A property condition report is a report on the physical condition of an asset that is prepared by qualified architectural and/or engineering professionals in association with a real property acquisition and finance transactions. Consequently, the term “Property Condition Report” can mean differing things depending on the type of transaction and the respective roles of the transaction participants.
For an acquisition transaction, a property condition report is typically commissioned by the buying entity in an effort to identify undisclosed physical deficiencies, including deferred maintenance, code deficiencies, recommended repairs, capital replacements, and suggested upgrades to enhance system performance, energy efficiencies, and/or life safety. It is typically advisable that equity level property condition reports be prepared by a multidisciplined team of professionals, appropriate to the level of property complexity. Larger, more-sophisticated assets require greater expertise, while smaller assets with less-complex systems are less demanding to evaluate. The team members for equity transactions should be experts in their respective disciplines who possess extensive experience in design, construction, forensics, and property due diligence. They should also be highly skilled communicators who can articulate their finding clearly and succinctly, both orally and in writing. A property condition report prepared in connection with an acquisition will usually include opinions of probable costs covering a 10-year evaluation period.
Property condition reports for finance transactions are typically narrower in scope than those prepared for acquisition transactions. This is primarily due to the fact that the lender does not have the same risk exposure as an equity investor. The lender has the owner’s equity – typically 30% to 50% of the asset value – as a buffer protecting the lender against their potential first dollar loss. Also, the lender does not need to understand the asset from a detailed operational perspective, so a more-limited assessment is generally suitable for their underwriting purposes. Most property condition reports for finance transactions are performed by a sole architectural or engineering professional. Property condition reports for finance transactions are typically focused on identifying deferred maintenance and code deficiencies (Immediate Costs), and projected capital replacements (Replacement Reserves) anticipated over the term of the loan, plus two years. As opposed to property condition reports prepared for equity transactions, which have no limits placed upon the dollar amount of identified deficiencies, the underwriting for finance transactions typically requires that the amount of the replacement reserves fall below the lender’s replacement reserve threshold which, in PCA’s opinion, are artificially low, relative to real operating costs that should be underwritten.
When selecting a firm to prepare a property condition report, it is imperative to choose a firm with the experience that is most suited to the transaction. Firms like PCA that specialize in equity level transactions provide much more comprehensive assessments than do firms that primarily cater to the lending community and are, therefore, not ideal candidates for finance-related engagements. Conversely, firms that cater to the lending community provide less-comprehensive property condition reports, and are not suitable for equity transactions. And, while the lower-priced fees offered by lender-oriented providers can be attractive, the potential for such firms to overlook significant and costly deficiencies is exponentially greater. As in all things, the adage: “You Get What You Pay For,” certainly applies to the property condition report.