A property condition assessment can protect against deal-killers.
Many investors ignore the
return on investment that property condition assessments often can deliver.
PCAs yield an ROI in three ways: protecting buyers from bad purchases;
providing buyers with information for price negotiations with sellers; and
finding opportunities to improve building value post-purchase.
Not all PCAs are the same.
The property condition scope outlined in ASTM E2018 is a very flexible
standard. The ASTM PCA is a walk-through assessment where a knowledgeable
architect, engineer, or building inspector walks through the asset, interviews
available personnel, reviews available records, and evaluates the condition of
all building systems. For large assets and clients with lower risk tolerance,
an engineering assessment firm can upgrade the inspection by bringing in a
specialist such as an elevator inspector or an engineer who is trained in
mechanical, electrical, structural, or plumbing systems. While this increases
cost and depth, property owners who regularly order equity PCAs should
experience greater ROI.
Some buyers hire engineers
to conduct PCAs to find deal-killer problems. These can include very large capital
expenditure items, such as leaking curtain walls, leaky plumbing, faulty
elevators, and heating, ventilation, and air-conditioning issues. As a general
rule, when the immediate needs and deferred maintenance items add up to 1
percent of the purchase price, they can kill a deal.
Deal-killer findings are
not uncommon. For example, during a recently completed PCA for a medical
building in Phoenix, the exterior insulation finish system was found to have an
undulating surface at specific locations, which triggered a concern about poor
installation. An interior inspection in those areas revealed blistering wall
paint, rusting lintels, and stained ceiling tiles, indicating moisture within
the exterior wall cavities plus the potential for mold to exist. After being
provided with the PCA report that included associated repair recommendations
and costs, the buyer decided not to move forward with the acquisition.
locations, seismic risk issues also can kill deals. Often a buyer’s seismic risk tolerance is
determined by its capital sources. Some lenders require a probable maximum loss
report and a seismic retrofit or a very expensive seismic insurance policy if
the PML report yields a number above a certain threshold. Buildings with high
PMLs can cost investors money in financing premiums or higher insurance costs
even if the asset never experiences a big earthquake.
Often buyers ask for
purchase price reductions to address PCA-reported items. Engineers sometimes
find themselves in the middle of these negotiations and their services,
expertise, and acumen can yield a very tangible ROI.
For example, during a
recently completed PCA for an office building acquisition in the Midwest, the
membrane roof system, which was 11 years old, was found to have water intrusion
issues due to poor installation. Because of the PCA findings, an infrared
detection test for the roof system was completed and pockets of subsurface
moisture were discovered within the roof assembly. The buyer was given the PCA
report and test results. A full roof replacement would have cost more than
$500,000. As a result, the seller negotiated several options to the buyer such
as providing a 10-year full roof warranty and annual maintenance with the
existing roof system in place or a significant reduction of costs in the
Energy benchmarking is a
useful tool, especially for value-add investors. Energy audits are
comprehensive studies of how buildings consume energy, resulting in a list of
energy-reducing recommendations with quantified installation cost, cost
savings, and payback period. The added value of a building comes from two
components: an increase in net operating income due to reduced operating
expenses and an increase in building value when applying a capitalization rate
to the reduced NOI.
As part of a recent office
building energy audit, a lighting system upgrade was recommended. The existing
antiquated T12 lamps and magnetic ballasts were replaced with T8 lamps and
high-efficiency electronic ballasts along with motion sensors where
appropriate. The total cost of the project was approximately $44,000, which
included a rebate from the local utility company totaling 15 percent of the
installation cost. The reduction in electric consumption saved $14,700 per
year, and the payback period was approximately 2.9 years. At an 8 percent cap
rate, this higher net income increased the building value by $183,000, or 4.2
times the installation cost. Over a 10-year period, the internal rate of return
of this investment is approximately 34 percent. With typical equity investment
yields in real estate falling well below 18 percent, investing in a lighting
upgrade certainly proved to be an accretive investment opportunity.
The cost of an equity PCA
with a specialty inspector may be more than $10,000 whereas a standard ASTM
E2018-compliant PCA generally costs around $2,500. Therefore it is important to
discuss your needs and what you know about the building with the engineer, as
all equity PCAs are custom in scope.
Joe Derhake, PE, is
president of Partner Engineering and Science, a national engineering and
environmental consulting firm. Contact him at email@example.com.