Impact of Flooding on the Value of Commercial Property in the United Kingdom

Transcription

1 Impact of Flooding on the Value of Commercial Property in the United Kingdom Namrata Bhattacharya, PhD student, School of Built Environment, University of Wolverhampton Jessica Lamond, Post-Doctoral research fellow, School of Built Environment, University of Wolverhampton David Proverbs, Professor and Head of Department, Construction and Property, University of West England Felix Hammond Lecturer, School of Built Environment, University of Wolverhampton Abstract The necessity for estimation of avoided loss in commercial properties has emerged as a serious concept in impact assessment studies. Disasters like flood are increasing with time thus proving importance of estimation of asset values especially to commercial properties. Commercial properties exposed to proximity to flood source, higher probability of occurrence of flood events, and flood characteristics (water depth, velocity and extension) are highly susceptible to flood risk. Lack of insurance against flooding in commercial property sector further aggravate the situation and increases the cost of damage.an estimation of the impact of different components affecting the vulnerability of commercial properties to flood risk and their implications on their market value is important since these factors have not gained much attention so far. Knowledge of impact of flooding on properties will be important for both the stakeholders of commercial property and the insurance companies as lack of flood insurance have been identified as a key determinant in property valuation, transfer and management. This preliminary research as part of a doctoral study examines evidences from previous studies with regard to methods used in estimation of property damage especially for commercial properties and the respective valuation models with reference to the UK market. The review seeks to identify any broad patterns of flood impacts on property market, major concerns of the property holders and to estimate the magnitude of impact.lessons are drawn from existing literature related to data requirement, choice of methodology, and analysis problems specific to the UK. Market changes have an important effect on the overall valuation pattern; however at this preliminary stage of research the exact change and effect that it has on value of property cannot be succinctly pointed out. The novelty in this research is that no cases have been published directly concerning asset valuation of commercial properties and its relationship in the context of flooding in the UK. Keywords: Commercial Property, Flood, Impact, Review, Value.

2 1. Introduction 1.1 Floods and the damage they cause Floods are a natural phenomenon; however when they exceed the coping capacity and damage life and property then they become a major source of concern. Not only in the UK but worldwide extent of damage caused by this natural disaster is constantly on the rise (Munich- Re, 2010). Several reasons have been identified for the increased number of flood events pertaining to natural and anthropogenic factors. Among the natural causes intense rainfall, snowmelt, erosion and seismic activities are the major concerns while as far as anthropogenic activities are concerned interference to the natural flow of rivers, development and high rate of urbanization, mismanagement of risk reduction authorities, failure of control structures and construction of inappropriate structures are the significant causal factors. Flood risk mainly encompasses two aspects- the hazard itself, i.e. the probability of occurrence of the flood and the consequences during and after the event. This involves the need to separately assess the damaging impact of flooding along with other physical and environmental investigations. Damage can be direct and tangible with immediate physical contact of flood water (lives, buildings and infrastructures, standing crops, machineries, equipment s, inventories, and products) or indirect and non-tangible (loss of economic production to flooded areas as well as areas away from those which are actually inundated, loss of job, migration, disturbance in market supply and market prices, physical and mental stress, disruption of normal life and livelihood) (Messner & Meyer, 2005). The UK suffers from risk of flooding from river, sea, groundwater, sewer, reservoirs, and surface water (EA, 2009). The Environment Agency plays a central role in management of flood risk and coastal management in the UK. Several flood events as in 2000, 2005 and 2007 and their severe impacts generated increased interest in flood risk management and government has recognized the importance of investment (up to 800 million in ) in risk reduction processes. However, the latest policies of the UK Government have reduced the current level of investments and this reduction is expected to continue in the future. The ABI (2010) noted that the investment has reduced from 2.13 Billion for the three years ( ) to 2 Billion for four years ( ). Steps like Planning Policy Statement (PPS25) have been taken to reduce and control the development in flood prone areas and government is trying to ensure warning and preparedness by increasing the number of households and businesses to benefit from systems like Flood-line for direct flood warning. In spite of all these measures there are still 2.4 million properties at flood risk from river and sea and 2.8 million properties at risk from surface water flooding in England and Wales (EA, 2009). Total expected annual damage to residential and non-residential properties is about 1Billion.With the increasing pressure of development, population expansion, land use changes and changing nature of climate with higher temperature, increased rainfall and sea level rise acting as drivers, flood risk is likely to increase in the future (Foresight, 2004).

3 The recent flood event in 2007, which created havoc in parts of England and Wales, has been estimated by the Association of British Insurers (ABI, 2009) to have cost about four times the normal yearly claim experience. The claim was about 3 Billion and among the total 135,000 claims 35,000 were from business properties alone (EA, 2009). This number could have gone higher if commercial property holders had shown more awareness and response, as residential property holders have done, towards flood risk in pooling their exposure through insurance. AXA insurance reported that 85% of the commercial property holders are aware of the risk but only 26% consider that as direct threat to their business (AXA, 2006). The reason behind such ignorance can be partly attributed to the lack of attention by stakeholders as well as researchers towards commercial sector so far. Regardless of the immense importance of the commercial sector to the national economy most current research studies are either partly or fully focused on residential properties. It has been recognized that new research is required to gain better understanding of the nature and characteristics of flood risk in the commercial property sector and identify the key elements that directly or indirectly have an impact on the value of assets under threat. 1.2 The purpose of Study The UK commercial property sector with an estimated turnover of 3200 billion and employing about 22.8 million people with an average growth rate of 2.2% since 2008 (BIS, 2010) is highly vulnerable to the increased occurrence of floods. The value of property damage is on the rise resulting in large scale loss mentioned earlier. This has led to the recognition that there is a need for assessment of the estimated value of the existing assets at risk in order to improve upon public administration, for example preparing flood protection plans, looking for alternatives to save or minimize property damage. In other words an estimation of endangered asset valuation is a pre-requisite for avoided loss. Understanding the functioning of different sectors within the commercial property framework is necessary to have an idea of the reasons behind the oversight in damage control and factors affecting the valuation of property. The necessity for estimation of avoided loss in commercial properties is an important aspect of impact assessment studies. Disasters like flood are increasing with time thus demonstrating the importance of estimation of asset values especially to the commercial sector. The added concern arises as to whether the decision of the government to bring cuts in investments in flood defence (ABI, 2010), or the changing policies of insurance companies to increase their premiums to the most risk prone areas after 2013 (after the end of Statement of Principles agreement), will actually have any significant implications on the value of commercial properties in the UK. It is also important to understand how the flood experience of 2007 had an effect on the company stake holders in adopting to flood protection and mitigation activities. Therefore the doctoral research seeks to develop a suitable framework to identify and analyse key aspects of vulnerability of commercial properties and their related asset values in the context of flooding. To this end it will focus towards understanding the impact of flooding and its implications on value of commercial properties. In that context, the present paper as part of

4 the research will put special emphasis on the preliminary insights gained from different literature sources in terms of factors affecting vulnerability of commercial properties towards flooding and the different methods used for analysis of damage assessment and valuation of commercial properties. The review will also indicate the possible uncertainties that have been identified in the proposed methodological approach and how to reduce their effects in research. 1.3 The aim and target audience It emerges that a body of literature exists on existing risk of flooding, (Johnson et.al, 2007; Kenny, 2006; Lamond, 2008; EA, 2009) the measures taken by the UK Environment Agency for flood risk management, investments attributed towards flood risk reduction and construction of new defences and some reports and evaluation from insurance industries as a whole in the UK. There is however a dearth of literature available with special reference to value of commercial properties and flooding. Some methodological studies on estimation of damage assessment were obtained from international sources including USA, Japan, Australia, Germany and from within the UK. This study summarizes the knowledge gained from the literature on the status of flood risk in the UK including insurance, the models and factors affecting valuation of commercial property and the models in different parts of the world used for flood damage estimation. Attempts are made to draw insights to the possibilities and hindrances in generating value models for commercial properties with reference to effect of flooding on them. This will feed into the on-going research towards investigating the impact of flooding on the value of commercial properties in the UK. In the wider context the beneficiaries from the study will be those stakeholders who are directly or indirectly related to the commercial property sector which are under the threat of flooding. These stakeholders can be classified into property holders or owners, property buyers or lease holders, local government, insurance companies, investors, occupiers, customers, suppliers, employees, and emergency service holders. The second group of beneficiaries will be the scientific community who will benefit from a study area which has previously been neglected. 2. Status of flood vulnerability and flood insurance in the UK The Environment Agency (2009) estimates about 5.2 million properties are under the risk of flooding in England and Wales out of which 185,000 are commercial properties. This is the first estimate that includes surface water flood risk thus increasing the total number of properties at risk to a large extent from their previous estimates. The main concerns for stakeholders of commercial properties in the UK based on the current situation of increased number of properties at risk and increased risk of flooding are (PLC property, 2011): Potential increase in the cost of insurance as insurance companies now have access to more reliable data including data on surface water flooding.

5 Many insurers are taking into account the risk from climate change and groundwater flooding and reviewing their flood insurance premium structures. Mortgage finance security in properties can be more difficult to acquire due to higher flood risk and lower security from flood insurance. Potential risk of disruption to business, loss of profit and lack of essential services Higher cost of relocation to other properties even for a temporary basis Higher repairing, replacement and reinstatement cost Negative effects in the form of economic, social and physical loss during and after a flood situation to the people related to the commercial property sector directly or indirectly. Based on the potential risks mentioned above it is realized that a well-informed knowledge base is required to bring in aspects of flood vulnerability and asset valuation in the same platform. These concerns will form the core of the research based on which further analysis will be performed. 2.1 Factors affecting vulnerability of commercial properties to flood risk There are several schools of thoughts defining vulnerability in their specific contexts. However the basic indicators that significantly affect the vulnerability of properties towards flooding are mainly the amount of exposure, type of assets exposed and their level of susceptibility described below in table 1. The study intends to use these vulnerability factors to develop a conceptual model for flood vulnerability of commercial properties. This will be further used in the form of vulnerability index and will be integrated with valuation index to analyse the implications of changing vulnerability on the valuation of commercial properties. Table 1.Vulnerability of commercial properties to flood risk (Adapted from Messner & Meyer, 2005) Vulnerability Analysis 1.Exposure indicators Exposure Flood characteristics Proximity to source of flooding, Elevation of the area, Probability of occurrence of flood, Existence of flood defence Flood duration, Flood velocity, Flood depth, Flood extension 2.Elements at risk Value/ Damage potential Buildings, Infrastructure, Machinery, Production

6 People, Other inventories 3.Susceptibility indicators Preparedness, Coping capacity Degree of realised damage Recovery, Resilience 2.2 Status of flood insurance in UK The general norm for flood insurance companies in the UK to evaluate property under risk has been to use the National Flood Risk Assessment (NaFRA classification of risk level) database which dealt with river and coastal flooding. Recently surface water data has also been introduced. The ABI decided upon some guiding principles based on which the Statement of Principles (ABI, 2008) with the government was agreed. This arrangement was organised after a long discussion and debate following the 2007 UK flood claim with the insurers and the government confirmed on the basis that significant risk protection measures will be taken particularly to those properties which are at high risk zone and as part of a series of agreements this arrangement will continue until However, there are certain exceptions to the statement of principles which were not included in this strategy which are significant for this study. All commercial properties except a poorly defined class of small businesses were excluded from the agreement. The agreement also excludes any new properties constructed after January 2009 and those properties which fall under significant risk zone and where there are no plans to do any mitigation work for the next five years. The insurance companies have full rights on the restrictions on price, terms and conditions they offer for issuing flood insurance(abi, 2008). Since most of the commercial property insurance does not cover flood risk therefore it becomes more important to generate awareness among the commercial stakeholders to be aware of the risk. 3. Damage assessment and valuation methods for commercial properties 3.1 Models for flood damage assessment The different valuation models for damage assessment of commercial properties are summarized below acquired from the literature. These models are internationally recognized and are used in industrialized countries suitable for regions where organized data is available.

7 Country Name of Model Scale of Study Type of loss estimation Impact parameter Resistance Parameter Australia (NR & M, 2002) Anu-Flood Micro Absolute Water Depth Object size and Susceptibility Australia (NRE, 2000) Rapid Appraisal Method (RAM) Micro Absolute Water Depth Object size, value, lead time and flood experience USA (FEMA, 2003; Scawthorn, 2006) HAZUS- MH Micro, Meso Absolute Water Depth Age and condition of assets Japan (Dutta et.al. 2003) Micro Absolute Water Depth Floor space, number of worker per unit type, land cover Germany (Kreibich, 2010) MURL, ICPR, Hydrtec, LfUG Meso Relative Water Depth, Specific Discharge in m 3 (for LfUG) Land use data (CORINE and /or ATKIS) Germany (Kreibich, 2010; Seifert, 2010) FLEMOcs Meso Relative Water Depth Size and sector specific, Land use data (CORINE and /or ATKIS) UK Penning- Rowsell et.al (2005) Micro and Meso Absolute and Relative Water Depth and Flood duration Object type and lead time

8 The Anuflood model (NR & M, 2002) used for a study in Queensland Australia obtained results differentiating in building structures and inventory. The advantages of using Anu-Flood is that it can use small sample size which can be useful for UK commercial property sector for construction of damage curves however it lacks in subjectivity and unable to compare between different types of business. The empirical synthetic study performed by the Rapid Appraisal Method (RAM) (NRE, 2000) in Australia estimating absolute damage based on average loss values is fast, less complex and cost-effective. Nevertheless, due to averaging they ignore damage data variability and also extreme values. This model can be helpful in areas where data variability is minimal.. In the case of HAZUS-MH, an empirical synthetic model used in the USA developed by FEMA (Federal Emergency Management Agency) relative loss functions used for damage value estimation can be used for both micro and meso scales (FEMA, 2003; Scawthorn, 2006).The smallest unit of measurement used for HAZUS-MH is the census block and it assumes that each census unit has approximately the same number of units/ assets. This is the biggest dis-advantage of the method and does not represent areas with low building density which is frequently the case in the UK. In Japan estimation of damage in a micro scale on a sector basis for commercial and industrial properties has been performed for estimation of actual damage (Dutta et.al. 2003). Moreover, this model introduced aerial photo for accuracy assessment. The model performs accurately in a small scale but unfortunately it is not feasible to use for a very large area. Conversely, some of the meso-scale models used in Germany are MURL, ICPR, Hydrtec, LfUG (Kreibich, 2010) and very recently FLEMOcs (Kreibich, 2010, Seifert, 2010), specifically designed for estimation of flood loss in commercial sector determines the potential damage based on water depth, size and sector, taking into account precaution and contamination has given good results in micro scale as well as meso scale thus has an option for countrywide estimation. In the UK guidance for absolute flood damage estimation models are available. The most popular is the model by Penning-Rowsell et.al (2005) where a synthetic model was developed to estimate actual damage in a micro or meso scale, based on water depth and flood duration as impact parameters and object type and lead time as resistance parameter. The above discussion illustrates that different models have their advantages and dis-advantages in estimation of damaged asset values and selection of one or more appropriate model for the particular research is yet to be determined. Suitability of a model will be based on the availability of data, the scale of study and expected output from the study. 3.2 Valuation of commercial properties The primary concern of a valuer is appropriate estimation of the value of any property for the owner on price or rent, for a prospective buyer on price of the property, for tenants interested in renting the property, value of security for lease, mortgage or compensation purposes. Therefore knowledge of the different circumstances and subjective value of a particular property is vital for the valuer. There can be marked difference in the value of a property based on the judgment and personal view of the valuer and the market situation at the time of valuation. There are different types of values existing in literature for example aesthetic value, social value however in majority of the cases market value is the primary concern of any valuation study so will be

9 the focus of this study. Market value is the capital sum or amount paid at a particular time with specific terms and conditions which are subject to legislation for specific interest or benefit in the property (Shapiro, 2009). According to the definition of the International Valuation Standards Committee the term market value is accepted as the reliable value used for valuation models. The market value is determined by the changing situations in the market, demand, supply, general economic condition, availability of finance physical constraints, policies and their impacts on the property. There are different types of valuation models used based on the different culture and experience of a country. They can be subdivided in to comparable methods, investment / income method, accounts/ profit methods, development/ residual method and contractors cost method (Pagourtzi, 2003). In the UK professional valuers are expected to comply with the Red book published by Royal Institute of Chartered Surveyors (RICS, 2011). This is generally used for valuation of company assets i.e., land and buildings. For those properties which do not have an actual market for sale depreciated replacement cost (DRC) is used. Such properties are called specialized properties. In case of evaluation of property for mortgage purposes for both free hold and lease hold properties the factors like nature of mortgage and security of mortgage are taken into account. Action of the local authorities are important to take into account since that might have a big impact in running the business and also the conditions of temporary boom in a specific market should not be taken into account while performing valuation of a property. The method of valuation used for such purposes are direct sales comparison or investment method. RICS has recently emphasized the need for accommodating the aspects of flood risk in valuation of properties. There is certain policy guidance provided by Planning and Policy Guidance note 25 published by Dept. of Transport, local govt. and regions explains the risks that should be considered during all stages of planning and development process in order to reduce damage of property from flooding in future. All these aspects have to be taken into consideration while incorporating valuation in the model for short or long term. Based on the suitable valuation model a valuation index will be generated indicating the factors affecting the valuation of commercial properties in response to environmental risk in the UK. Focus will be centred to those factors which directly or indirectly have a relation to risk of flooding. 4. Lessons learnt from literature Based on the literature review from the different methodological approaches related to examining the influence of flooding on the value of commercial properties in the UK the proposed research has learnt the following lessons. 4.1 Data requirement The proposed methodologies described above demands availability of specific and detailed data. In order to gain appropriate results data related value for commercial properties on a temporal basis, location details, stock of fixed assets, census data on business distribution,

10 flood risk data, data related to historical flooding and details of the flood characteristic data will be required. The determination of methodology will have to be tailor-made based on the condition and type of property and their market value. Attention will be given to the total affected properties and sample size distribution will be based on that. In the UK the total number of commercial properties affected might not be large in any one location however; the total loss estimated can be high. Therefore determination of appropriate sample size is a major issue for the study. 4.2 Indicative factors Different models have used different factors for damage estimation. Valuation models consider market factors for valuation while damage estimation models are spatially and temporally specific in nature. To integrate these two to develop a certain model will have to be very sector specific. The spatial extension and temporal variation in the effective data will be taken into account while choosing appropriate methodology. 4.3 Market changes / inflation Property market is dynamic in nature and so is its value. One of the major causes of such dynamism is the rate of market inflation. In the temporal aspect of the study the influence of inflation on market value of property can be of considerable interest. To reduce the effect of inflation in research use of corrected price index is considered to be useful. 4.4 Regional specifications For any model of meso scale it is important to identify and consider the local variability among the affecting factors. For example there is regional variation in the number of properties affected, their rate of profit, wage, labour capacity, and cost of assets. These can be covered by using regional data and regularly updating the old database. 5. CONCLUSION The review has revealed the factors affecting the vulnerability and valuation of commercial properties. Clearly, flooding has an impact on the value of property depending upon the location, type, proximity to flood site, and resilient measures. It is also time specific and changes spatially. Market changes have an important effect on the overall valuation change, however the exact change and effect that it has on value of commercial property is yet to be determined. A detailed site survey or field work is necessary to validate the reviews from the literature and reveal specific conclusions which will be an integral part of the on-going

11 research. The long term impact of flood risk apart from the sudden destruction following a flood event is the major area of concern and determining the appropriate estimation of time for the model will be a challenge for the research. The selection of methodology depends upon the availability of data which also determines the sample size and spatial extension of the study. The nature of flooding in UK and the corresponding affected property in terms of number, size and type will also determine the sample delineation and appropriate methodology. Detailed data on property transaction is not readily available and the ruling factor of insurance is also an important issue to be considered. The lack of flood risk research in the specific domain of commercial properties gives further impetus to the research proposed herein; to quantify the impact of flooding on the value of commercial property in the UK. References ABI (2008). Revised statement of Principles on provision of flood insurance. In: ABI (ed.). London: ABI. ABI. (2009). Flooding-Information for consumers [Online]. Available: Infor mation_for_consumers.aspx, Accessed ABI (2010) ABI comments on flood investment plans. ABI formers/press-releases/economy-and-finance/abi-comments-on-flood-investment-plans- $ $ htm Date accessed AXA. (2006). Preparing for climate change: a practical guide for small businesses. Axa Insurance Company, London BIS (2010) SME Statistics for UK region Department for Business Innovation and skills. EA. (2009). Flooding in England: A national assessment of flood risk. Environmental Agency, Bristol FEMA (Federal Emergency Management Agency) (2003) HAZUS-MH TechnicalManual.Washington, DC: FEMA, Department of Homeland, Technical Report. Floodsite. (2007). Evaluating flood damages: guidance and recommendations on principles and methods. Frank Messner, E. P.-R., Colin Green, Volker Meyer, Sylvia Tunstall, Anne van der Veen, UFZ Foresight (2004) Future Flooding Vol 1: Future Risks and their drivers. Foresight.UK Johnson, C., Penning-Rowsell, E. & Tapsell, S. (2007) Aspiration and reality: flood policy, economic damages and the appraisal process. Area, 39,

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13 Seifert, I., Kreibich, H., Merz, B. & Theiken, A.H. (2010). Application and validation of FLEMOcs - a flood-loss estimation model for the commercial sector. Journal of Hydrological Sciences, 55, pp