Robert Szustakowski, The Lotis Engineering Group, PC
This is one that I’ve been scratching my head over for years. No one buys a house without a home inspection. We don’t want to get a surprise of bad electric or a leaky roof AFTER we’ve made that big purchase. And based on that report, we bicker about hundreds of dollars.
But many lenders never think twice about the physical and structural condition of the commercial property before then lend significant money and, believe it or not, before they foreclose.
What’s a PCA?
A Property Condition Assessment (PCA) is a “home inspection for commercial property.” It is intended to look at similar items, such as electrical, structural, mechanical, etc., of a property. The biggest difference is that PCAs are not intended to look at items costing hundreds but rather thousands of dollars to address.
There is (of course) an ASTM guidance for PCAs, “Standard Guide for Property Condition Assessments: Baseline Property Condition Assessment Process” (ASTM E2018-15). It outlines in rather extensive detail the items that can (should?) be in a PCA. I say “can or should” as a PCA that addresses all items in the ASTM standard is extensive. It would include electrical, plumbing, mechanical, building shell, roofing, drainage, etc. Having read such reports, I can tell you that it notes such items as to whether the building has sufficient water pressure or not along with other items that are not likely to be overly applicable in many instances.
However, the guidance also states that the scope of the review can and should be modified based on the needs of the user (the bank). In the past, I have suggested different layers of study, based on the needs in a particular situation.
It should be noted that some federal multi-family lenders have their own requirements for PCAs; the following would not be appropriate for their needs.
Soundness and Safety Level – This study is very limited in use and is intended for buildings that will undergo significant renovations. This was devised after clients requested full ASTM-level PCAs of buildings to be gut renovated. This meant that most of the information collected would be irrelevant shortly after the loan closed as the systems were removed. The purpose of this level of study would be to assess whether the building is structurally sound to allow for the planned renovations and that there would be no public safety issues (e.g., falling façade).
Base Level – This is a level of study that often seems appropriate; the specific systems assessed vary based on property type. Each property type has certain “big ticket” items. For example, a retail plaza has significant façade, roofing and parking and significant repair/ replacement of any of these can create result in significant costs to fix. So the PCA scope should concentrate on these items. Alternatively, a multi-story building in an urban area has almost no roof and no parking. But it likely has a central heating system and an elevator that can be costly fixes.
The PCA here should concentrate on those items. It is important, however, for the bank and the consultant to agree on these items before the start of the study.
ASTM Level – This would be a full ASTM-level report, covering ALL systems and areas. While such may be very useful to a purchaser, it may not provide significantly more information to a lender than a Base Level study.
It should be noted that compliance with the American with Disabilities Act (ADA) may need to be addressed in any of these.
There have been discussion recently regarding expanding due diligence relative to “green” buildings. I would define that term rather broadly to include anything from buildings with solar panels on the roof to LEED-certified construction.
Obviously, such situations would significantly impact the repair or replacement costs, not just to things like solar panels, but the underlying roof, having to address the solar panels at that time. There may also be specific requirements on the nature of replacement windows, heating systems, etc. These items are best addressed during the PCA.
What’s in the Report?
Lenders only understand two things – time and money. In the end, the report should provide costs to repair deficiencies and the time during which it should be addressed. Generally, there are three different time frames to be addressed.
- Immediate Concerns – These are items that should be addressed as soon as possible, typically within no more than six months. Such items include safety concerns such as bad sidewalks, missing stairs, missing porch railings, etc., or items that are significantly impacting the building (holes in the roof).
- Intermediate Concerns – These are items that should be addressed over a stated time period, such as within one or two years. Such items can include resurfacing a parking lot, re-pointing of bricks, etc. These items do not pose safety hazards but left unattended can impact the building.
- Long-term Concerns – The timing here varies based on the needs of the user. For many lenders, these are items that will need to be replaced during the term of the loan but can be accounted for in the daily operating budget or a capital budget (roof replacement, window replacement, etc.). They typically include numerous items nearing the end of their useful lift.
Each of these concerns should be listed along with associated costs. Some costs (such as Immediate Concerns) are typically identified as single numbers as they need to be addressed in the near-term. However, Long-term Concerns may best be expressed as a cost per unit of an apartment building, for example, to assist the bank in assessing operating expenses.
Doesn’t My Appraiser Do This?
No. An appraiser may take some items into account in their review, such as the need for a roof replacement or deferred maintenance, that impacts value. But the appraiser does not include the detailed assessment a professional consulting firm will complete.
When to Require a PCA
It amazes me that, like environmental studies, lenders tend to order PCAs based on property values. For example, I am aware that they are only required on properties valued at over $5MM at one lender. Typically, a borrower that is able to procure a $5MM or $10MM mortgage is experienced in commercial building purchases and assessment. They likely have done their own due diligence pre-purchase. Developers often have facilities departments that assess properties pre-purchase and maintain their investment. Generally, PCAs of these properties yield few issues.
On the other hand, while you have borrowers that may be excellent lawyers, doctors and manufacturers, they do not have expertise in buildings and construction. As we’ve all seen, the borrower’s “fall in love” with properties and do not see the warts. I have seen manufacturers move into old warehouses with leaky roofs and insufficient power, doctors buy apartment complexes with extensive building code violations, etc. It is in both your and your borrower’s best interests to make sure that all are aware of any shortcomings associated with the building.
Do not assume that these items have been considered pre-purchase; if they state that they have, ask for proof (a letter from an architect for example). If they provide a two page “home inspection report” for their commercial property, you may not want to accept it.
If this is a re-finance for the borrower, they will likely be less willing to have the property inspected. But especially on investment properties, your doctor, lawyer or manufacturer may not have set foot on the property in some time and all is left to a management company. It does not take many building condition issues on low-end properties to significantly impact value.
Your determination on whether to need a PCA should be based on: age of the structure; known and documented upgrades; borrower’s experience in commercial real estate; purpose of the loan (i.e., whether it’s a standard mortgage or construction loan); and, finally, value of the property.
That being said, ALWAYS, ALWAYS, ALWAYS obtain a PCA prior to foreclosure. I have seen numerous properties that were either walk-aways, as the repair costs would make the value of the property minimal, or required significant expense paid by the lender after foreclosure just to make the property acceptable for sale or, in the event of multi-family housing, safe for tenants.
What Do PCAs Cost?
This is not easily answered. So much depends on the scope of the project as well as the location, the size and complexity of the building and systems, cost estimates are next to impossible other than to say more than $500 and less than $10,000. But in comparison, the cost to replace any one of the “big ticket” items will almost surely exceed the costs of a PCA.
Finding Qualified Consultants
The number of qualified consultants in an area will vary, mainly by the amount of construction being completed in the area. Numerous qualified firms, especially national firms, are located in growing urban areas. However, there are significantly fewer firms once you move out of such areas. You may need to bring in a firm from out of the area to complete the study.
Ask about qualifications and experience. A retail plaza or office building requires a different skill set than a surgical center with many specialized systems. And, as always, be sure that the consultant is properly insured.
About the Author
Bob has been completing environmental due diligence for lenders for 30 years. He has developed and managed environmental programs, as a consultant and bank employee, for some of the largest and smallest banks in the country. He has also devised bank programs for construction monitoring and routine property inspections.