Does the Mortgage Market Price in Physical Risk?

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Natural disasters are increasingly causing widespread damage and economic disruptions. How have these physical risks affected residential mortgage and residential mortgage-backed securities (RMBS) — one of the largest asset classes in the U.S. and globally? To quantify these risks, we applied MSCI GeoSpatial Asset Intelligence to the U.S. agency RMBS market. 

Rising physical risk may lead to higher insurance costs, which in turn could elevate borrowers’ credit risk and borrowing costs by pushing up debt-to-income ratios. It could also negatively impact local economy and employment, and may lead to reduced preference for homeownership for high hazard areas. Our regression analysis between zip-code level home price appreciation (HPA) rates and hazard rates suggests a 0.4% reduction in annual HPA rate for high hazard loss rates over the past decade. 

For example, home price appreciation patterns are heavily driven by many local socioeconomic and demographic factors, such as the local economy and employment growth, and population movement during COVID-19. We saw this when we looked at the annual HPA rates and “excess” HPA rates across hazard rates groups, for the 2014-2024 period. (We define the “excess” HPA rate as a zip code level value subtracted by corresponding average value from surrounding areas, in order to isolate the potential effect due to physical risk.) 

We saw a very different patten, however, for the earlier 10-year period of 2003-2013. Although various negative factors associated with higher physical risk may reduce location desirability, these effects are often offset by hedonic values associated with high-risk areas, such as the scenery value. The emerging trend of HPA shortfalls related to physical risk in recent decades may be driven by a combination of rising insurance premiums, growing costs from natural disasters and increased public awareness of physical risks.