Earthquake Prone Buildings: The Risks

If you own a commercial building, assessing and addressing its ability to withstand an earthquake should be at the top of your priority list. But, safety aside, what are the risks of having a building deemed ‘earthquake prone’? Prendos Head Valuer Gordon Edginton talks us through the legal requirements and wider ramifications when it comes to value.

New Zealand’s recent seismic events – from the devastating Canterbury quakes in 2010/11 to the more recent Kaikoura quake in 2016 – have seen kiwis become more aware of seismic issues and the ability of buildings to withstand earthquakes.

But what exactly deems a building ‘earthquake prone’ and when is rectification required? As Gordon explains, it’s not as cut and dried as you might think.

“The 2004 Building Act states an Earthquake Prone Building is one that would be likely to collapse in a modest earthquake. Existing buildings must be at 34% of New Building Standards (NBS) when it comes to earthquake strengthening – anything lower than that requires an upgrade.”

Assessing a building’s earthquake strength requires a registered structural engineer or, better still, specialist seismic engineers like the team at Prendos. They’ll prepare Initial Seismic Assessment reports, including an Initial Evaluation Procedures (IEP) assessment, which looks at the building’s structural performance.

If the findings show the building isn’t at 34% NBS, an upgrade is required. However as Gordon explains, a grey area exists where – while you’re not legally required to upgrade the building – you may find it beneficial to do so.

“Buildings with an NBS rating between 34% and 67% are deemed moderate risk and there’s no statutory requirement to strengthen them. However, with the heightened market awareness of seismic issues, the marketability and value (both from a leasing and sales perspective) of earthquake prone buildings has been negatively impacted.”

Market Effects
It’s clear that market resistance to buildings with low IEP ratings does exist.

While 34% NBS is the legal minimum threshold for a building to be considered safe, both the occupational and investment markets are generally adopting a level of 67% NBS when it comes to decision making and discounting.

Tenant demand is increasing for buildings with an earthquake rating of 67% NBS or better, with many tenants including earthquake resistance as one of their considerations when selecting a property to lease. Some Government and blue chip tenants even have policies in place which don’t allow them to renew leases in buildings with an IEP score of less than 67% NBS – with many requiring 80% to 100% NBS.

“Modern buildings with a higher earthquake resistance are seeing increased demand, and this is likely to positively impact their value as investors and tenants become more discerning of these characteristics,” says Gordon. “Older buildings are losing attraction unless they’ve undergone seismic upgrading.”

Because older buildings incur increased insurance costs (as well as potential upgrading costs in the future), they can become more costly to lease, especially where the building operating costs are paid by the tenant. This negatively impacts demand when they are compared to more modern, cheaper space.

Lending and Insurance Issues
Banks and insurers are also becoming more wary of older buildings with low IEP scores, which is impacting the ability to reinsure or raise finance for a purchase. This in turn impacts on demand and value.

Banks are concerned with how the IEP rating impacts on the security offered – the expected upgrade costs, the ability to ensure adequate insurance cover, the security of tenure with existing leases, the likelihood of renewal and whether a tenant can walk away if there’s no insurance. They’re also wary of how regulatory changes, mandatory upgrading and market reaction will impact on value.

“We’re aware of some instances where banks simply won’t loan against a property with a low IEP, which means the asset can only be purchased by a cash buyer, not a buyer raising finance against the asset. Most banks need properties to have a 67% NBS rating for any new business and require IEP reports for any lending. If a building has a low IEP rating, the lender will likely take into account the impact of the future costs required to bring the building to a minimum of 67% NBS.”

Insurers are naturally risk adverse, so it’s never a certainty that insurance will be easily obtained. For example, it’s now very difficult to get cover for pre 1935 buildings. No insurance means no bank loan – which not only reduces the liquidity of the asset, but the number of potential buyers it will appeal to. Even if insurance can be obtained, earthquake prone buildings will attract higher premiums and higher excess payable on any claim.

“Market evidence is wide ranging on the subject,” says Gordon. “Some sales show a clear drop in value due to poor IEP ratings, while others show no discounting – but these may be sales to overseas or poorly informed investors, or for properties sitting on valuable redevelopment land.”

“At the end of the day, a building’s earthquake resistance will impact upon its value in the future, and I’d certainly expect more discounting in price for buildings with a poor IEP.”


Disclaimer
This is a summary of general information relating to seismic issues affecting property. It is not a complete description of the issues affecting real estate and is provided for general information purposes only. Prendos strongly recommends you contact a suitably qualified engineer for advice on seismic issues relating to a particular property. Prendos does not accept any liability for loss or damage which may result either directly or indirectly from any advice, opinion, representation, information or omission whether negligent or otherwise contained in the above material. There is extensive information available online and we recommend reviewing the Building Performance Publication prepared by the New Zealand Government “How the system for managing earthquake prone buildings works”.

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