The Dangers of Earthquakes in CRE Finance

The Dangers of Earthquakes in CRE Finance

How A Little Understood Report Can Impact Your Bottom Line

PSRS Can Be Your Advocate for Alternatives

What is a PML and why do those three letters matter?

New stricter standards are being required by some lenders for the Probable Maximum Loss (PML) report. This report is a commonly-used tool by real estate investors, lenders and insurers to assess worst-case scenario of a building damage from a seismic event. In areas known for having earthquakes PML reports are one of the most common requirements by lenders for real estate transactions along with the Appraisal, Phase 1, and Property Condition Assessment.

How does the PML outcome impact my property?

With the PML, lenders establish very specific thresholds. If you are over the threshold, then the property will require earthquake insurance. This can be a deal killer. It can make the insurance requirement on a property jump by 10 fold.  For example, an annual insurance premium could increase from $10,000 to $100,000 a year – making a significant impact to the bottom line and negatively impacting your loan proceeds.  Alternatively, owners can choose to retrofit their buildings to get their PML results below the threshold for earthquake insurance. However, cost and scope of work required may be prohibitively high.

Why is the PML especially challenging?

Explanations for the PML are not always obvious. With the PML you must accept the number you are given, so, we dug into the methodology behind the report. As it turns out, nearly all of the companies use a methodology from an obscure publication called Earthquake Spectra in a brief section written in 1987 by two researchers known as Thiel and Zsutty. The factors the PML engineers use in the current reports about building construction, site stability, etc. all come from this source (although a few use a different methodology).  In addition, lenders are starting to modify their parameters (thresholds), meaning your PML results will be more meaningful moving forward.

What is PSRS’ role?

As the investors’ advocate, we work to understand the nuances of all necessary reports and seek ways where possible to mitigate the outcomes for clients. In many cases the reports are quantifiable and based on very real and obvious data. However, the companies that write the reports either don’t have the time or access to the necessary data to change their conclusions.  For example, if the borrower purchased their property and conducted a soils study to determine how solid the ground underneath the building was, the company conducting the PML study may not be privy to the results. But despite not having this information, it is one of four factors they use to draw their conclusions.  This is where we step in. Where possible we can look for historical data or other evidence that might contradict or help alleviate the report’s conclusions.

What changes are we seeing in how these results are being used?

Consider how scenario expected loss (SEL) or the scenario upper loss (SUL) in the PML are quantified. The SEL is always the lower number and the one that lenders have been willing to accept. However, we find that more lenders are now using the higher SUL standard. The new PML requirements also mean that a licensed civil or structural engineer with applicable experience will be needed to visit the site, which adds to costs and is more time intensive than before. Many buildings in Southern California built before a certain year are sure to rank the higher number and incur the earthquake insurance requirement.

What does the future hold?

Earthquakes are a true threat in California. The concern over the impact and damage to people and property is real. Even now Los Angeles has published a map of buildings it deems unsuitable or in need of repair relative to earthquake preparedness and other cities, including Santa Monica, are, in the very near future, forcing building owners to begin expensive retrofits.
It’s critical to have someone on your side who is willing to do the research, investigate the outcomes and consider alternatives to avoid potential additional costs.

Get prepared and call PSRS today: 310.471.1911

Why PSRS

  • Non-recourse financing
  • Lock rate at application
  • Terms – Floating Rate to 40 Year Fixed
  • Minimal to no reserve structure
  • Current servicing portfolio of $5.5 Billion – Fast servicing decisions
  • Nationwide coverage in the US on all commercial and multi-family real estate
  • Loan sizes from $1 Million to $100 Million+

About PSRS

Founded in 1972, Pacific Southwest Realty Services (PSRS) is one of the largest privately-held commercial mortgage banking firms in the Western United States. Our funding sources include major life insurance companies, banks, credit companies, CMBS and institutional investors.

Access to diverse capital sources insures a high level of success in arranging commercial real estate loans, apartment loans, mezzanine loans, and equity transactions that our clients have come to expect. Our long-term lending relationships give us greater latitude in solving problems and closing loans in a timely manner.  After the loan funds, our experienced, in-house servicing team handles many issues such as assumptions, lease approvals, payoffs, insurance and many other similar matters.

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