Property condition assessment
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Property condition assessments (PCAs) are due diligence projects associated with commercial real estate. Effectively they are more detailed versions of home inspections and have similar (and additional – see below) value propositions. Often they are done as part of a property transfer and are done along with a Phase I Environmental Site Assessment.
They are done in both equity and debt markets. On the equity side, these reports primarily have value to the purchaser in that they can understand the issues and the potential costs associated with owning a property. The Property Condition Report (PCR) would be used in these cases to negotiate the purchase price much like a home inspection. These reports tend to be very detailed, may require a number of specialists to evaluate the various building systems (e.g. HVAC, elevators) and can cost $20,000 to $100,000 or even more.
In debt markets, the reports have the value of letting the lender know that the borrower will likely have sufficient cash flow to operate, maintain and update the property over the course of the loan. This provides some assurance to the lender that the loan will be repaid or in the worst case, the property will not decline in value in the situation they have to sell it to recoup their loan amount.
PCAs are not to be confused with facility condition assessments, which are similar in nature but serve a different purpose.
The PCA process began to formalize in the early 1990s as a response to the Resolution Trust Corporation (RTC). The process of performing PCAs began to become routine and formalized with the increased demand however there were still many inconsistencies. A 1995 Standard & Poor's Guide further defined the process and then in 1999 ASTM released a standard called 2018-99. Since 2000 tremendous growth in the securitized lending market, or commercial mortgage-backed securities, caused a spike in the completion of these reports as they were required to complete a deal. Further, this has led to advancements and convergence on the scope, methodology and cost.
It is important to discern however the difference between a PCA done for the debt/CMBS markets and that of one done for equity markets as the cost, methodology, detail and value proposition vary tremendously.
PCAs utilize building diagnostics to identify problems, but diagnostics go further to determine solutions and predict outcomes to the found problems. A PCA covers ten major areas including:
- Building Site (Topography, drainage, retaining walls, paving, curbing, lighting)
- Building Envelope (Windows and Walls)
- Structural (Foundation and Framing)
- Interior Elements (Stairways, hallways, common areas)
- Roofing Systems
- Mechanical (Heating, Ventilation, and Air Conditioning)
- Vertical Trans (Elevators and escalators
- Life Safety, ADA, Code Comp. Air Quality (Fire Codes, Handicapped Accessibility, Water/Mold
The PCA process generally consists of two phases: a site inspection and data analysis. The site inspection should be a thorough and representative picture of the structure and abovementioned building systems. For larger buildings, a general rule of thumb is to view 10% of the building; however, depending on the structure, floor plan and building systems, this may not be enough to afford a representative picture. The report should include a narrative summary of the building type and condition, and cost tables of the immediate and long-term expenses of the building maintenance.
Value proposition and users
The users of a PCA may include a seller, a potential buyer, a lender, an investor or an owner.
The reports may be of use for:
- Negotiating the purchase price of a property (buyer)
- Capital or strategic planning (an owner)
- Loan approval (a lender)
The Executive Summary of a PCR is effectively the Replacement Reserves Cost Table. The report may be 20-40 pages in length however this table summarizes most of the Deferred maintenance items found.
These tables may be from 8 years in length to 40 or even more. The typical table is 12 years for most CMBS work (loan term plus two years).
In the lower part of the image you can see that the Cost Per Unit for this report is $20. Properties fall into one of two main categories. Either they are per unit/bed/pad/room (apartment, hospital, mobile home park, hotel respectively) or they are done on a square foot basis (commercial and industrial).