Y2K Won't Go Away
Leasing Issues and Litigation Will Bug Property Owners and Managers Into the New Year.
Probably it’s already too late. Property professionals who have not acted by now could face the brunt of possible problems when the year 2000 begins. Fortunately, many have expended phenomenal time, money, and energy to prepare for this looming deadline.
In light of these extensive efforts to eradicate the millennium bug, real estate and Y2K professionals are optimistic about the real estate industry’s ability to deal with issues that may arise.
However, regardless of whether Jan. 1 will be business as usual or a catastrophic series of malfunctions, property owners, managers, and tenants should heed these last-minute suggestions to rest easier on Dec. 31.
What’s at Risk?
As most people know, any device or system with an embedded computer chip that is non-Y2K compliant possibly could shut down as of Jan. 1, due to the chip’s inability to recognize the "00" digits as the year 2000 instead of the year 1900.
In buildings, the systems that supply necessary services are at the most risk of problems: security access; heating, ventilation, and air conditioning; fire and life safety such as alarm systems; and telecommunications. Office buildings, retail facilities, and even warehouses and hotels have multiple systems with embedded chips. Anticipated outcomes range from a nonevent — due to property management’s efforts to achieve compliance — to building lockouts, electrical and telephone outages, and loss of other services that could interrupt business.
What to do as Jan. 1 approaches depends a great deal on what has been accomplished so far. According to experts, the following tasks should have been completed by Dec. 31:
- test all critical systems with embedded chips;
- investigate possible manual operations options;
- prioritize operations for a worst-case scenario; and
- establish an ongoing dialogue with all vendors, including local utility providers, to determine their contingency plans.
Based on testing procedures, most property managers should have a rough idea of which systems are likely to fail and how to deal with those failures. Thus, for the remainder of this year, property managers should work to increase communication with tenants about which potential shutdowns could occur. In addition, property managers should contact vendors to determine their plans for continued service.
Property managers, particularly those managing multitenant office buildings, should review the following procedures to ensure that they have been completed.
Develop Contingency Plans.
It is essential to create a contingency plan for the failure of all systems containing an embedded chip, all services that depend on a third party, and virtually all building operations. In this regard, both property managers and tenants should be comfortable with how the building will provide emergency services such as electricity, telephone, and building access if systems fail on Jan. 1. In most cases, owners should look to energy suppliers, telephone companies, and other outside vendors for answers to these questions.
Both tenants and landlords should designate Y2K liaisons and arrange for these representatives to meet regularly. After determining potential problems, the liaisons should work together to carry out contingency plans that will minimize the problems that could ensue. For example, if a building has a large tenant with a number of business-critical systems, such as a trading floor, the landlord and tenant should discuss the potential effects of a system shutdown to determine whether the tenant’s critical systems should be tested individually.
Large, multitenant office buildings should try to book 24-hour, seven-day-a-week security guards, on-site elevator technicians, fire and life safety technicians, and additional staff for the weeks after Jan. 1. The duration of required additional services will depend on the severity of the situation.
Additionally, property management personnel should not schedule time off until well after the Y2K dust settles. Phone trees should be set up to quickly inform tenants, vendors, lenders, investors, and other interested parties of the building’s status.
Numerous sources offer advice on Y2K issues relating to real estate. Talk to neighboring or local standout properties for ideas. Online, the Building Owners and Managers Association’s Web site (http://www.boma.org/) includes a list of Y2K resources, including a user’s group, Web sites, vendors, and guidelines for systems testing and contingency planning.
The phrases loss of services and business interruption will be core issues in another anticipated Y2K result — litigation — now being hotly debated by trial lawyers, insurance companies, and politicians.
In July, President Clinton signed legislation that makes it more difficult for businesses to sue based on Y2K noncompliance. The new Y2K law grants companies a 90-day grace period to fix any problems before they can be sued. In addition, the law limits class-action suits by requiring plaintiffs to file in federal courts while restricting the amount of punitive damages plaintiffs can receive. Most lawyers and businesses agree that the law will hurt businesses by curbing their losses; however, Congress believed that it is necessary to quell rampant litigation during a potential period of national emergency.
Another aspect compounding the problem is the fact that insurance companies are not legally required to voluntarily disclose how Y2K claims will be handled. Therefore, owners and tenants should request statements from their carriers and vendors’ carriers indicating how these claims will be settled.
Y2K likely will bring a series of unknown challenges. Of particular interest to property owners and tenants is the allocation of increased costs brought on by potential Y2K problems and preparation.
Both pre- and post-Jan. 1 costs are expected to be substantial. For example, during the recent testing of a 1 million-square-foot multitenant office building, the fire and life safety system malfunctioned and the landlord had to spend $250,000 to correct the problem.
In this situation, the manufacturer of the system no longer was considered liable because the building was nine years old and the system’s warranty had expired. Thus, the building’s owner was forced to absorb the additional costs. If these costs can be passed through as an operating expense, it would result in a 25-cents-per-sf increase in the building’s operating expenses. Thus, a 100,000-sf tenant would incur a $25,000 expense if the costs are passed through under either a triple-net or base-year/expense-stop lease.
Unfortunately, these types of costs may be just the tip of the iceberg. Whether or not Y2K-mitigation costs can be passed through, how they are included in the base year, and the amortization length of the costs will continue to be debated over the next few years. This reasoning stems from similar experiences with the treatment of other unanticipated mitigation costs, including sprinkler retrofit costs, repair costs from the 1994 Northridge, Calif., earthquake, and similar government-mandated charges that landlords attempted to pass through to tenants.
Leases typically state that a landlord may pass through costs that either are government mandated or that increase building efficiency and/or decrease future costs. Landlords, however, might use this cost-savings argument to validate pass-throughs of Y2K-compliance costs. For example, elevators might be completely retrofitted to become more efficient and, at the same time, the elevator company will change all embedded chips to Y2K-compliant chips.
A lease area in which the landlord ultimately could be hurt is through the inflation of the 2000 base year. If one-time Y2K costs are included as part of a tenant’s base year, the fact that such costs may not include Y2K costs in subsequent years means that the landlord may not be able to recoup other inflated costs in future years. In sum, the base year would be artificially inflated.
Happy New Year?
If a building is not Y2K compliant today, it most likely will not be by the end of the year. Consequently, property managers should do as much as possible to prepare tenants and staff for the worst, while hoping for the best. Whatever the outcome, Y2K creates another area where competent and trained property professionals can add value to building management.