CKIV03: Impact of Seismic Risk on Lifetime Property Values
J. L. Beck, K. A. Porter, R. V. Shaikhutdinov, S. K. AU, K. Mizukoshi, M. Miyamura, H. Ishida, T. Moroi, Y. Tsukada, and M. Masuda
This report presents a methodology for establishing the uncertain net asset value, NAV, of a real estate investment opportunity considering both market risk and seismic risk for the property. It also presents a decisionmaking procedure to assist in making realestate investment choices under conditions of uncertainty and riskaversion. It is shown that that market risk, as measured by the coefficient of variation of NAV, is at least 0.2 and may exceed 1.0. In a situation of such high uncertainty, where potential gains and losses are large relative to a decisionmaker’s risk tolerance, it is appropriate to adopt a decisionanalysis approach to realestate investment decisionmaking. A simple equation for doing so is presented. The decisionanalysis approach uses the certainty equivalent, CE, as opposed to NAV as the basis for investment decisionmaking. That is, when faced with multiple investment alternatives, one should choose the alternative that maximizes CE. It is shown that CE is less than the expected value of NAV by an amount proportional to the variance of NAV and the inverse of the decisionmaker’s risk tolerance, ρ.
The procedure for establishing NAV and CE is illustrated in parallel demonstrations by CUREE and Kajima research teams. The CUREE demonstration is performed using a real 1960sera hotel building in Van Nuys, California. The building, a 7story nonductile reinforcedconcrete momentframe building, is analyzed using the assemblybased vulnerability (ABV) method, developed in Phase III of the CUREEKajima Joint Research Program. The building is analyzed three ways: in its condition prior to the 1994 Northridge Earthquake, with a hypothetical shearwall upgrade, and with earthquake insurance. This is the first application of ABV to a real building, and the first time ABV has incorporated stochastic structural analyses that consider uncertainties in the mass, damping, and forcedeformation behavior of the structure, along with uncertainties in ground motion, component damageability, and repair costs. New fragility functions are developed for the reinforced concrete flexural members using published laboratory test data, and new unit repair costs for these components are developed by a professional construction cost estimator. Four investment alternatives are considered: do not buy; buy; buy and retrofit; and buy and insure. It is found that the best alternative for most reasonable values of discount rate, risk tolerance, and market risk is to buy and leave the building asis. However, risk tolerance and market risk (variability of income) both materially affect the decision. That is, for certain ranges of each parameter, the best investment alternative changes. This indicates that expectedvalue decisionmaking is inappropriate for some decisionmakers and investment opportunities. It is also found that the majority of the economic seismic risk results from shaking of Sa < 0.3g, i.e., shaking with return periods on the order of 50 to 100 yr that cause primarily architectural damage, rather than from the strong, rare events of which common probable maximum loss (PML) measurements are indicative.
The Kajima demonstration is performed using three Tokyo buildings. A ninestory, steelreinforcedconcrete building built in 1961 is analyzed as two designs: asis, and with a steelbracedframe structural upgrade. The third building is 29story, 1999 steelframe structure. The three buildings are intended to meet collapseprevention, lifesafety, and operational performance levels, respectively, in shaking with 10% exceedance probability in 50 years. The buildings are assessed using levels 2 and 3 of Kajima’s threelevel analysis methodology. These are semiassembly based approaches, which subdivide a building into categories of components, estimate the loss of these component categories for given ground motions, and combine the losses for the entire building. The two methods are used to estimate annualized losses and to create curves that relate loss to exceedance probability. The results are incorporated in the input to a sophisticated program developed by the Kajima Corporation, called Kajima D, which forecasts cash flows for office, retail, and residential projects for purposes of property screening, due diligence, negotiation, financial structuring, and strategic planning. The result is an estimate of NAV for each building. A parametric study of CE for each building is presented, along with a simplified model for calculating CE as a function of mean NAV and coefficient of variation of NAV. The equation agrees with that developed in parallel by the CUREE team.
Both the CUREE and Kajima teams collaborated with a number of realestate investors to understand their seismic riskmanagement practices, and to formulate and to assess the viability of the proposed decisionmaking methodologies. Investors were interviewed to elicit their risktolerance, ρ, using scripts developed and presented here in English and Japanese. Results of 10 such interviews are presented, which show that a strong relationship exists between a decisionmaker’s annual revenue, R, and his or her risk tolerance, ρ ≈ 0.0075R1.34. The interviews show that earthquake risk is a marginal consideration in current investment practice. Probable maximum loss (PML) is the only earthquake risk parameter these investors consider, and they typically do not use seismic risk at all in their financial analysis of an investment opportunity. For competitive reasons, a public investor interviewed here would not wish to account for seismic risk in his financial analysis unless rating agencies required him to do so or such consideration otherwise became standard practice. However, in cases where seismic risk is high enough to significantly reduce return, a private investor expressed the desire to account for seismic risk via expected annualized loss (EAL) if it were inexpensive to do so, i.e., if the cost of calculating the EAL were not substantially greater than that of PML alone.
The study results point to a number of interesting opportunities for future research, namely: improve the marketrisk stochastic model, including comparison of actual longterm income with initial income projections; improve the riskattitude interview; account for uncertainties in repair method and in the relationship between repair cost and loss; relate the damage state of structural elements with points on the forcedeformation relationship; examine simpler dynamic analysis as a means to estimate vulnerability; examine the relationship between simplified engineering demand parameters and performance; enhance categorybased vulnerability functions by compiling a library of buildingspecific ones; and work with lenders and realestate industry analysts to determine the conditions under which seismic risk should be reflected in investors’ financial analyses.
TABLE OF CONTENTS
Chapter 1: INTRODUCTION
 Overview of Seismic Risk and RealEstate Investment Decisions
 Objectives of the Project
 Organization of Report
Chapter 2: LITERATURE REVIEW
 Introduction
 Risk in Real Estate Investment
 Methods To Evaluate Earthquake Losses
 Theory For RealEstate Investment DecisionMaking
Chapter 3: METHODOLOGY FOR LIFETIME LOSS ESTIMATION
 BuildingSpecific Loss Estimation Per Event, Per Annum
 BuildingSpecific Loss Estimation Over Lifetime
 Formulation of RiskReturn Profile
Chapter 4: FORMULATION OF DECISIONMAKING METHODOLOGY
 The Investment Decision
 PostInvestment PostInvestment Decisions
 Proposed Investment DecisionMaking Procedure
Chapter 5: CUREE DEMONSTRATION BUILDING
 Recap of AssemblyBased Vulnerability Methodology
 Description of CUREE Demonstration Building
 Vulnerability Analysis of AsIs Building
 Vulnerability Analysis of Retrofitted Building
 RiskReturn Profile and Certainty Equivalent
 Sensitivity Studies
Chapter 6: KAJIMA DEMONSTRATION BUILDING
 Summary of Kajima Demonstration Building
 Seismic Hazard Estimation
 Kajima SeismicVulnerability Methodologies
 Seismic Vulnerability Functions
 Risk Profile
 Marketability Analysis
 Lifetime Property Value and RiskReturn Profile
Chapter 7: INVESTMENT CASE STUDIES
 Summary of US Real Estate Investment Industry
 US Investor Case Study
 Summary of Japanese Real Estate Investment Industry
 Japanese Investor Case Study
Chapter 8: CONCLUSIONS AND FUTURE WORK
Chapter 9: REFERENCES
Appendix A: RiskAttitude Interview
Appendix B: Interview Script in Japanese
Appendix C: Fragility and Repair of Reinforced Concrete MomentFrame Elements
Appendix D: DiscreteTime Market Risk Analysis
Appendix E: A Stochastic Model of Net Income
Appendix F: Moments of the Lifetime Loss
Appendix G: Structural Model of CUREE Demonstration Building
Appendix H: Retrofit Cost Estimate
Appendix I: Output of Kajima D Program for Cash Flow Analysis
File Download 
Type 
Size 
CKIV03 
PDF 
5.4 MB 
