A study led by economists at the Environmental Defense Fund identifies some surprising regions, such as Appalachia and northern New England, as overvaluation hotspots.

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Unrecognized flood risks driven by climate change mean U.S. homes may be overvalued by $187 billion — a “climate housing bubble” more than double the size of a previous estimate, according to a study published Thursday in Nature Climate Change.

The peer-reviewed study, which was led by economists at the Environmental Defense Fund (EDF), identified some surprising regions — such as Appalachia and northern New England — as overvaluation hotspots.

The study laid much of the blame for the tendency to underestimate the risks posed by climate change on outdated flood insurance rate maps and inconsistent state-level flood risk disclosure laws.

But government subsidies for flood insurance and mortgages are also part of the problem, the study concluded, because they distort price signals and transfer flood risk away from property owners and onto taxpayers.

As policymakers take steps to revise flood insurance and lending policies to reflect the increased risk of climate change, the study may provide a new sense of urgency for state and local governments at the highest risk of losing property tax revenue if the climate housing bubble bursts.

“The cost of unrealized flood risk in the U.S. real estate market is an increasing threat to economic stability for households, communities and municipalities,” the EDF’s Jesse Gourevitch said in a blog post summarizing the study’s findings. “Despite [the] clear need for improving flood risk communication via updated flood maps, broadening flood risk disclosure laws at the state and federal level, and increasing investment in flood risk reduction, the realization of these risks will largely depend on policy choices that influence the distribution of flood-related costs in society.”

Climate housing bubble hotspots

Median property-level overvaluation as a proportion of properties’ current fair market value | Source: “Unpriced climate risk and the potential consequences of overvaluation in US housing markets,” Nature Climate Change, Feb. 16, 2023

Thanks in part to outdated flood maps, 83 percent of the overvalued properties at risk of flooding identified by the study lie outside of Special Flood Hazard Areas (SFHAs) — 100-year flood zones mapped by the Federal Emergency Management Agency (FEMA).

That helps explain why areas like Appalachia and northern New England — and Texas, Idaho and Montana — have some of the highest median property-level overvaluations as a proportion of properties’ current fair market value.

“Misperceptions of natural hazards and climate change further limit homebuyers’ ability to rationally price flood risk, as a range of systemic biases may lead to underestimation of the probability and severity of being affected by flooding,” the study notes.

Biggest risk in raw dollars is on the coasts

Total overvaluation in dollars | Source: “Unpriced climate risk and the potential consequences of overvaluation in US housing markets,” Nature Climate Change, Feb. 16, 2023

But in terms of absolute dollars, the study found overvaluation is concentrated along the Gulf, Atlantic and Pacific coasts. While flooding is understood to be a risk in many of those markets, population densities and property values tend to be higher. So while some flood risks might already be priced in, any underestimation of risk can add up to big dollars.

The study estimated that properties in Florida, for example, are overvalued by more than $50 billion.

Homeowners don’t get price signals

Even in areas where homeowners are required to be insured against flooding, subsidies of National Flood Insurance Program (NFIP) premiums and “climate-agnostic mortgage lending practices” have created distorted price signals by transferring flood-related costs away from property owners, the study asserts.

“Only recently are these price signals starting to shift under the NFIP’s new pricing methodology, Risk Rating 2.0, which determines premiums based on individual assessments of flood risk and rebuilding costs for each property, and as mortgage lenders begin to insulate themselves from credit risk associated with exposure to flood risk,” the study notes.

Under Risk Rating 2.0, all new policies issued by FEMA since Oct. 1, 2021, have been subject to the new rating methodology, as well as policies renewed on or after April 1, 2022.

Mortgage lenders are well aware of the threat climate change poses not only to the National Flood Insurance Program but to mortgage giants Fannie Mae and Freddie Mac, which guarantee payments to investors who fund most home loans.

A 2021 report funded by mortgage lenders warns that climate change could strain flood insurance to breaking point, undermine home prices and drive mortgage defaults, exposing Fannie and Freddie to losses when uninsured homeowners suffer flood damage.

While one independent estimate puts the number of people living in floodplains at close to 40 million people, only 13 million people live in areas formally designated by FEMA as prone to flooding and requiring flood insurance, that report notes.

The Infrastructure Investment and Jobs Act of 2021 allocated $600 million to FEMA to improve its outdated flood maps, according to the study, and information on flood risk is also becoming more widely available to homebuyers through private sources.

Real estate websites like Redfin and Realtor.com, for example, provide property-level flood risk estimates calculated by the First Street Foundation, which along with Zillow provided data for the study.

In 2021, the U.S. Department of Housing and Urban Development published a climate adaptation and resilience plan outlining objectives that include reducing climate-related financial risks to HUD mortgage programs.

Last year, Fannie and Freddie’s federal regulator put the companies on notice that climate change “poses a serious threat to the U.S. housing finance system” and that they must factor the risks posed by climate change into their decision making.

Municipal tax revenue at risk

Higher flood insurance premiums, tighter mortgage lending standards and increased public awareness of flood risk could all end up hurting property values in flood-prone areas.

If that happens, “municipalities with a large share of properties at risk of flooding and that are also heavily reliant on property taxes for revenue are vulnerable to fiscal losses,” the study warns. And unlike the collapse of housing prices after the Great Recession of 2007-2009, “declines in property values due to climate risk are unlikely to be temporary — particularly for properties affected by sea-level rise.”

But it’s not only coastal counties — but many in inland areas in northern New England, eastern Tennessee, central Texas, Wisconsin, Idaho and Montana that could be facing a one-two blow from property overvaluations and heavy reliance on property taxes for revenue.

“Despite relatively high overvaluation, local governments in states such as Alabama, Louisiana and West Virginia are insulated from property devaluation because they are less reliant on property taxes for revenue,” the study concluded.

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Email Matt Carter

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