Coping with Natural Disasters
Red River Valley Flooding Provides a Valuable Example for Property Owners and Managers.
Editor’s note: The devastating flooding in the Red River Valley of North Dakota and surrounding areas in April 1997 brought myriad problems for residents and businesses. But the experience also offers some insight on how commercial real estate professionals can prepare for and cope with such natural disasters. Some emergencies, such as floods and hurricanes, often are preceded by some warning; others, including earthquakes and fires, frequently are not. Nonetheless, nearly every area of the country is susceptible to disasters of one kind or another and commercial property owners and managers can learn from the Grand Forks, North Dakota, area’s misfortunes.
When the dikes broke in Grand Forks, immediate evacuation was necessary. The floodwaters caused the sewer and water systems to overflow and shorted out electrical systems, while shifting buildings broke gas lines. The combination of these caused the unimaginable—a fire. In Grand Forks’ central business district (CBD), which had four feet of water rushing through the streets, a fire blazed from building to building. Fire trucks could not reach the fire without stalling and could not connect with fire hydrants that were under water. To fight the fire, trucks were placed on top of National Guard trailers and pulled to the site; helicopters dropped fire-fighting materials from the air. The objective turned from putting out the fire to trying to contain it; ultimately it burned for 20 hours, damaging three city blocks.
In all, the Red River rose 22 feet above flood stage, with crests four feet higher than ever recorded. Although massive flooding occurred all along the North Dakota and Minnesota border, the most severe property damage occurred in Grand Forks and its sister city across the river, East Grand Forks, Minnesota. In Grand Forks, population 45,000, the whole town was evacuated and 8,000 structures were damaged. In East Grand Forks, population 9,000, only 27 properties were not affected by the flood.
Implications for Real Estate
The flood affected every sector of the real estate business, including brokerage, development, and management. In the brokerage sector, everyone scrambled to get their businesses up and running, trying to assess the opportunity cost of downtime.
In fact, the economics of downtime became a major factor in all real estate decisions. Properties for sale that avoided flood damage moved quickly. Financially strong businesses that owned their existing buildings moved rapidly through the business funnel to a relocation or rebuilding decision. These businesses had more control over the process than those who leased.
Properties on the market for lease obviously had strong demand from displaced businesses. However, the damage or destruction clauses in most leases obligated tenants to move back into their preflood space upon restoration of the space. The property destruction clause in a commercial lease, commonly referred to as "simply standard language," became very important for landlords and tenants. It also became clear that these clauses are not standard or uniform. However, the reality of the disaster brought landlords and tenants together in a cooperative spirit to help residents and businesses find alternative housing.
Landlords had to make some difficult decisions. They could move forward with short-term leases that might extend into long-term leases, or they could hold out for businesses that could commit for a longer-term lease.
Industrial and warehouse space was in high demand from local businesses, as well as disaster-relief organizations including the Red Cross and the Salvation Army. These landlords faced similar issues on whether to lease to short-term or long-term tenants. In retrospect, the short-term leases worked out well. The emergency organizations were professionals in flood relief and understood landlords’ need to maintain the premises.
One unique alternative for short-term space was office sharing. Undamaged businesses offered office space to those who needed it. (Technically, this probably violated the sublease clause of most leases; however, doing the right thing far outweighed the technical aspects of the lease for both landlords and tenants.) In some cases, competitors turned into supporters by providing space and office services. Law firms and insurance, real estate, and software companies were just a few of the organizations that provided space.
A real estate nightmare—losing the records in the register of deeds office—compounded the problems in Grand Forks. The damaged records were frozen and shipped to a reclamation company. However, lack of access created a major roadblock to rebuilding: many properties needed title transferred before the work could begin, and lenders needed to have titles reviewed and documents filed. Title transfers and filings are set by state law, which fortunately the governor suspended during the disaster, providing a policy by which title work could be done on properties.
The flooding caused the development sector to shut down immediately. Labor and resources shifted to fighting the flood, then to repair and construction work. The immediate housing shortage prompted residential development, coupled with commercial development by businesses that had no other alternative. Development was hampered by the short construction period—winter weather shuts down new construction from November to late April—but is expected to come back strong to catch up with preflood trends.
With the federal and state governments’ financial investment, future development is expected. According to a recent Wall Street Journal article, the federal government is providing the town with a grant of $171 million, $20 million of which will be slated for improving the downtown area. Local developers are divided over whether the flood and fire, which destroyed 11 buildings in the Grand Forks CBD, was a blessing or the final death knell. Some regard it as a chance to replace the loss with more efficient buildings, hopefully attracting business back to a downtown that already was losing ground to other areas. Others, according to the WSJ, foresee the few businesses that remained downtown now moving south of town near the Columbia Mall, where a building boom of retail centers, fast-food outlets, apartment complexes, and office buildings continues unabated. While the city council recently approved funding for a four-building corporate center, time will tell if a rebuilt Grand Forks will become a vibrant center for tourists and businesses that city boosters envision.
Several national agencies were involved with the recovery, including the Federal Emergency Management Agency (FEMA), Small Business Administration (SBA), U.S. Army Corps of Engineers, U.S. Department of Housing and Urban Development, Federal Highway Administration, Department of Agriculture, and others to a lesser degree. The North Dakota National Guard established the state’s flood recovery office headed by Maj. Gen. Murray Sagsveen. When asked about the recovery effort at a legislative conference in Bismarck, North Dakota, Sagsveen said, "It’s like taking a jigsaw puzzle, putting it in a box and shaking it up. It doesn’t take long to shake it up, but it takes a long time to put it back together."
The biggest financial benefit for property owners was insurance coverage. Two types of insurance may benefit an owner with flood damage: private and federal. Typical private insurance coverage with backup riders covering sewer backup, equipment failure, or income loss did cover some claims. The payout to a property owner depended on the fine print and the state insurance department’s interpretation. Private insurance with sewer backup coverage generally paid out the limit of $5,000 to $10,000.
National flood insurance paid up to the face value of the insurance or for damage covered by the policy, whichever was less. In general, the National Flood Insurance Program covers mechanical and electrical damage in the lower level of a property and all damage above the main floor. The federal government provides flood insurance through local insurance agencies. The cost varies by zone; it’s about $0.43 per $100 of property value for the first $135,000 and $0.19 per $100 of property value thereafter, up to an insurance cap of $250,000. This policy must be purchased at least 30 days prior to a claim. Prior to the flood, fewer than 1,300 federal policies were taken out in Grand Forks. In part, many believed the cost too high for minor flooding. Of course, after the flood, having made that investment would have been a real bargain.
Once the damage was assessed and repair cost estimates completed, many owners had to make a difficult decision: Should they liquidate their investment or rebuild? Liquidation meant selling at a deep discount or turning the property back to the lender. Rebuilding required the investment of additional cash, bank refinancing, or SBA financing—all of which reduced an owner’s equity in the property.
Most properties faced an immediate negative cash flow status. With tenants gone—some for good—the mortgage payments and other monthly expenses accumulated. Most lenders took an immediate position that up to six monthly mortgage payments could be abated until the end of the original loan period. Many local lenders had a substantial part of their portfolio in nonrecourse, single-family homes, which directly affected their ability to provide more flexibility to commercial borrowers.
The types of ownership, financing, and extent of property damage were key factors that owners considered when making post-flood decisions. However, if the damage was manageable, most owners chose remodeling, then looked for the best method to fund the repairs.
Set up in temporary offices, SBA proved to be the best alternative for most owners by providing two types of loans: one for physical loss and another for economic loss. These loans were negotiated on an individual basis ranging from 4 percent to 8 percent with an amortization period ranging up to 30 years. The rate was based on the owners’ ability to obtain other financing. If other financing was available, SBA would set the interest rate higher. The amortization period was based on projected cash flow.
To complete the application for the physical loss, estimates were required from contractors to assess the cost of rebuilding. To determine the economic loss, pro forma was compiled to determine the rent loss. Next, the proposal wended its way through the SBA process. The local office reviewed them and forwarded them to the SBA office in Fort Worth, Texas, where a loan officer was assigned to individual files to perform the initial underwriting. Once completed, the underwriter presented the initial proposal to the property owner. After the rate and term were negotiated and agreed upon, the loan proposals went to a senior loan officer for approval. Finally, the proposals were forwarded to SBA’s legal department, where loan documents were drafted. The final documents were signed and the loan was closed. At this point, SBA provided a check for the economic loss loan.
The physical loan was treated much the same as a construction loan: The bills were submitted to SBA as the work progressed.
Local officials were extremely worried about having enough contractors to rebuild the city, while at the same time concerned the disaster would attract opportunists who would take advantage of the situation. The city and state devised a unique solution: a one-stop shop for all contractors. Before any contractors could go into an area that had been evacuated, they were required to be licensed, registered, and have photo identification badges.
A temporary one-stop shop was established that housed all of the agencies in one room; these included the Secretary of State for licensing, job service, workers compensation, tax department, and city officials. This enabled a new contractor to complete all the necessary documentation in one location and to receive immediate approval and identification badges. The last agency in the room, the Bureau of Criminal Investigation, was instrumental in screening out problem contractors by running background checks.
Hopefully, the lessons learned from the Red River flood will not be needed again in the Grand Forks area. However, as much as we try to predict the weather and the future, we can never be certain. The only certainty is that unexpected natural disasters will continue to occur—and learning from the experience of others can only aid in preparing for the worst before it occurs.