaches.

1. 1. The federal tax code provides tax breaks for owners of real estate. The more expensive the real estate, the greater the tax subsidy regardless of the risks to which the property is exposed.

1. The financialization of real estate is driving prices up across the country. Real estate used to be owned by individual homeowners and businesses. Today, it is increasingly owned by financial funds driven by financial goals and speculation. Investors have easy ways now of dumping money into the real estate market without actually buying a home or some business real estate and without having to understand the specifics of a property. This extra source of liquidity just adds to the speculative froth since investors do not scrutinize what their real estate investment funds are buying and those funds are forced to buy into rising markets in order to deploy their investors’ cash, pushing up prices even further.

Where owners don’t bear the risks and true costs of insuring and rebuilding, they have an incentive to keep engaging in risky behavior since all of the upside accrues to owners and nearly all of the downside is handed to taxpayers via subsidies and government-funded insurance and disaster recovery. If tomorrow coastal property owners were forced to bear all the risks and costs associated with such property, the bull market in coastal real estate would almost certainly halt and probably reverse. People would find safer and less costly alternatives.

Even with all the subsidies and public backstops for coastal development, there will almost certainly come a time in the decades ahead when climate-change-induced destruction of coastal property will overwhelm the ability of governments to respond by subsidizing rebuilding in order to set up yet another round of destruction. One way that could happen is that taxpayers living in the interior of America will tire of paying for the losses of coastal real estate owners and demand that those owners shoulder the risks and losses themselves.