PROPERTY CONDITION ASSESSMENTS FOR COMMERCIAL AND RESIDENTIAL REAL ESTATE LENDING
For loans secured by real estate, there are obvious considerations such as the borrower’s creditworthiness, the property’s loan-to-value ratio, and the presence of environmental risks like lead-based paint or asbestos.
But other, less obvious considerations can also impact a commercial real estate deal. One such issue is building maintenance. Borrowers who allow an asset to deteriorate because they can’t—or won’t—pay for routine upkeep can cause serious problems for lenders. In today’s economy, maintenance considerations take on even greater importance because many borrowers are strapped for cash and the cost of building materials is rising. Fortunately, a tool called a property condition assessment (PCA) can help a lender factor these important considerations into lending decisions. Property Condition Reports are the gold standard in the commercial real estate industry. They contain a property description and a review of building components.
From elevators and air conditioning to electrical systems and parking lots, building maintenance represents a significant cost of property ownership. If a borrower fails to conduct routine maintenance, it can affect the lender in several ways. First, a property with significant material deficiencies could lead to direct liability for the bank. Second, if the property is not maintained regularly, its value deteriorates—a concern since the property serves as collateral. And third, if borrowers are skimping on routine maintenance, this could indicate that money is tight for them, which could affect their ability to repay the loan.
Owing to the potential exposure an improperly maintained building presents, lenders should include an evaluation of building conditions and deferred maintenance needs into their decision-making process.
THE BASICS OF A PCA
A property condition assessment benchmarks the physical condition of a property’s structures and provides estimates of deferred maintenance and future capital costs. Banks, lending institutions, bondholders, purchasers, equity investors, and sellers routinely rely on PCAs, although they’re most commonly conducted for lenders or owners as part of a commercial real estate transaction’s due diligence or asset management functions.
Sometimes referred to as an engineering report, a capital needs assessment, or a physical needs assessment, a property condition assessment consists of a site walk-through, document research and review, and interviews with facility managers and others familiar with the property. The results, which are presented to the client in a property condition report (PCR), include, among other things, an assessment of the property’s general physical condition and deferred maintenance status, an estimation of the remaining useful life of the components, recommendations for repair of items important to the property’s current operation, and probable costs to remedy observed or predicted material physical deficiencies.
Cost estimates are typically projected over a set amount of time—usually the term of the loan. “If a building is worth $1 million and has $250,000 of deferred maintenance over five to 10 years, the lender should take this into consideration for credit quality,” explained Michael Kulka, P.E., a vice president and principal with PM Environmental.
The industry standard for property condition assessments is ASTM E2018-08, Standard Guide for Property Condition Assessments: Baseline Property Condition Assessment Process. E2018-08 provides guidance on the evaluation of a property condition relative to:
• Structure and foundation.
• Electrical systems.
• Heating system components.
• Air conditioning system components.
• Ventilation systems.
• Plumbing systems and fixtures.
• Roof surface, including flashings, drainage, and chimneys.
• Interior components (concentrating on noncosmetic considerations).
• Exterior wall components, including doors, windows, and signage.
• Landscape components, including walkways, driveways (excluding sewers), and retaining walls.
• Review of any outstanding fire, building, water, and/or tax violations.
A property condition assessment is the single best indicator of how borrowers treat their assets. If the PCA indicates that the borrower or client has a great deal of deferred maintenance, lenders can assume those habits won’t change.
While PCAs can be conducted on any type of property—residential, commercial, or industrial—they are typically performed on properties involved in commercial real estate transactions. These commonly include hospitals, affordable and market-rate multifamily and senior housing, car dealerships, vacant or abandoned buildings, chain restaurants, banks and bank branches, food stores, office buildings, hotels, self-storage sites, warehouse/distribution facilities, shopping centers, and parking structures. Typically, the assets subjected to a PCA are valued at $2 million or more.
While the ASTM standard does not outline specific requirements for the PCA field observer (defined as the person who conducts the PCA and prepares the report), it recommends that the PCR reviewer be an individual “who possesses a professional designation in architecture or engineering, or appropriate experience and/or certifications in the construction field. The PCR reviewer should have experience commensurate with the subject property type and scope (size, complexity, etc.) and experience in the preparation of PCRs.
PCAs performed for lenders typically have much narrower scopes than those performed for equity investors or owners. Therefore, a PCA performed on behalf of a borrower may not be applicable for lenders’ underwriting purposes.
METROPOLITAN’S PCA’S
METROPOLITAN is the industry leader in Property Condition Assessment (PCA) services for engineering due diligence projects associated with commercial real estate transactions.
We designed our PCA to determine the present physical condition of the project and its improvements. We provide our decision intelligence regarding future anticipated issues, which may result in a financial risk or liability.
A METROPOLITAN Property Condition Assessment process includes:
· A visual walk-through to observe the existing conditions.
· Interviewing persons with knowledge of the property and its maintenance;
· Review of the available construction documentation, maintenance records, drawings, public records and current budgets.
· Deciphering the information gathered and presenting it with intelligence for repair or further detailed review if the issues cannot be determined through visual observation alone.
ASTM E2018-08, the Property Condition Assessment process
ASTM E2018-08 is the Standard Guide for Property Condition Assessments and sets the foundation for the Property Condition Assessment process. It is the initial assessments that baselines the quality and property structure.
Our practices to uphold the ASTM E2018-08 Standards include:
• Defining high-quality practices for the PCA of real estate improvements
• Facilitating consistent and pertinent content in Property Condition Reports
• Developing practical intelligence for site observations
• Performing document reviews and research associated with conducting PCAs and preparing Property Condition Reports
A property condition report from METROPOLITAN contains a property description (site, buildings, history, code compliance and maintenance) and a review of the following building components:
• Site Improvements (Access, Parking, Paving/Drainage, Walks/Curbs, Utilities, Lighting, Landscaping/Irrigation, Fences/Walls, Signage and Disabled Accessibility/ADA);
• Building Improvements (Foundation, Structure, Floor Construction, Exterior Wall Construction, Roof and Canopy Construction, Windows, Doors, Balconies/Terraces, Stairs, Interior Floors & Walls and Appliances/ Cabinets, Disabled Accessibility/ ADA);
• Building Mechanical, Plumbing & Electrical Systems (HVAC, Plumbing, Electrical, Vertical Transportation, Fire Protection/Life Safety Systems);
• Tenant Spaces (Interior Finishes, Kitchen Appliances, HVAC, Plumbing/Fixtures, Electrical, Fire Protection/Life Safety Systems);
• Other Issues (e.g., Fixtures, Furnishings and Equipment (FF&E) for hotels, more detailed mechanical studies, more detailed ADA surveys, etc.) - these issues can be included in a property condition report, but must be discussed prior to being proposed.
Buyers, lenders, sellers and downstream investors know a property condition report from METROPOLITAN can be relied upon to make investment-grade decisions.
METROPOLITAN ENGINEERING, CONSULTING & FORENSICS (MECF)
Providing Competent, Expert and Objective Investigative Engineering and Consulting Services
P.O. Box 520
Tenafly, NJ 07670-0520
Tel.: (973) 897-8162
Fax: (973) 810-0440
E-mail: metroforensics@gmail.com
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