Simplified Estimation of Economic Seismic Risk for Buildings

Seismic risk enters into several important real-estate decision-making processes:
purchase of investment property, performance-based design of new structures, seismic
rehabilitation of existing buildings, and decisions regarding the purchase of earthquake
insurance, for example. In such situations, it matters who the decision makers are, how
they make decisions, what aspects of seismic risk most concern them, how long their
planning horizon is, and other parameters. We focus on one of the more common seismic
risk decision situations: the purchase of existing commercial property by real-estate
investors in seismic regions. (The most common situation is probably purchasing a home
in seismically active regions.)
Economic seismic risk to these properties is assessed every time the property
changes hands, on the order of every five to ten years. By contrast, a building is designed
and built only once. Thus the most common opportunity for market forces to
bring about seismic-risk mitigation for commercial properties is at times of sale. Anecdotal
evidence suggests that these are mostly missed opportunities: risk is typically not
mitigated, even in more vulnerable buildings.
This can be partly explained by considering the context in which seismic assessments
are performed. During virtually every sale of an existing commercial building, the
buyer assesses the building’s investment value using a financial analysis that considers
revenues and expenses, rent roll, market leasing, physical condition, and other property
information. The investor makes his or her bidding decision based on projected income
and expenses, using one or more of the economic performance metrics of net present
value, net operating income, cashflow, internal rate of return, and capitalization rate.
The input to this financial analysis is typically provided by a real-estate broker representing
the seller, whose figures the investor checks and modifies during a duediligence
study. Many of the inputs are known values—number, duration, and income
from current leases, for instance—but many are uncertain. Vacancy rates, market rents,
and other important parameters fluctuate significantly and unpredictably, leading to substantial
uncertainty in the future economic performance of a property. In the face of
these uncertainties, the bidder usually estimates investment value using best-estimate inputs
and then again with deterministic sensitivity studies to probe conditions that would
lead to poor performance (higher future vacancy rates, for example). The future cost to
repair earthquake damage is not one of the parameters the bidder uses in the financial
analysis. This is important: seismic risk is not a market quantity.
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