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Could environmental risk define future mortgage lending?

Mortgage lending mainly revolves around the risk associated with the borrower but what about the property – not just the bricks and mortar but the land it is built on and the air the occupants breathe? Should lenders be paying more attention to environmental risk? Robin Wells, head of sales & marketing at Future Climate Info (FCI), reports.

Lenders run their businesses based upon risk. Mortgage affordability defines how risky a borrower may be, with calculations based on many factors from income to credit history to demographics. But what about the risk on the asset itself? As we get smarter about these risks, will environmental risks that could damage or destroy the bricks and mortar become more defining factors in the mortgage process?

We are collecting more information on environmental risks – from flooding to pollution – and the scale of these risks is becoming more apparent. This, coupled with the continued expansion of the UK’s property footprint onto new land and the increasing risks created by climate change, mean that environmental risk can and should be on all mortgage lenders’ radars.

Surface risk: flooding
The most common and, arguably, well-known environmental risk in the UK is flooding. Around one in seven UK homebuyers have faced a potential flood risk when buying a property in 2017, a trend that picks up in more urban and populated areas. With one in four homebuyers in the capital encountering a potential flood risk last year, this puts London at the centre of the issue, compared to just 11% of those in rural and remote areas.

A combination of environmental factors over the past decades have been attributed to the increase in flood risk. When Michael Fish wrongfully dismissed the imminent arrival of Britain’s biggest storm on record in 1987, he could not have imagined that this type of once-a-century storm might become an annual event all over the world, with storms like Desmond, Eva and Frank.

Earlier this year, the Environment Agency warned that intense bouts of flooding are going to become more frequent, following a pattern of severe flooding over the past 10 years that can be linked to climate change and instances of extreme weather.

Homebuyers are also increasingly concerned ,as well as educated, about the environmental issues that cause flooding; and the implications influence their decision making. Compared to 2016, there were fewer properties at risk of flooding sold in 2017, particularly in urban cities and rural towns.

Yet there remains a lot to be done in the effort to educate and inform homebuyers on the potential issues they might face around flooding. Particularly 18 to 34-year-olds – the UK’s core first time population – are unlikely to perceive flood risk in their area. To address this issue, there have already been calls to introduce ‘flood certificates’ for properties, which, like Energy Performance Certificates, would show when the property was last flooded, the depth and nature of flooding, or give an assessment of feasible recommendations.

Over the next couple of years, it will be interesting to observe whether mortgage lenders will choose to limit their exposure in urban ‘flooding hotspots’. With flooding in the UK set to increase even further, particularly those applications stemming from locations with heavy rainfall on record or in the stormy north, lenders might need an additional review regarding risk before being approved.

Unseen risk: subsidence and sinkholes
Lenders might see subsidence and sinkholes as a surveying issue, and to an extent they are right. Issues with foundations can be fixed by builders or at least be mitigated against with insurance. But the broader issue that’s causing much of the instability – the huge network of mines under the British Isles – is something lenders should be more aware of when assessing risk to property portfolio investment.

The risk of subsidence comes from a result of poor ground quality, foundations or historic mining sites under properties themselves. A recent study found that between January 2014 and October 2017 more than 250 sinkholes formed around Great Britain, at a rate of around one a week.

The study also found that 40% of these sinkholes are the result of historical mining activity, which has left holes and cavities liable to collapse. Mining operations historically extracting metal, chalk and coal are responsible for most sinkhole occurrences, and these took place all over the UK ever since the Bronze Age. The British Geological Survey has records of more than 230,000 active and disused mines under our feet, a list which grows every day.

We have only been able to properly map what’s under our feet for the last few decades, and technology improvements are helping us to find more historic mines. But there are likely to be many more secrets for us to uncover. In the meantime, as developers look further afield to find more land to build upon, it’s possible that more homes are being built upon ground that is not as stable as it looks. Lenders may wish to take a closer look at what’s underneath the assets they are lending against to ensure they are not on shaky ground.

Risk in the soil: contaminated land
It’s not just the mines under our feet that could be a risk to lending. Most people will be unaware of the scale of contaminated soil that our properties sit on, and worryingly no one is fully aware. The government estimates that there could be as many as 100,000 potentially contaminated sites in the UK of up to 200,000 hectares. But that could still be the tip of the iceberg: estimates suggest we are only aware of a fifth of the total contaminated land sites in Britain.

Soil is often contaminated as a result of historical environmental mismanagement. An old gas works, a long-gone petrol station, an industrial rubbish dump from a long-razed factory – these things can all potentially require an environmental clean-up. Heavy metals and acids have often seeped into the soil, and could adversely affect people’s health, a result of a time before stringent regulation or indeed evidence of past misdemeanours.

Heavy metals and chemicals in the soil can affect homeowners digging in their gardens or excavating to build extensions. In recent years, environmental permits and regulation have meant new properties are less likely to have been built on contaminated land. However, the land on which older buildings from the 19th and 20th centuries were built may not have been adequately cleaned or even been flagged as potentially contaminated.

Under 78A(2) of the Environmental Protection Act 1990, the Department of Environment, Food and Rural Affairs (DEFRA) is tasked with supporting and funding the clean-up of any sites that local authorities find to be contaminated. But, in 2014 the government announced a wind-down of all financial aid to clean up contaminated sites, with the programme ending in March 2017. Since then, there has been no support for developers investigating or building on land. Between 2000 and 2017, the government paid out nearly £30 million in remediation to clean up more than 400 sites in England and Wales.

It’s unclear what this has meant for home developers since the funding dried up. There is a concern that prime locations could be overlooked to avoid the costs of clean-up, or that property prices may increase as a result of increased development costs.

For lenders, this unseen risk should be a concern. The scope of contaminated land in the UK could be vast, and a home sitting on soil that needs remediation could lose value.

A rising new risk: air pollution
Over the past couple of years, air quality has also grown to be one of the UK’s most pressing issues. Scientists estimate that as many as 40,000 Britons die as a result of air pollution each year, while the High Court recently judged 45 local authorities to be unlawfully breaching safe levels of nitrogen dioxide (NO2).

Our recent study shows that in 2017 nearly £25 billion was spent by homebuyers on properties in areas of the country where this is likely to occur, meaning that one in 20 residential transactions might have been affected. Again, as an issue particularly in urban areas, homebuyers are increasingly watching reports of poor air quality with growing concern about the implied ill-effects it may have on their health.

But unlike flooding and contaminated land, data on air quality is not a requirement for environmental reports. This makes it harder for homebuyers to find out this crucial information about their upcoming property investment. Future Climate Info has become the first UK provider to make this type of information available at no extra cost – giving homebuyers clarity of insight for the first time on the quality of the air they are signing up to breathe when they purchase a home.

In April, Barclays launched its first ‘green’ mortgage, with a discounted interest rate to borrowers who were buying energy-efficient new-build homes. The initiative was born out of an increase in demand from buyers to live in homes that are energy efficient, and an effort to support ‘greener choices’. Is it conceivable that lenders will offer a similar incentive for ‘clean’ or ‘breathable’ homes in the future?

Our analysis suggests that those buying in highly polluted areas might already be paying a ‘pollution premium’ of 32% more on average in affected areas of the country. These figures are impacted by expensive postcodes in cities like London, Manchester and Nottingham often suffering from high levels of NO2 due to traffic and stagnant weather conditions but could yet worsen in years to come. As opposed to the ‘green mortgages’, regulators and green finance measures by the Bank of England may see ‘pollution premiums’ increase to discourage sales in areas with poor air quality.

With the demand for both ‘clean’ and ‘green’ homes set to increase, this growing environmental risk will be the most interesting to watch over the next couple of years, and may see those professionals with a nose for what lies (and breathes) ahead rewarded for their foresight.

More information reveals more risk
As technology advances, our understanding of emerging risks that are involved in lending is getting better, as are our processes for risk modelling. We now have a better handle on the environmental risk around us. This, in turn may begin to uncover ways to improve lending processes that would have been unthinkable just a few years ago.

Today, mortgage lending mainly revolves around the risk associated with the borrower. Yet the borrower is not what the lender invests in: the mortgage is for the property, and the foundation it is built upon.

So, is it time for lenders to look more into (and around) the homes they are investing in, beyond its structure? If we are able to see, model and mitigate the wider risks to the bricks and mortar, based on the environment they exist within, surely smart lenders will begin to assess how these risks could impinge on their portfolios?

Will future climate shifts adversely affect some building societies with regional lending portfolios? Will first-time buyers be priced out of clean air neighbourhoods? Will elderly people find their equity is reduced due to smarter data finding previously unseen risk under their feet?

For an industry that is based wholly on risk, it makes sense to take note of the environmental risks above and below the bricks and mortar. Having access to the right data and insights to inform these decisions could become a critical issue for businesses as well as consumers.

Executive summary

  • More information is being collected on environmental risks – from flooding, soil contamination, subsidence and sink holes to pollution and air quality. Environmental risks should be on all mortgage lenders’ radars.
  • The most common environmental risk in the UK is flooding. The Environment Agency has warned that intense bouts of flooding are going to become more frequent due to climate change and extreme weather.
  • The risk of subsidence comes from poor ground quality, foundations or historic mining sites under properties. A study found that 40% of sinkholes are the result of historical mining activity, which has left cavities liable to collapse.
  • Another environmental risk is contaminated soil that properties sit on. The government estimates there could be as many as 100,000 potentially contaminated sites in the UK but estimates suggest we are only aware of a fifth of them. In 2014 the government announced a wind-down of all financial aid to clean up contaminated sites, with the programme ending in March 2017.
  • Air quality is another potential hazard – up to 40,000 Britons die as a result of air pollution each year. The High Court recently judged 45 local authorities to be unlawfully breaching safe levels of nitrogen dioxide.

Source: Mortgage Finance Gazette