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The Economics of Discounting and Valuing Coastal Real Estate Deprecation Caused by Climate Change

Tuesday, April 11, 2017 10:18
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(Before It's News)

CNN reports that President Trump's Florida real estate might be flooded by the year 2100.   If we take the efficient markets hypothesis seriously and if we discount future rents, what are the implications for the value of his property today?  Devin Bunten and I explore these issues in this paper.

Suppose you own an asset that is stuck at a specific place.   Consider two different scenarios;

Scenario #1;   In the absence of climate change, let there be a 99.2% chance that the property survives for another year.

Scenario #2;  In the presence of climate change, let there be a 95% chance that the property survives for another year.

Assume the inflation adjusted annual rent = R   and assume the interest rate = 3% each year forever.

Under these assumptions, the owner of the asset's loss due to climate change =

Sum from j=0 to infinity  .99.2^j*R/(1+.03)^j  - .95^j*R/(+.03)^j

where ^ is the “raised to the power”  so 3^2 = 9

This math reflects the changes in the expected present discounted value of a property caused by climate change.

If you sit down and read the CNN piece, I would note several points.  First the Trump asset depreciates over time. If Trump recognizes that flooding will destroy it, then he will allow the structure to depreciate and less is lost when it is submerged.  The rational asset owner will either put it on stilts or strip it of all valuables. Yes, he would lose the land but if this occurs in 80 years then the present discounted value of this loss is tiny.  While Trump might lose his land, other land that is now “coastal property” will appreciate in value. This pecuniary externality is ignored by the media.

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