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Standards and the Property Condition Report

With regard to property condition reports, one size does not fit all.

The Property Condition Report has become a standard part of the due diligence process when acquiring or funding commercial real estate

With an estimated 250,000 transactions each year receiving some sort of condition assessment, the prudent investor, manager, or investment banker has a right to know what to expect in these reports. Unfortunately, there has been little consistency in the industry.

Initial attempts to develop standards came from the financial community itself. Most large players in the commercial real estate market developed their own guidelines - commonly a one or two page document that lists the building systems to be investigated. In a few instances, these guidelines are more comprehensive. Sometimes, they have requested things that are quite impossible or not affordable. Examples of these are code compliance reviews or certifications that the building was built per plans.

None of the guidelines have the level of detail or consistency as those same company's guidelines for Environmental Site Assessments. Most commercial real estate professionals had more experience with ESAs and were in a better position to direct such activities. In fact, many of the national engineering firms that have offered to provide property condition surveys started out as environmental consulting firms. They too had little experience with this type of engineering service.

Standard & Poor's Develops Guideline

The advent of Commercial Mortgage Backed Securities and the return of a strong Real Estate Investment Trust market caused rating agencies to take an interest in the property condition report. Duff and Phelps published guidelines. In 1995, Standard & Poor's published Real Estate Finance Property Condition Assessment Criteria.

The inch-thick document provides a scope of work for property condition assessments of retail, multifamily, hospitality, industrial/flex space, office buildings, and nursing homes. These guidelines are comprehensive and the resulting report provided much, if not all, of what an investor/financier needs to know about the condition of the building.

Unfortunately, the level of investigation required to complete such an assessment exceeded what most clients were willing to pay. A so-called "short form survey" was developed, but it did not provide enough information. As a result, most consultants found themselves offering a scope between the short and standard form.

ASTM Develops a Standard

More recently, a task group was formed by ASTM to develop a standard practice. ASTM is well known in the building and construction industry for testing procedures and standard practices for a variety of building materials, systems and applications. Construction documents often specify that products meet ASTM standards.

A preliminary draft of the standard has been developed and is undergoing editing and review. Because of the complexity of the task, and because users of the standard are anxious to have something soon, the committee proposed to draft a baseline standard, to be released in 1997. Modifications and addenda to the baseline may come later. Now, in 1999, it appears that the document will actually be published as a "standard guide."

An interesting sidebar to this development is that not all engineers are happy with the creation of an ASTM standard for property condition assessments. They argue that such standards eliminate much engineering judgment and the related refinement of the practice. The standard may also serve to disguise the quality practitioner from the unqualified follower of a prescriptive standard. Although there may be some truth to these arguments, the volume of real estate transactions that must be reviewed underscores the need for consistency.

The Scope Depends on the Nature of the Transaction

The ASTM committee must also grapple with the varying needs of different users. If a building is being acquired by a sophisticated buyer, detailed information about current condition is necessary but the buyer may already have a good understanding of operating costs and capital reserve requirements. Others who acquire properties may indeed be interested in a capital reserve schedule to know what may be required over time. Mortgage underwriters may require reserves as well, although if the property is part of a pool, the only requirement may be for the cost to address deferred maintenance and current defects. With regard to property condition reports, one size does not fit all.

Optional Item

In addition to calculating capital reserves, a variety of other questions may arise which may or may not be within the scope for any particular client. Among the most significant of these issues are compliance with the Americans with Disabilities Act, seismic considerations, local zoning and code issues, capacity and adequacy of systems and feasibility of changes.

Conclusion

The condition of a building is not always of primary importance in transactions that are driven by return on investment and sales quotas. However, it can have a dramatic impact on the overall viability of the property and its underlying financing. Each client has their own set of criteria for what is important. Having a national standard will establish a baseline for comparison of properties and consultants. But it cannot replace the wisdom and experience of a knowledgeable building inspection engineer. Working with the client, the engineer must develop a scope that both meets industry standards and the particular needs of the client. In looking for such an engineer, clients are encouraged to consider firms that have established a track record with property condition assessments.

The Engineering Advisor is intended to enhance your knowledge of technical issues relating to buildings. For additional information on any subject, please feel free to call us. Our commitment is to provide you with timely, accurate information.

Criterium Engineers, Copyright © 1999