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SEISMIC RISK
Structural designs in seismic (earthquake prone) regions differ from other areas of the country in that they include stiffening modifications to withstand the movement, shaking, etc. of seismic forces. In areas with a high probability of damage from earthquakes, an understanding of the seismic vulnerability of a new investment property should always be included as part of the real estate investment underwriting process. Major economic losses on both new and old properties can and do occur, as evidenced by the earthquake of January 17, 1994 whose epicenter was approximately one mile southwest of Northridge, California. Prior to that event, steel moment frame buildings, a modern structural design methodology, was considered highly effective in resisting seismic forces. The Northridge event (not a particularly large event) apparently pushed these structures to their design limits, causing unexpected damage to a large number of new structures. Older structures performed as expected, with many experiencing severe damage beyond repair resulting in substantial economic loss as far away as Santa Monica, 15 miles from the epicenter (EQE, 1994).
Seismic risk management is one of the least understood risks of the real estate investment process. With most California properties not being insured for earthquake loss, seismic risk probably poses the greatest potential risk of substantial loss to a real estate investment. Because many lenders do not understand seismic risk, there is no universal requirement to insure against seismic risk as a condition of a mortgage loan, as is now required for other potential casualty losses. Lenders wishing to remain competitive in California, understand that requiring meaningful earthquake insurance will likely prevent them from conducting very much business since availability of insurance coverage is limited and premium costs are high. Non-structural damage to all but the most earthquake resistant structures can equate to losses of 20% to 30% of a building's replacement cost from a modest significant event. Assuming that the funds needed for repairs are readily available and that a competent project team can be assembled to begin the repair process in a timely manner, repairs can take 6 months or more. The most owner-friendly leases in California have clauses that allow tenants to vacate in the event that such repairs are not completed within 6 months. Many have time frames one-half as long or less. Any lender who does not include understanding and underwriting the potential risks from earthquake loss is unknowingly assuming the lion's share of an owner's risk. Such a lender should expect someday to be in the unenviable position of foreclosing on a vacant property that requires substantial repair or worse, is a total loss.
Construction methodologies and seismic code requirements have evolved over the past two decades. As a result, newer buildings, particularly mid and high rise buildings, are expected to exhibit a significantly higher level of earthquake protection than older designs. Code requirements are intended to assure basic safety by attempting to minimize potential injury inducing damage, such as structural collapse and radical shifting of heavy contents. Buildings designed in accordance with codes will still sustain direct physical damage to the building structure and to major non-structural elements due to shaking, lurching, fault rupture, landsliding, liquefaction, and tsunami. These are known as "primary" sources. Damage from primary sources can take the form of excessive and permanent deformation to structural members and connections, cracking of structural and non-structural components, and the misalignment and breaking of utilities and components of mechanical transportation such as elevators and escalators. Secondary damage caused by hazards released from an event, such as fire or water damage are often greater than the primary damage.
Estimating seismic damage is a complex matter involving problems of structural analysis, specification of ground motion, probability of occurrence, and definition of damage. The seismic vulnerability of a building depends upon its age, structural type, the soil conditions upon which it is constructed and its proximity to a fault. Currently there is no one universally accepted methodology for estimating seismic risk as a component of investment underwriting. In processing loans there is a need to utilize a simplified analytical methodology that can provide a rapid assessment of the order of magnitude of the risk that can be expected. To date, several sophisticated computer based rapid risk analysis methodologies are available on the market. The best of these are based on a methodology originated by the Applied Technology Council resulting from its research published as ATC - 13 Earthquake Damage Evaluation Data for California (ATC, 1985). This methodology is based upon the opinion and experience of seismic experts regarding the expected response of building types to a range of seismic events. The methodology provides estimates for expected losses for various building structural types at various earthquake intensities. These expected losses are expressed as probable maximum loss (PML).
Probable Maximum Loss is the estimated cost to repair the damage resulting from a seismic event of a defined intensity, expressed as a percentage of a building's total structural reproduction cost. Typically this cost does not include the cost to replace a building's contents or the additional cost of performing repairs after-hours (evenings and weekends) with a tenant in occupancy. The intensity of an event is usually defined in terms of the Modified Mercalli Intensity (MMI).
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