What lessons can we learn and apply to commercial real estate from the Champlain Towers South condominium collapse in Surfside, Florida?

Author: Caley LaRue

Headlines from the press

  • Judge Overseeing Surfside Collapse Case Worried Survivors Won't Get Enough Insurance Money. Newsweek, August 20211

  • Plaintiffs' lawyers have filed some two dozen lawsuits following the collapse of the Champlain Towers South condo tower last month, seeking payouts for the 98 deaths and destruction of 136 apartments it caused. The lawyers say it would take $1 billion to compensate everyone fairly. Wall Street Journal, July 20212

  • The insurance "will obviously be inadequate to compensate everyone fully to the extent of their horror," Judge Michael Hanzman of the 11th Judicial Circuit of Florida said at an early hearing. MarketWatch, July 20213

It's hard to look at the tragedy coming out of the Champlain Towers South condominium collapse in Surfside, Florida and not wonder: How would the headlines be different if this was a for-profit company's building versus a not-for-profit condo association with limited financial resources? Take out the word 'condo association' and insert 'multifamily owner' or 'REIT Board of Directors' with perceived deeper pockets and this situation becomes very real for commercial real-estate.

The estimate for damages from the Surfside collapse has been speculated to be as high as a billion dollars. Insurance coverage is reportedly limited to around $50 million, with $31 million for the physical property loss and $18 million for the liability litigation.With roughly two dozen suits filed primarily against the condo association's Board of Directors, where will the funds come from that the plaintiffs are seeking?

What lessons can we learn and apply to commercial real estate through this horrible tragedy and loss of life? What if such a collapse had occurred at an enclosed mall, a large rental apartment building or a packed theater? Surely the headlines and accusations of poor management/negligence would read differently for the owner of those assets. The judge overseeing the Surfside collapse has pressed for a final resolution in one year so that the finite insurance proceeds can go to the victims, not the lawyers.If Surfside had been a commercial real estate property, it is unlikely the claims would be resolved in a year's time.

The preponderance of damages sought in such tragic situations is on the liability side, not from property loss. Property losses can be easier to value than a liability, as the time-honed commercial appraisal process works well here (as well as the time-honed lender's requirements for property coverage limits). Liability loss is much harder to value as it is so fact-specific to what and who caused the negligence and when it occurred.There is no well-established process to predict liability damages with as much certainty as property losses. Plus, property owners never expect a catastrophe of such magnitude to happen to them.

Harder-to-predict (and predictive loss model) liability losses skew higher-risk towards assets focused on density of humans. There is a higher risk of liability loss at multifamily/large venues, for example, versus industrial warehouses or self-storage assets. But the baseline exposure is certainly there for everyone, regardless of the asset class.

Much institutional-quality investment tends to be in properties that are newer in age and better maintained. Deferred maintenance is less of an issue. Investors in Class B or lower quality assets really need to factor in the physical health of the asset when investing – as the potential for liability loss could be enormous compared to the return on investment capital. Had this 40-year-old condo building been a commercial building, lenders would likely have mandated higher property insurance limits; however, the liability insurance limits may not have been any higher as this is more of a discretionary purchase decision.

How does the perennial debate between annual investment return and capital budgets/expenditures play out now against such a tragic loss? We all know that regular maintenance is the key to preserving the underlying value of any asset, but the emphasis on proper maintenance is likely to intensify in the face of such a large liability loss. Asset managers need to have a stronger voice in looking at all aspects of risk, and the liability for deferred maintenance just became more prominent for every portfolio. Certainly, Class A/B properties have it a bit easier, as the maintenance expense is generally less than for a lower-grade portfolio. Yet, maintenance needs to be performed regularly for every class; if not, it becomes deferred maintenance.

Most people associate risk as sudden and unexpected loss, but what about slow and predictable risk? Think of wooden stairs that are not inspected for long periods of time. Asset managers/property managers need to make the property owners understand that regular and preventative maintenance is the greater part of a risk management program and not just a property-level expense.

We frequently think of risk management in terms of insurance – and there is certainly a role for insurance to play. But insurance is rarely the solution to the problem; rather, it is the broom that comes in to clean up afterwards if a problem has not been properly resolved upfront. Commercial real estate professionals frequently focus more on property insurance since it is a big spend, but equally, if not more so, the liability aspect also needs proper assessment.

While risk management needs to start with good maintenance, effective insurance must be in place for unforeseen losses that cannot be predicted or fixed through maintenance. The liability to anyone in the chain of command (property management, asset manager, Board of Directors, etc.) is best addressed by having an indemnity agreement in place for the individual by their employer. This agreement becomes the first line of defense for anyone accused of making poor decisions on assets management. Property Manager Errors & Omissions and Directors & Officers liability insurance are two critical insurance policies to augment the risk management/risk mitigation chain. Insurance brokers who are well-versed in the nuances of commercial real estate can assist in determining the appropriate limits to purchase.

The loss of life from the Champlain Towers collapse was tragic. Hopefully, we can honor the lives lost through a greater focus on preventative maintenance and risk management.

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