Bill Tryon Bill Tryon

How can property owners, investors and lenders protect themselves from increased risks?

The seismic risk landscape is changing. For the first time, the U.S. Geological Survey has included “man-made earthquakes” in a study of seismic hazards in the US. In addition to that, ASTM just released revised standards and guidance for Seismic risk Assessments and Probable Maximum Loss reports (known as ASTM E2026-16a and E2557-16a). And, the Cities of Los Angeles and San Francisco have implemented mandatory retrofit ordinances that require the seismic the correction of seismic deficiencies at thousands of at-risk buildings. Investors and lenders have yet to decide on the best way to handle these changes.

We are hosting a webinar on Wednesday June 29th that looks more closely at these changes – so be sure to register for that now! First, let’s take a closer look at the impact that human-induced earthquakes have on commercial real estate.

Human-Induced Earthquake Risks A few years ago, a 5.6 magnitude earthquake buckled highways, toppled chimneys, tumbled bricks from buildings in Oklahoma, and woke seismologists up to a growing problem. Oklahoma has had earthquakes before, but until the early 1990’s they were limited to one or two per year, yet last year there were nearly 900 earthquakes above 3.0 on the Richter scale. Concerns were extended last year when several quakes over 3.0 were felt in the Dallas area. Along with a few other areas of the US, Oklahoma and Dallas are experiencing increased earthquake activity as a result of human activities – the injection of waste water from fracking operations into the subsurface.

There has been much debate over the cause of this increased activity, but the USGS has officially acknowledged related risks. Earthquake hazard maps published in 2014 included areas of human-induced earthquake activity, though the maps did not reflect ground shaking expected to result from these earthquakes. More recently, USGS published a one-year seismic hazard forecast addressing the hazard from human and natural earthquakes in the Central and Eastern regions of the U.S. The new USGS data shows six states are most at risk of human-induced earthquakes: Oklahoma, Kansas, Texas, Colorado, New Mexico and Arkansas.

“By including human-induced events, our assessment of earthquake hazards has significantly increased in parts of the U.S.,” said Mark Petersen, chief of the USGS National Seismic Hazard Mapping Project.

Though the magnitude of earthquakes experienced in these areas so far is relatively low, it is important to understand that the Richter scale used for measuring earthquakes is logarithmic, so that the wave amplitude of a 5.0 earthquake is 10X that of a 4.0, and the amplitude of a 6.0 earthquake is 100X that of a 4.0. More importantly, a 6.0 earthquake releases ~900 X the energy of a 4.0 earthquake. According to a report issued by the Federal Emergency Management Agency, FEMA, a 6.0 earthquake in Dallas, relatively small by California standards, would result in property damage in the range of $10 Billion.

These maps provide a comparison of the risks from induced earthquakes in Dallas/Fort Worth and Oklahoma to the West coast and New Madrid fault areas, indicating more widespread potential for damage in the areas of induced earthquakes. As a direct indicator of losses, the maps may be alarmist, since they are based upon a 1% chance of exceedance over the next year, but the comparison to areas of historical earthquake activity is informative. The maps depict the intensity of ground shaking based on the Modified Mercalli scale, which captures the way earthquakes feel to those affected, as well as the associated level of damage.

How Does This Impact CRE? Some impacts to commercial real estate are obvious. When buildings are damaged as the result of an earthquake, owners will have to rebuild or complete repairs. Unlike damage from fires, though, earthquake damage is excluded from hazard insurance policies. As a result, owners would have to come out of pocket. The value of the damaged properties would be decreased, but the threat of such damage can also affect values. Property values in the general area can also be affected, though recovery normally occurs within a year or two following the event.

Less obvious impacts include damage to local infrastructure, disruption of critical services, interruption of property operations resulting in loss of business or investment income, possible loss of tenants and re-tenanting costs, loss of inventory or other building contents, and difficulty in refinance or sale of the property.

The estimation of the risk of property damage is complicated by several factors:

  • Induced earthquakes occur closer to the surface than most natural earthquakes, resulting in an increased surface ground shaking damage to structures. 
  • Peak ground acceleration data normally used in estimating earthquake losses has not been released by the USGS.
  • Building codes in the area have not been modified to reflect seismic design criteria, which may result in an increased risk of damage.
  • The probability and magnitude of induced earthquakes is expected to vary depending upon the proximity to injection sites and the quantity of material injected.
  • The maximum magnitude of induced earthquakes can’t be determined from historical record. In a conference held in 2014, experts agreed that 7.0 would represent a reasonable estimate of maximum earthquake.

How can property owners, investors and lenders protect themselves from increased risks? If you’re building a new building, ask your engineer to evaluate the design in the context of current information.  If you own or are buying or lending on properties in affected areas, consider engaging an engineer to visit the site and review construction plans to provide an opinion of damageability. These studies are commonly referred to as assessments of Probable Maximum Loss, the standards typically applied to these estimates allow significant discretion to consultants and clients to determine the scope and depth of investigation. At minimum, clients should consider assessment in accordance ASTM Standard Practice E2557; however, the development of peak ground acceleration estimates used in estimating the PML will require additional study or extrapolation from currently available information.

Buildings built after the implementation and enforcement of modern criteria for the prevention of wind damage (2007) are less susceptible to earthquake damage. As an initial screen, building owners and investors can look for the following additional indicators of increased damageability. Though the absence of these conditions is not an assurance of low damageability, they represent an increased potential for damage if found.

  • Buildings over 8 stories
  • Multi-story buildings with large openings or building areas (e.g. parking or commercial space), also known as soft-story construction
  • Unreinforced masonry
  • Direct contact with other buildings
  • Concrete buildings, regardless of construction date (for possible non-ductile design)

Adjusting Your Seismic Risk Policies The new USGS data shows that seismic risk has increased significantly as a result of human activity. In order to adequately manage risk across their portfolios, lenders’ risk management policies should consider PML ratings not only for assets in commonly recognized high-hazard areas such as California, but also those in blind spots across other parts of the country.

Again, we will be addressing questions surrounding the USGS revisions, and the many other recent changes affecting seismic risk policy during our webinar on Wednesday June 29th at 2pm EDT.  The webinar will also be available on demand for 3 months, until September 29th.  Register here!