ASSESSING FLOOD RISK IN COMMERCIAL REAL ESTATE

NOTE TO READERS: This article was just published in the Winter edition of the EBA Journal. Professional members of the Environmental Bankers Association responded to last year’s epic hurricanes to provide valuable response work, assess contamination and assist in getting businesses back up and running. This article documents those important efforts with a look toward what last year’s historic hurricane activity means for the future of assessing flood risk at commercial properties, as well as the results of EDR’s analysis into the types of environmental risks in the storms’ areas of impact. Links to the Journal and details on other articles are provided in the FOR MORE INFORMATION section following this brief.

 

 

 

 

 

In late August, Hurricane Harvey made landfall in Houston with damaging floodwaters, followed closely by Hurricane Irma in southern Florida. The growing frequency of weather events like these record-breaking hurricanes have important implications for managing the risk associated with properties located in areas sensitive to flooding.

EP FIRMS MOBILIZE GROUND-LEVEL EFFORTS

The immediate impact of Hurricane Harvey on the environmental due diligence market was on lenders and consultants working in the Houston area. Some sustained damages to their office space, and displaced workers needed to be relocated or work remotely, while others came through unscathed. As flood waters receded, the Houston area faced many of the same questions that arose after Katrina:

  • What types of hazardous wastes were handled and stored in the hardest-hit area?
  • What potential contributing sources existed in the area before the storms hit?
  • What effect will the storms have on the market for Phase I ESAs as clean up and reconstruction gets underway?

Houston’s position as a large energy hub—home to oil refining and production facilities, chemical manufacturing complexes and other environmental risk operations—makes the area particularly vulnerable to contamination. Much of the news coverage post-Harvey focused on Superfund sites as well as the Arkema petrochemical plant that exploded after losing emergency power to its cooling systems. An analysis conducted by EDR immediately after Hurricanes Harvey and Irma showed that, in addition to SEMS/NPL sites, the areas of impact from both hurricanes included more than 3,000 other sites with known contamination on-site or that handle hazardous waste. A breakdown of EDR’s analysis by storm, study area of impact and type of risk is as follows:

 

 

 

 

 

 

 

In the months following Harvey and Irma, damaged properties needed to be carefully assessed for the impacts of any releases of hazardous chemicals and petroleum products. Reclamation of properties was complicated, particularly in the Houston area, by the presence of hazardous materials either from floodwater or from storage tanks and drums whose viability may have been compromised. The two most important aspects of the cleanup included environmental sampling and accounting for the hazardous waste and toxic chemicals in the area.

Financial institutions with bank locations and holdings in the impacted area also felt a hit.

“ENERCON assisted a large national bank client with disaster response and recovery efforts in the Texas coastal region for hurricane Harvey and in Florida and Georgia for hurricane Irma. The bank had plans in place to rapidly assess damage to branches and offices and take corrective action to get services to their clients back up and running as quickly as possible. ENERCON staff was called into the client’s emergency response command center before each storm made landfall, and was asked to mobilize a field team as soon as evidence of damage to bank buildings was detected. In the weeks following landfall of Harvey and Irma, our team assessed more than 100 bank buildings in the storm affected areas.  In addition, ENERCON mobilized a team from across the country to Florida in the wake of Hurricane Irma to assist a major utility with disaster relief efforts.” Xandra R. Garanzuay, P.E., Project Engineer, Enercon

CBRE estimated that Hurricane Harvey caused between $81 billion and $108 billion in property damage and economic loss for the greater Houston area. Up to 100,000 apartments were flooded, amounting to one of every six units in the area, and nearly 200,000 single-family homes sustained storm damage. EDR’s sister company, Trepp estimated that there were 2,414 loans with a total balance of exposure of $23.6 billion worth of debt that was sold as CMBS , according to an analysis of 33 Harvey-hit counties derived from FEMA’s list. On top of that, banks, insurance companies and other types of lenders also hold billions of dollars of debt backed by real estate in the affected region.

Environmental consulting firms stepped in to provide expertise in the areas of insurance claim support, testing, mold assessments and hazardous waste management. At impacted properties, Harvey also drove the need for Property Condition Assessment professionals to assess structural damage, as well as mold/indoor air quality professionals whose expertise has been critical for assessing damage related to water intrusion.

In an interesting technology side note, drones took to the skies to assess hurricane damages in both Texas and Florida for insurance purposes. Companies used drones on a much larger scale than ever before to record site conditions, to save time and avoid sending staff into potentially unsafe areas. Travelers Insurance, for instance, has 65 certified drone pilots among the 600 employees deployed to the Houston area.

Flood Risk and the Commercial Real Estate Lending Sector

The full extent of these storms on the commercial real estate market remains to be seen. In the hardest-hit regions, the risk of higher commercial mortgage defaults, particularly by borrowers lacking insurance, could drive properties back onto the selling block. There will also be a large concentration of insurance claims, and carriers are likely to be more cautious about issuing policies in the region, particularly given the contamination unleashed by the storm. Moreover, the contamination left in Harvey’s wake could also generate a more acute awareness of the need for environmental insurance as a way for clients to manage business risk, particularly in flood-prone areas. This could lead to Phase I opportunities with insurance providers serving this area. Rating agencies, lenders, insurance firms and investors are also likely to scrutinize loans in FEMA-affected zones much more closely in the coming months and even years. Loans originated for CMBS pools could be subject to the most stringent levels of environmental due diligence.

These epic storms are also raising awareness of the need for urban planning and design to account for the likelihood of severe weather events especially in flood-prone areas, and will likely alter infrastructure and land use development decisions for years to come into the least vulnerable areas. While the scientific community has clearly acknowledged the increasing risk of flooding both in coastal communities (as well as some non-coastal communities), the real estate finance world, including both debt and equity investors, has largely ignored the long-term impact of increased flooding.

“Investment time frames of say 5 to 10 years, have permitted investors to essentially box the risk with flood insurance along with a healthy dose of denial,” observed Michael Berman, a consultant and Fellow at the University of Pennsylvania Institute for Urban Research at Wharton. “Virtually no one takes into account a potentially significant increase in flood insurance costs over the next decade, nor the possibility that properties may be literally inaccessible for as long as 40 days a year due to tidal and other flooding. Also, no one is accounting for potential flood-related reductions in property values over the next 10 to 20 years.”

In the wake of recent storms, organizations and municipalities are starting to address these issues. Led by organizations such as the Rockefeller 100 Resilient Cities initiative and the Bloomberg Foundation’s efforts, a handful of cities have begun to engage in long-term planning in areas with the most exposure to disruption to their economies over the next 30 to 50 years, but these efforts are only the beginning of what will be an increasing focus over the coming decade with implications for commercial property owners, lenders and the due diligence community that supports them.

FOR MORE INFORMATION

The EBA Journal’s Winter edition is posted here for association members. In it, you’ll a related hurricane article by Dale Allison on ATC’s Tales from the Field doing hurricane response work in Florida, as well as other articles listed below:

  • How a Federal Jury Tagged a New Landowner with PCB Liability
  • Green Financing for Multifamily Housing
  • Seismic Risk Considerations for Real Estate Stakeholders
  • Infill Development of Oil Fields
  • Bitcoin, Blockchain & XMS
  • Why Lenders Should Conduct Adequate Environmental Due Diligence