' The Year 2000 and Real Estate:
What every property owner
should know about the Year
2000
By Tom Grotewold
Fortunately, the Federal Reserve Bank began relatively early
raising the Year 2000-awareness level at member banks.
Today, the Fed has continues to coordinate the remediation
and testing process at most financial institutions. Because of
the Fed's efforts, in general most commercial banks are very
familiar with and progressing towards meeting the Year 2000
Challenge.
The Fed has sent a very clear message to the banking
community about the business continuity risks associated
with the Year 2000. A few Y2K experts have speculated that
the Year 2000 may impact the ability of banks to open vaults,
wire transactions, calculate interest and deposits etc., which
in turn could cause a panic among depositors. The panic
could turn into a run on the bank, and that is what the Fed
wants to avoid. A potential counter-measure suggested by the
Fed is to make additional funds available to banks so that
they meet an increased demand for cash and continue
operations.
The Securities Industry Association (SIA) is currently testing
the Year 2000 progress of the larger brokerage firms and
exchanges. The initial reports indicate that the tests are being
executed with great success, but keep in mind that the SIA
started years ago and has spent a tremendous amount of
money and man-hours fixing the problem. James Spellman,
spokesman for the SIA has reported that they are very
pleased, and less concerned, but also realize that Wall Street
still has a long way to go.
Wall Street is very adept at looking at multiple components of
a company, compiling information, placing a value on this
information and creating a market price for a stock. Changes
in management, revenue and earnings reports, product liability
issues, revenue potential etc. all can have a positive or
negative impact on the price of a stock. Today, there are
investment advisers that are placing a value on the relative risk
associated with a company's ability to successfully overcome
the impact of the Year 2000.
While not perfect, an analogy can be made between investing
in the stock of a company and lending on a commercial
property. In both instances, the lender/investor has an
ownership interest and a certain amount of risk. Commercial
institutions that lend on existing or proposed real estate
projects evaluate several components.
For example, a lender may evaluate:
who is the recipient of the loan
what is their history and track record
where is the building located
what are the local and national market conditions
how are similar projects performing locally and
nationally
how marketable is the project
who are the existing tenants
what are the credit ratings of the tenants
Historically, the lower the risk equated to more favorable
financing terms and conditions.
Typically, because real estate loans are significant in value
and the due diligence process takes time, real estate
financing can take a long time to get approved. Lenders
require that properties be inspected for hazardous waste in the
soil, structural integrity, and asbestos in the building, all of
which add time to the process. However, the process may get
event longer as institutions begin to integrate Year 2000
analysis into their due diligence.
Why should a lending institution think about the Year 2000?
One reason is that Y2K has the potential to impact the value
of its loan/investment. How? Regardless of the age of a
building there are several areas that can have an exposure to
the Year 2000. The exposure to Y2K will have an impact on
the value of a property. The list below details the areas.
Based on known Y2K disclosures, Building Management
Systems may be impacted in several different areas
including:
Building & Elevator Access via card key
Building Access - magnetic locks with backup
batteries could lock Tenants out
Elevator card access - fails to operate because
the cardholder isn't recognized
Life Safety (fire detection & suppression, alarms,
emergency exits...)
Liability issues
City ordinances may not allow building
occupancy
HVAC Services (heating, ventilating and air
conditioning)
Environmentally sensitive network outages (i.e.
client servers, mainframes)
Security Systems
Exposure to illegal activities
Exposure to insurance, liability & safety issues
Energy Management Systems
1/1/1900 and 1/1/2000 are on a Monday and
Saturday respectively
The BMS may inappropriately heat and cool
down later in the week
Telecommunication network
Voice
Data/Fax
Video
Utilities, water treatment etc.
Building vendors
Security, fire & emergency
Other Vendors - food services, office and
building supplies...
The list above represents primarily "embedded systems"
involved in the operations of a building, and does not take into
account the developer/landlord's billing, maintenance or
management software. One critical Building Operating System
failure may cause an indefinite interruption of business.
Continuing to play out this hypothetical scenario, let's assume
that the building is forced to close because of a Year 2000
failure in one or more of the systems listed above. That means
the tenants cannot occupy the premises or operate their
business. Unless the problem is resolved quickly, the tenants
may claim a breach of their right to "quiet enjoyment" of the
leased premises.
However, keep in mind that the property is one of many
buildings in the central business district that are experiencing
the same problems. The volume of Y2K related problems
could result in significant delays caused by either a shortage
of skilled repair personnel or a shortage of replacement
equipment. Both could contribute to a slow recovery.
Meanwhile, the tenants become further inconvenienced, they
stop paying rent and some also lose major clients because
they cannot conduct business as usual. After some period of
time, the tenants get organized and file a class action suit
against the building owner. The bad news for the building
owner is that property insurance and business interruption
insurance companies both view the Year 2000 as a
"non-fortuitous event," and decline to extend any monetary
coverage. (Currently, the majority of the insurance industry
has indicated that because it cannot develop annuity tables to
quantify the risk of the Year 2000, it considers Y2K to be a
"non-fortuitous event")
Where is the most exposure? Perhaps the owner of a high
rise property will encounter the greatest risk. A quick
pro-forma may demonstrate this assumption. Let's assume
that the property is 1 million square feet. The market value is
$150 million or $150 per square foot, and the building owner
has $30 million in equity. The average tenant in the building is
5,000 square feet, and so assuming a 5% vacancy rate, there
are approximately 190 tenants in the building. The average
lease rate is $14.00 net, which means the building generates
about $1,167,000 in rent per month.
Assuming the worst, the tenants stop paying rent and that
amounts to approximately $38,000 per day. Recall that the
building still needs remediation of the Year 2000 Problem and
that cost may be a little or it may be a lot. The total of the
Year 2000 cost is an unknown, but we know that it must be
expensed in the year that it is incurred according to GAAP
standards.
The greatest risk comes in the form of litigation from the
tenants. What value will the tenants' attorney place on their
client's inability to conduct business? Will it correlate to some
average daily income lost? What could the value of the suit be
if the tenant loses its major clients because of the tenants'
inability to occupy or conduct business? What if the tenant is
forced to file for bankruptcy?
Recommendations:
Real Estate financiers may want to treat the Year 2000 similar
to asbestos and hazardous waste. The best, fastest and most
expensive alternative is to hire a Year 2000 solution provider
that specializes in embedded systems remediation. Hire the
Y2K provider to generate a "Year 2000 compliance report"
prior to finalizing any loan agreements. This will provide an
overview of the effected systems.
The Y2K solution group probably has developed a Y2K
compliance database, and this database is important to
speed, documentation and accuracy. The compliance
database stores building systems that are known to be either
Y2K compliant or non-compliant and the database can
generate a report relatively quickly. A detailed Y2K
compliance report is currently taking 6-10 weeks to complete,
and costs approximately $30,000 - $50,000. This range does
not include any repair or replacement costs that will be added
to the cost of the compliance report.
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