Doomsday prophets in Los Angeles are waiting for the Big One.
It’s the earthquake with a magnitude of 7.8 or above that would strike along the southern San Andreas fault line, pulverizing L.A.’s built environment, flattening homes, offices, shopping centers and likely leading to tens of billions of dollars in property damage — not to mention loss of lives.
Such a quake would be 44 times stronger than the one in Northridge in 1994, a 6.7 magnitude disaster that killed 58, injured more than 9,000 and caused more than $49 billion in economic loss.
“God forbid, we have another one, because the estimates for damage are north of $75 billion, maybe $100 billion,” said Alexandra Glickman, an insurance and real estate expert at Arthur Gallagher Risk Management Services.
There’s a 99 percent chance that at least one earthquake with a magnitude greater than 6.7 will strike California in the next 30 years, according to the California Earthquake Authority.
Yet only around a fifth of commercial properties across California have earthquake insurance, according to estimates from Andy Tran, an insurance commissioner at the California Seismic Safety Commission. That leaves most landlords exposed to the full extent of any damages that may arise from a big quake.
The reason? Earthquake insurance isn’t cheap. Deductibles are often 5 percent of the estimated cost to rebuild a property, costing some landlords a couple of dollars per square foot each year.
“It’s very, very expensive,” said Babak Ziai, the founder of BrandView Capital Partners, which owns six mixed-use office properties across L.A. That cost has proven prohibitive for many landlords, who are taking a gamble and hoping that their buildings are solid enough to withstand a sizable earthquake.
Birth of a safety net
Earthquake insurance, which most major insurers and many smaller firms provide, has been around since the 1970s.
Traditionally, however, it was mostly institutional investors who’d opt in, as their purchases were often highly leveraged and their lenders would pressure them to get insured.
Meanwhile, researchers at Stanford University and the University of California, Berkeley, started developing engineering models and standards to determine whether buildings were at risk in the case of an earthquake.
“They were able to figure out where there are potential losses and what those projected losses would be,” Glickman said, referring to what is now known as probable maximum loss modeling.
California has also updated construction codes for buildings. L.A. County has specifically identified certain buildings that are highly exposed to earthquake damage and has mandated they be retrofitted — though Glickman said the dates for enforcement are routinely pushed back.
Even with strict codes, more commercial owners have opted into insurance in the last 20 years, as buildings have started to get older.
Protecting investments
“Buildings are not like fine seasoned wine, they do not get better with age,” she said. Institutional owners, rather than lenders, started to understand the need to protect investments.
In 2014, Rexford Industrial Realty, one of the largest owners of industrial properties in Los Angeles, did not carry earthquake insurance.
“Substantially all of our properties are located in areas that are subject to earthquakes and are not currently insured against such an event,” Rexford said in an annual earnings report for 2014. “We will continue to monitor third-party earthquake insurance pricing and conditions and may consider obtaining third-party coverage if we deem it cost effective.”
In 2016, the firm still didn’t add earthquake insurance policies, but did disclose that it would retrofit properties if advised by seismic engineers.
A year later, Rexford obtained earthquake insurance coverage for all of its properties.
“A severe earthquake in the Southern California region could result in uninsured damage to a subset or even a substantial portion of our portfolio and could significantly impact our cash flow,” Rexford said in its 2017 annual report. The firm still has earthquake insurance on its portfolio today, according to its most recent earnings report.
Bigger landlords might have the cash on hand. Boston Properties carries earthquake insurance with a deductible equal to 3 percent of the affected property’s value — slightly less than the average insurance plan for commercial properties.
At the Colorado Center, the firm’s 1.1 million-square-foot office campus in Santa Monica, insurance would cost around $6.8 million per year, given that the value of the firm’s ownership is around $229.6 million, according to an earnings report from earlier this year.
It’s far harder to convince smaller commercial property owners to kick up the cash for insurance.
“It’s a choice and it’s up to you,” Ziai said, adding that he opted out of earthquake insurance on a 100-year-old property in Venice Beach and chose to do a seismic retrofit within 18 months.
Etan Frankel, an L.A.-based investor who owns 10 properties in California, chose not to renew an earthquake insurance policy on a strip mall he owns. The price tag would have been up to $20,000 per year.
“If an earthquake destroys it, we’re not going to rebuild a strip mall,” he said, adding that the costs of fire insurance and services such as trash collection have all risen in recent years.
But in the event an earthquake does level a property, someone still has to pay rebuilding costs.
“If you don’t have the equity, you might throw the keys to the lenders and say that was fun,” Glickman said.
But for smaller landlords, lenders will require the buyer to undergo a Probable Maximum Loss analysis — a report conducted by a structural engineer to determine how much of the property would falter in the case of an earthquake.
If the report determines more than 20 percent of the property would be lost in the event of an earthquake, a lender might then require the incoming owner to renovate and upgrade the property to fix some of the structural issues.
Even if a retrofit has been done, owners might still buy earthquake insurance as retrofitting drives down the price, Glickman said.
With a retrofit, “your building might be earthquake resistant,” Glickman said. “There’s no such thing as earthquake proof.”
Will it happen?
Small business owners who also own property rarely have earthquake insurance, according to Tran, the commissioner at the seismic safety commission.
“It’s a lot of experience bias — most Californians have not experienced a massive earthquake,” Tran said.
It’s also a lack of education and understanding of insurance in general, he added. “Talk to the average person, some think they have it.”
Others assume the federal government will step in and help pay for rebuilding costs in the event of a large quake.
“The average [FEMA and Small Business Administration] payouts are like $20,000,” Tran said. “That’s not going to get you through an earthquake. And it’s a loan.”
Deciding whether to get insurance is a difficult choice for landlords, given that it’s subjective and the risk is difficult to fully understand, according to Ziai. “It’s been 100 years, nothing has ever happened to [the property] and then it becomes just so subjective,” he said.
“With earthquakes, it’s easy to say it hasn’t happened for a while,” Glickman said. “But the longer you wait, the higher probability one will happen.”
The post Shaken, not stirred: LA commercial landlords are opting out of earthquake insurance appeared first on The Real Deal Los Angeles.
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