Building a Climate-Adjusted Pro Forma

This is Climate-Ready Real Estate Investing, the intelligence briefing for stakeholders in the nearly $400,000,000,000,000 global real estate market, the world's largest asset class. The goal is to provide you with the intelligent signals to be profitable today while ensuring we will have a tomorrow. Listen, then implement to do good things and make money. I'm your host, Jamie Wolf. In the last brief, we followed the institutional capital and mapped where it is flowing in 2026 and precisely why.

The next question is the practical one. How do you actually model climate risk in a deal? Not conceptually, not in a framework document, in a real pro form a with real line items and real decision points. Today, we build it together. But first, before we dive into the case study, for those of you who haven't been here before, welcome to Climate Ready Real Estate Investing.

Each week, in addition to guest expert interviews, our audience receives three short briefs focused on market intelligence, strategy, and underwriting like today, as well as narratives of current events with future implications. The theme underlying Climate Ready Real Estate Investing is a deep concern for the well-being and viability of our planet today and tomorrow and a desire to explore how best to support this industry. Global real estate, the world's largest asset class at nearly $400,000,000,000,000, and making both profitable and forward thinking big picture decisions borrowing from the Hippocratic Oath to first do no harm. Last month, we reframed climate change as a matter of market structure rather than ideology. This month, we're going to look at everything through the lens of climate as capital strategy because early recognition creates investor advantage.

With that as context, the market we're working in today is Miami Dade County in Florida in The US, one of the most studied climate risk real estate markets in the world and simultaneously one of the most active investment markets in The US. Miami Dade is useful for this exercise because it illustrates all three of our signals in concentrated form. What is happening here is happening in slow motion in coastal markets from Houston to Charleston to Norfolk and in a different form in wildfire markets from LA to Fort Collins to Suburban Sydney. The pro form a framework we build today applies everywhere the signals are moving. Signal four is the valuation gap and market repricing signal.

A measurable and growing divergence exists between traditional appraised values and climate adjusted values in Miami Dade. Appraisers using the standard comparable sales methodology are not yet consistently adjusting for flood zone exposure. The divergence is real, documented, and materializing as deal level pain for investors who transacted at appraised value. Signal one is the insurance repricing and availability signal. Florida's domestic insurance market is currently rebounding.

Still, it experienced acute structural distress once, and it's not unforeseeable that it will happen again. Citizens Property Insurance Corporation, Florida's state backed insurer of last resort, established by the Florida legislature in 2002 ballooned in 2023 to become the state's largest insurer, peaking at over 1,400,000 policies. We've mentioned this before. Only after sweeping tort and litigation reforms were enacted in twenty twenty two and twenty twenty three did Florida's private homeowners insurance market see significant stabilization in multiple new market entrants. The lesson is that a market dominated by an insurer of last resort has its own category of capital risk.

Signal six is the chronic climate stress signal. Miami Dade now experiences measurably more extreme heat days per year than a decade ago. Since 1970, the county has documented an increase in the number of days above 90 degrees Fahrenheit from 84 to a 133 per year, and that number continues to rise. Climate models predict dangerous heat index days will increase significantly over the coming decades. Sea level rise is documented at approximately three to nine millimeters per year with recent measurements at the higher end of that range.

Nuisance tidal flooding in coastal areas is now routine rather than exceptional. These are not projections. They are already occurring and on the operating expense line. The question for today, how do you build a pro form a that accounts for all of this, and what does that model look like in practice? Here's a deal scenario.

A 200 unit multifamily development in Homestead, Florida in the southern portion of Miami Dade County acquired in mid twenty twenty one for $38,000,000 at a going in capitalization rate of six and a half percent. This was an entirely conventional transaction at the time. The underwriting was consistent with market standards. The broker was competent. The lender was satisfied.

No one in the deal, buyer, seller, broker, lender, or appraiser anything unusual or negligent by the standards of 2021. The original underwriting assumptions, insurance at 840,000 per year, approximately 4,200 per unit annually, consistent with 2021 broker estimates for Florida coastal multifamily. Debt service coverage ratio DSCR at closing approximately 1.82 times at a standard 65% loan to value and prevailing 2021 interest rates comfortably above the lender covenant of 1.2. Net operating income, NOI in year one, February. Target internal rate of return over a seven year hold, 8.2%.

Solid underwriting. Acceptable returns. Standard deal. But here's the 2026 reality. Insurance renewal quote, $1,680,000 per year.

That's a 100% increase over five renewal cycles. A compound annual growth rate of approximately 15% consistent with the documented trajectory of Florida coastal multifamily insurance from 2021 to 2026. The annual NOI impact of single line item is a negative $840,000. This is money that simply left the income statement with no change in rents, no change in occupancy, and no operational failure by the operator. The DSCR at the current insurance cost is approximately 1.2, sitting directly on the lender covenant.

That's not a default. That is a zero margin position. Any further deterioration in operating performance, a soft leasing quarter, a maintenance event, or a single nuisance flood that temporarily displaces units trips the covenant. The lender is not yet holding options, but the lender's watching. The signal for implication at a six and a half percent capitalization rate and 840,000 NOI reduction implies a market value decline of approximately $12,900,000 against an original purchase price of 38,000,000.

That's a 34% value erosion event, not from a hurricane, not from a recession, and not from any operational misstep. When HVAC cost escalation is layered in, the picture worsens. Common area utility costs driven by extended cooling seasons and increasing heat intensity in Miami Dade are running approximately 40% above what baseline inflation alone would suggest. On a 240,000 annual HVAC baseline, that's roughly 96,000 in additional annual NOI drag above what a well modeled underwriting would have forecast. Combined with the insurance escalation, total unmodeled NOI deterioration approaches $936,000 annually.

At a six and a half percent cap rate, that implies total value erosion of approximately $14,400,000, 38% of the original purchase price across just two operating line items. The signal six overlay adds further texture. Two units in the portfolio experienced flood intrusion events from nuisance tidal flooding. Not an named storm, not a hurricane, just the chronic sea level rise that was already documented at every NOAA tide gauge in South Florida in 2021. And the building constructed in 2006 predates the current statewide code updated for the eighth edition in 2023, which incorporates the advanced ASCE seven dash 22 engineering standards and significantly updates ultimate design wind speed maps as well as stricter requirements for roof uplift, cladding, and water resistance.

Think older building, more exposure, fewer resilience feature. The target IRR of 8.2% is no longer achievable. With permanent NOI reduction of approximately 936,000 and a proportional compression in exit value, the realistic IRR in this deal in our modeled scenario has likely retreated to the four to 6% range, a significant underperformance relative to underwriting, but not yet an insolvency event. The property can still service its debt. The equity is deeply impaired, not eliminated.

The sponsor will recover capital. The sponsor will not recover the return profile that justified the acquisition. That distinction matters. This is not a catastrophic loss. It is a compounding returns problem that will define this operator's fundraising capacity over the next several years, and it originated entirely from climate driven operating cost escalation that was visible, documentable, and modelable in 2021.

So what's the underwriting analysis? Step one is to look at signal four. Start with a climate adjusted valuation. Before you run a single income or expense assumption, pull the FEMA flood zone designation for the property. In this case, the homestead property is partially in zone AE, the highest risk designation for riverine and coastal flooding, indicating a 1% annual chance of flooding, which is also called the hundred year floodplain.

This designation exists in public FEMA records. It was freely available in 2021. It was not obtained at underwriting. Next, check insurer market depth. The question isn't whether you can get insurance today.

It's how many carriers will actively quote this property. The carrier count is itself a signal one distress indicator. It only takes one new severe event to abruptly change the insurance market. When fewer carriers are willing to write a property, pricing power shifts entirely to the remaining carriers, then pull climate adjusted comparable capitalization rates. Climate aware institutional buyers are currently pricing flood zone multifamily in Miami Dade at cap rates 50 to a 120 basis points wider than those for equivalent non flood zone assets in the same county, a spread documented in transaction Applying that adjustment to the homestead property produces a climate adjusted appraised value of approximately 31 to 33,000,000, a 5 to $7,000,000 valuation gap relative to the $38,000,000 acquisition price that existed at the moment of original closing, not in hindsight at closing.

Step two, signal one. Three scenario insurance model. Do not use the broker's budgeted insurance figure. Obtain actual quotes from at least three carriers for the specific property, flood zone, building vintage, and coverage structure. FEMA zones a, AE, and VE carry significantly higher carrying costs.

You can review ongoing regional commercial and multifamily transactions through CBRE Miami Capital Markets for precise real time metrics. Now build three scenarios, base, moderate, and severe. In your base scenario, 1,680,000 per year escalating at 10% annually. This is a conservative assumption based on the documented historical trajectory of premium escalation in Florida. Even the base case is significantly above the original underwriting.

In a moderate scenario, that 1,680,000 per year escalating at 20% annually with one nonrenewal event from a primary carrier occurring mid hold requiring placement with Citizens or a surplus lines carrier at higher cost. This scenario captures a market continuing to deteriorate at a pace consistent with the twenty one to twenty three experience. In the severe scenario, insurance triples within three renewal cycles. Before 2022, premiums saw 50% year over year increases for multiple years, and Citizens became the only available backstop. It could happen again.

The lender requires an additional flood endorsement at year four, adding further annual cost. This is the tail risk scenario. Not the expected case, but the one a seven year hold must survive. Step three, signal six, chronic cost escalation on each operating line. Utilities model 3% annual escalation above normal CPI inflation for HVAC related utility costs based on documented Miami Dade utility cost trends.

This is not dramatic. It compounds. Over a seven year hold, the cumulative NOI drag relative to a standard inflation assumption is material. Capital expenditure hardening investment. What does it cost to improve this building's climate resilience?

Impact resistant windows and doors, a 100 and 80,000. Backup generator for common areas, 95,000. Elevation of electrical infrastructure above the flood intrusion threshold, a 100 and 40,000. Total hardening CapEx, 415,000. This is a cost, but it is also a mitigation.

A hardened building has a deeper insurance market because fewer carriers exclude it. It has lower vacancy risk during minor climate events because residents do not lose power or experience intrusion, and it has a more credible exit story for a broader pool of buyers. The $415,000 hardening program should be modeled as a value creating investment, not a pure cost, and it must be in the model from day one, not discovered at year three. Step four, signal four, climate adjusted exit assumption. The buyer of this asset in 2031 or 2032 faces the same insurance market you're in today, likely a worse one.

A buyer who requires DSCR coverage at entry must build their bid price around the insurance cost they face at the time of acquisition, not the insurance cost you had when you bought. The exit cap rate assumption must reflect the structural reality. Use a seven and a quarter percent exit cap rate instead of the six and a half percent entry cap rate. This 75 basis point cap rate expansion at exit driven by the buyer's forward insurance cost and the narrowing of their qualified buyer pool alone significantly compresses the exit multiple. The math is not complicated.

The discipline is. Three scenario IRR output. The original underwriting 2021 assumptions IRR was 8.2%. This is the number that went into the investment committee memo. In our modeled base climate scenario, insurance at 10% annual escalation from the current 1,680,000, seven and a quarter percent exit cap rate IRR is approximately 4.9%.

Still positive, below most institutional hurdle rates, a disappointing hold, not a catastrophe. In the modeled moderate climate scenario, the IRR is approximately 3.8 below most institutional hurdle rates of six to 7%. The fund does not hit its waterfall. The GP does not earn carried interest. The LP receives a return below its alternative cost of capital.

In the modeled moderate scenario, the IRR is approximately 3.8% below most institutional hurdle rates of six to 7%. The fund does not hit its waterfall. The GP does not earn carried interest. The LP receives a return below its alternative cost of capital. In the modeled severe climate scenario, the IRR is approximately 1.6% below the cost of capital, a wealth destruction event on a deal that cleared every standard underwriting screen in 2021.

The conclusion is that to generate an acceptable risk adjusted return under the moderate climate scenario, this deal required a purchase price of approximately 30 to $31,000,000, an 18 to 20% discount to the actual $38,000,000 transaction price. Alternatively, it required a documented hardening CapEx plan built into the acquisition thesis at closing combined with a purchase price adjusted for the flood zone exposure already disclosed by the FEMA data. There are three responses to the climate adjusted pro form a, reprice, reposition, and redirect. And every deal in a climate sensitive market produces one of these three outcomes. Your first strategic response is to reprice, negotiate the acquisition price down to reflect documented climate risk.

The data supports you. The FEMA flood zone map is public. The signal for cap rate differential is an institutional transaction comps. Sellers and their brokers are aware of the insurance market. They are managing it on existing portfolio assets.

The Climate adjusted pro form a gives you a defensible data grounded basis for the price conversation. Use it. Your second strategic response is to reposition. If you're acquiring at or near market price because the deal has other strategic value, build the hardening CapEx into the acquisition thesis at closing. Budget the $415,000.

Plan the FEMA flood zone appeal if the property has grounds for a letter of map amendment. Although use caution, just because your appeal gets approved doesn't mean the zone won't actually flood. Just Google Camp Mystic's zone appeal in the Guadalupe River flood. A better hardened asset has a deeper insurance market, a stronger tenant profile, a more defensible DSCR, a and more credible exit story for a wider buyer pool. The repositioning investment is not a sunk cost.

It is carried at exit value. Your third strategic response is to redirect. Some deals simply do not work at any price in a climate distressed market. When the severe scenario produces an IRR below the cost of capital and the moderate scenario already breaks the lender covenant, the discipline of the climate adjusted pro form a is knowing which deals to exit before you are committed, before you sign the purchase and sale agreement, before you deploy the equity, before you begin the hold period inside a deteriorating market. This is the most valuable application of the framework.

The deal you do not do is often the best return you ever generate. If you take one practical tool from today's episode, it is this. Add the three scenario insurance model to every underwriting model you run from this point forward, base, moderate, and severe. Calculate the DSCR and IRR under each. If the moderate scenario breaks your lender's covenant or drops your IRR below your fund hurdle rate, you have answered the question of whether the deal works before you sign the purchase and sale agreement.

The CRDF deal stress test provides a complete framework. The underlying framework, the signals, the line items, the scenario logic doesn't expire with the data. The deal stress test is designed to be populated with your current numbers. The framework is the durable part. Download it free at climatereadyre.com once you subscribe.

I ask the same question at the end of every show. If you could jump ten years into the future and then come right back, how would the revelations of the future impact your underwriting assumptions in 2026? The insurance budget, the exit cap rate, the operating cost escalators, knowing what you know about Miami Dade's insurance market. We have seen what the downside of climate exposed assets look like when it arrives in your pro form a next time we flip the story entirely because the green premium is exactly as real as the brown discount, and there's a market in Europe where the bifurcation is already complete, already liquid, and already telling us what every major city will look like within the next decade. Next episode, we go to Amsterdam.

That's episode 15, green premiums and brown discounts. Don't miss it. That wraps it up for today. Be sure to subscribe to Climate Ready Real Estate Investing to receive free downloads for our market intelligence and strategy and underwriting briefs. Listen to the podcast and find us on Twitter and LinkedIn.

If you'd like to be a guest on the show, you can register at climatereadyre.com, the place where resilient returns and resilient communities meet. Until next time, I'm your host, Jamie Wolfe. Be good and do better for today, tomorrow, for you, and for all. Know your signals and be climate ready. This has been intelligence briefing on Climate Ready Real Estate Investing, where we explore climate through a financial lens to achieve resilient returns and resilient communities.

Find us on LinkedIn and Twitter. To get the Climate Ready Deal Framework to help you reevaluate your deals, go to climatereadyre.com, enter your email address, then check your inbox. See you next time. Climate Ready Real Estate Investing is an independent intelligence briefing. We synthesize publicly available research, industry reporting, and data, sometimes with the help of AI enabled analytical tools, into commentary and analysis on the trends shaping real estate, climate risk, and the long term durability of communities.

Nothing in this program is investment, financial, legal, tax, or other professional advice. Always do your own due diligence and consult qualified professionals before making decisions.