Across the State of California, seismically unsound buildings are gaining the political attention needed to create and enforce regulations to address risk. Last week, the City of Los Angeles announced a policy to map all the deficient buildings within the City. Both San Francisco and Santa Monica have passed measures aimed to improve the seismic resilience of their residential building stock.
The aim of the measure to take building stock inventories is to identify the buildings that would benefit from structural improvements such as a seismic retrofit or rehabilitation design. Buildings that are especially sensitive are wood frame buildings with a soft story, generally at the first floor retail or parking regions. Currently there is no easy way to identify which structures are wood-framed and soft story as there is no state-wide master database. This concern for the public has prompted City officials in the City of Santa Monica and Los Angeles to appoint engineers to identify and catalogue apartment buildings that are susceptible to structural failure or collapse in a future, major temblor (see an article about Santa Monica's initiative here). Under the new plan in Los Angeles, they will pick up where they left off many years ago with their formal building inventory. By mapping out which buildings are at risk and require improvements to mitigate the hazards associated with the soft story, the safety of the building's inhabitants and the building's overall sustainability is made a priority.
The City of San Francisco is a step ahead in their laws. All buildings that are wood framed with a soft story that are more than 3 stories tall with more than 5 residential units constructed prior to 1978 are already subject to San Francisco's mandatory seismic retrofit ordinance. The City of Los Angeles may soon implement similar regulations for the mandatory retrofitting of soft-story and/or other vulnerable buildings if the political backing holds strong. Other California cities, including Oakland and numerous other East Bay cities are making similar plans for a retrofit ordinance.
What will this changing regulatory landscape mean for the commercial real estate industry?
A change in seismic safety laws will likely result in higher costs to retrofit older, less stable buildings. While retrofitting was previously at the discretion of the building owner, specific parameters indicating the necessity of a greater level of protection within the building could result in a higher cost for structural modifications.
In order to not pass the cost onto their tenants, many building owners will look for financing opportunities to pay for these costly repairs. For lenders, this may represent an opportunity to increase the amount of the loan at origination to cover the cost of the seismic retrofit or to issue a second loan for the purpose of retrofitting. There is the chance that the borrower may not have sufficient equity for a second loan and that the expense of the retrofit could result in default on the loan and/or foreclosure on the property. In order to protect themselves, lenders will have to take care as to how and under what stipulations that they issue their loans.
The prospect of a structural evaluation and retrofit does not necessarily constitute a road block to a potential deal. As a temporary fix, earthquake insurance may be able to be obtained, although it is expensive and sometimes not an option for soft story buildings. In some cases, retrofitting is a much less costly expenditure as compared to obtaining earthquake insurance.
Opportunities
The passing of these laws and regulations can also be a benefit lenders and commercial building owners. Sellers of commercial buildings want to make their properties as marketable as possible and seismic retrofitting is one way to do this. Buyers will perceive the building as a more valuable asset and lenders will view the property as a more secure investment since Probable Maximum Loss (PML) is lower than it might be in a building that has not been seismically retrofitted. A PML of less than 20% can reduce insurance premiums. Most building owners can recover their seismic retrofit costs in 2-8 years because of reduced earthquake insurance premiums. In addition, this lowered PML fulfills the requirements of most lenders and more lenders will be able to lend on the property. A building owner will attract more qualified buyers or be able to more easily acquire cash for improvements.
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