The local impacts of climate change: Evidence from property prices around the world

By Giulia Faggio*

According to the International Energy Agency, overall CO2 emissions are likely to reach 12-15 gigatons by 2030. The renown British economist Nicholas Stern (2008) warns that, under these conservative projections, “that would give us around a 50–50 chance of a temperature increase above 5°C, [which] would eventually lead to sea-level rises of 10 meters or more. […] The world would probably lose more than half its species. Storms, floods, and droughts would probably be much more intense than they are today.

These projections have strong implications for both the insurance industry and real estate markets. Because of more extreme and frequent weather episodes, insurers face increasing losses. For instance, the US insurance industry reported $62 billion losses in 2005 (the year of hurricane Katrina) – up from an average of $44 billion in the 1950s. In an attempt to control losses, insurers have risen premiums or have become unwilling to write policies in areas at risk.

The price of houses that are in areas that face more extreme weather conditions seem to adjust more slowly than insurance rates do. Taking the Netherland as an example, 36% of the country is at risk of flooding were its river- or sea-defences to breach. Despite this, recent survey evidence suggests that Dutch people severely underestimate the flood risk that they, and their property, face. Respondents seem not to take into account flood risks in their investment decisions. In contrast, they value sea-views the most. Nevertheless, a recent study by Maarten Bosker and co-authors reach an opposite conclusion: flood risk is reflected in property prices. They find that Dutch houses in a flood risk area are about 1% cheaper than houses without any risk of flooding.

To fight increasing emissions and their potential adverse effects, several government schemes to stimulate the generation of renewable energy have been rolled out. Among renewable energy sources, wind power production has become increasingly popular among policy makers. Currently, about 39% of the wind power capacity is located in Europe, 26% in China, and 20% in the US. The crucial question here is where to exactly place wind turbines because of the negative externalities they can create in terms of noise pollution and reduced quality of views affecting nearby property values.

A small but growing literature investigates the local impact of wind turbines, providing mixed results. Some studies from the US and UK find no impact of wind turbines on house prices. However, these studies use small datasets and often focus on a few wind farms. Conversely, a Danish study finds evidence of visual dis-amenities of offshore wind parks in Denmark. An average Danish household would be willing to pay €122 per year to increase distance to a wind farm from 8km to 80km. A recent study by Steve Gibbons finds that a UK household would be willing to pay €1,250 per year to avoid having a wind farm within a 2km distance; and around €150 per year to avoid having a wind farm visible in the 8km-14km range. Looking at the Netherlands, a preliminary study by Martijn Dröes and Hans Koster also finds a negative effect of wind turbines on house prices. Their results also show strong anticipation and adjustment effects: price houses drop two years before the placement of a wind turbine and adjustment effects last till five years after its placement.

Nevertheless, most of the current energy use relies on natural resource extraction. The recent findings of shale gas in various places in the world have led to a heated debate on the potential adverse effects of gas drilling. In any case, compared to coal and petroleum derivatives, natural gas has a lower carbon footprint than other pollutants. The question is whether potential negative externalities are indeed experienced by local homeowners. A US study by Christopher Timmins and co-authors look at the impact of shale gas activity on property values in Pennsylvania. They show that houses that use groundwater are negatively affected by nearby gas development. Homes dependent on piped water, on the other hand, appear to receive small benefits from that development. At a broader geographical scale, they find evidence of strong house price increases before drilling takes place, followed by a house price decrease after drilling, likely due to speculation.

Climate change has various impacts on the local environment, which can be (partly) quantified by looking at the impact on property prices, as increased uncertainty about future weather events have already affected the behaviour of homeowners. Climate change can also have an indirect effect on property prices by increasing energy costs and encouraging the switch towards renewable energy sources. In search of alternative sources, wind power production has gained momentum. What perhaps was not taken into account in earlier policy discussions is that wind farms generate negative externalities in the form of noise pollution and reduced quality of views affecting nearby property values. Finding ways to compensate for these negative externalities should be high on the policy agenda.

* Giulia Faggio is a research officer at the Spatial Economic Research Centre, London School of Economics. She holds a PhD. in economics from KU Leuven. Her fields of expertise are urban economics, real estate economics and environmental economics.