The Sustainability Story – Episode Summary

Episode Title:

Daniel Warcholak, CFA: Understanding Climate Risk in Mortgage-Backed Securities

Podcast:

The Sustainability Story (CFA Institute)
Date: September 7, 2025
Host: Nicole Gehrig (Director of Global Industry Standards at CFA Institute)
Guest: Daniel Warcholak, CFA (Head of Capital Markets, Basis Investment Group)

Main Theme & Purpose

This episode focuses on the growing significance of climate risk within the commercial mortgage-backed securities (CMBS) sector. Daniel Warcholak, a seasoned securitized real estate debt investor, shares his hands-on experience assessing, managing, and pricing climate-related risks. The conversation covers the evolution of environmental risk in real estate investing, the three major categories of climate risk, data sources, market incentives like green credits, and practical lessons for investors integrating climate and sustainability concerns into securitized asset portfolios.

Key Discussion Points & Insights

Daniel Warcholak’s Personal Connection to ESG & Sustainability

• Daniel’s experience with Hurricane Katrina in 2005 was a turning point, making the impacts of environmental risk tangible for securitized debt investors.
  • Quote (03:13): “We own the credit risk in these pools … when Hurricane Katrina hit, it did tremendous damage … we had properties that were in that area that were impacted directly … it really got my attention and made me appreciate and understand the exposures and potential risks that are created by these types of events.” – Daniel Warcholak

Defining Climate Risks in CMBS

Daniel organizes climate risk in real estate-backed securities into three main categories:

• Physical Risk:
  Damage or value loss due to environmental events (e.g., floods, hurricanes).

• Transition Risk:
  Costs and operational challenges in adapting properties for greater sustainability, such as pursuing green certifications (e.g., LEED).

• Insurance Risk:
  Rising costs and reduced availability of insurance coverage, particularly in catastrophe-exposed regions.

  • Quote (06:02): “The physical, the transitional, and the insurance [risks], are kind of how I start to frame how we think about it. ... In 2024 there were $27 billion events, a 10% growth rate from 10 years ago.” – Daniel Warcholak

Physical Risk—Rising Exposure Due to Climate Events

• Use of NOAA data to track the frequency and cost of billion-dollar climate events, with clear evidence of increasing risk over the last two decades.
• These risks are now “impossible to ignore” for anyone managing portfolios of real estate-backed securities.

Transition Risk—Adapting for a Greener Economy

• Outlines the economic incentives and challenges in pursuing green building certifications like LEED:
  • Cost estimates: 3–4% higher for construction adopting baseline sustainable features.
  • Benefits:
    • Up to 31% higher rent premiums for LEED-certified buildings.
    • 14% rent premium persists even when controlling for location for recent builds.
    • 4–5% higher occupancy on average for certified buildings.
  • Highlights future risk of “stranded assets” as non-certified properties may face discounting or increased default risk upon refinancing.
  • Quote (11:11): “If your average bond is backed by a 10-year mortgage loan ... that property could really become a stranded asset ... if the market continues to want to move to more efficient and better properties.” – Daniel Warcholak

Insurance Risk—Rising Costs and Consequences

• Insurance premiums and deductibles are “growing exponentially,” which threatens property net cash flows.
• Rising real estate taxes also erode value, often as municipalities seek funds for disaster recovery.
  • Quote (17:47): “$1 of extra cost in a property that falls straight through to the net cash flow ... can have an impact of about $12 on the value. So there’s a multiplier effect ... as you have these ramped up costs.” – Daniel Warcholak

Real-World Impact: Case Studies

• Insurance shortfalls and natural catastrophes (e.g., hotels closed due to hurricanes) can create direct credit events.
• Long-term erosion of property value due to persistent cost increases, even without a major event.

Integrating Climate Risks into the Investment Process

Daniel outlines a multifaceted approach:

• Disclosures and Due Diligence:
  • Examining offering materials for zone-based risks (flood, earthquake).
  • Scrutinizing Phase I environmental reports for legacy contamination.
• Data & External Tools:
  • Leveraging NOAA and MSA-level environmental risk data.
  • Using third-party environmental and performance ratings.
  • Reviewing “walkability” scores and sustainability certifications.
• Site Inspections & Active Engagement:

  • Physically visiting properties and direct communication with sponsors/owners.

  • Engaging borrowers on business plans and sustainability initiatives.

  • Quote (24:49): “We actually have people who will go and visit … understand them, do a physical site inspection. ... We might ask about any programs [like] LEED certification ... are you making improvements?” – Daniel Warcholak

Market Incentives: Green Credits and Alternative Financing

• Green Credits:
  • E.g., Fannie Mae credits of 15–25 basis points off loan rates for certified properties.
  • Larger loans see material savings; thus, strong incentive to pursue and maintain certifications.
• C-PACE Financing:

  • Special financing for energy improvements, repaid via property taxes rather than traditional mortgages.

  • Often accompanied by favorable tax treatment and specific to states or municipalities.

  • Quote (28:06): “There are a couple of incentives … an investment in your property, which I think has returns to it. ... Fannie Mae offers credits ... 15–20 basis points ... on multifamily loans that can be 20, 30 million dollars ... that translate into major, major benefits.” – Daniel Warcholak

Lessons & Practical Advice for Investors

• Always review available climate and catastrophe data—the trendlines are undeniable and growing steadily.

• Anticipate “gaps” where insurance or municipal response may fall short.

• Climate risk impacts the entire capital structure, from equity through to senior debt, and must be considered at every level.

• There is “no downside” to pursuing more sustainable practices for properties; they enhance value and performance across metrics.

  • Quote (33:03): “Look for the gaps, not only the events. … You assume, if you have some type of risk, ‘oh sure, the municipality is going to take care of this’ … but look for the gaps, because they’re there. And you have to understand how that’s ultimately going to hit your portfolio.” – Daniel Warcholak

Notable Quotes and Memorable Moments

• On the acceleration of billion-dollar disasters (NOAA):
  “In 2024 there were $27 billion events ... a 10% growth rate from 10 years ago. ... The dollar amounts are higher and higher each year ... as that intensity builds, this is a risk that you cannot ignore in your portfolio.” – Daniel Warcholak (06:02)

• On rent premiums for green buildings:
  “Buildings ... certified ... do have a green type rating ... actually command up to 31% rent premiums compared to buildings which are not.” – Daniel Warcholak (10:47)

• On insurance and property value:
  “Insurance premiums have grown exponentially ... taxes are also growing exponentially because the local municipalities are faced with more and more massive cleanups ... $1 of extra cost ... can have an impact of about $12 on the value.” (17:47)

• On integrating climate risk into investing:
  “Look at the data that’s out there and think about how these things are actually impacting your portfolio ... there’s no downside to ... making things more sustainable ... there’s real upside, even at the personal level, to being environmentally responsible.” (33:03)

• On the necessity of careful underwriting:
  “Nothing happens [to the property] ... and then when you build all those factors together ... it basically makes your portfolio more volatile ... price accordingly whenever you’re making your investment decision upfront.” (20:10)

Timestamps for Key Segments

• 03:13: Daniel’s Hurricane Katrina story—personal “attention getter” for climate risk
• 06:02–09:15: Framework for climate risk: physical, transitional, insurance
• 10:30–13:25: Transition risks—LEED, rent premiums, stranded assets
• 15:23–17:50: Real-world cases—impact of disasters and insurance on CMBS credit
• 21:10–26:17: Integrating climate risk into investment process; disclosures, data, direct engagement
• 27:12–30:45: Green credits, C-PACE financing, and policies incentivizing sustainability
• 31:32–34:30: Key lessons learned and practical advice for investors

Conclusion

Daniel Warcholak delivers a detailed, practitioner’s perspective on grappling with climate risk in mortgage-backed securities. He emphasizes data-driven underwriting, direct engagement with property sponsors, and the strong business case for sustainability. The episode concludes with actionable lessons on risk management and the value-creating effects of sustainable property investing—making it a must-listen for investors, asset managers, and anyone interested in the intersection of ESG and securitized finance.