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Projects : CUREE-Kajima Joint Research Program

CKIV-03: 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 decision-making procedure to assist in making real-estate investment choices under conditions of uncertainty and risk-aversion. 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 decision-maker’s risk tolerance, it is appropriate to adopt a decision-analysis approach to real-estate investment decision-making. A simple equation for doing so is presented. The decision-analysis 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 decision-maker’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 1960s-era hotel building in Van Nuys, California. The building, a 7-story non-ductile reinforced-concrete moment-frame building, is analyzed using the assembly-based vulnerability (ABV) method, developed in Phase III of the CUREE-Kajima 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 force-deformation 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 as-is. 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 expected-value decision-making is inappropriate for some decision-makers 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 nine-story, steelreinforced-concrete building built in 1961 is analyzed as two designs: as-is, and with a steelbraced-frame structural upgrade. The third building is 29-story, 1999 steel-frame structure. The three buildings are intended to meet collapse-prevention, life-safety, 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 three-level 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 real-estate investors to understand their seismic risk-management practices, and to formulate and to assess the viability of the proposed decision-making 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 market-risk stochastic model, including comparison of actual long-term income with initial income projections; improve the risk-attitude 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 force-deformation relationship; examine simpler dynamic analysis as a means to estimate vulnerability; examine the relationship between simplified engineering demand parameters and performance; enhance category-based vulnerability functions by compiling a library of building-specific ones; and work with lenders and real-estate industry analysts to determine the conditions under which seismic risk should be reflected in investors’ financial analyses.


- Overview of Seismic Risk and Real-Estate Investment Decisions
- Objectives of the Project
- Organization of Report

- Introduction
- Risk in Real Estate Investment
- Methods To Evaluate Earthquake Losses
- Theory For Real-Estate Investment Decision-Making

- Building-Specific Loss Estimation Per Event, Per Annum
- Building-Specific Loss Estimation Over Lifetime
- Formulation of Risk-Return Profile

- The Investment Decision
- Post-Investment Post-Investment Decisions
- Proposed Investment Decision-Making Procedure

- Recap of Assembly-Based Vulnerability Methodology
- Description of CUREE Demonstration Building
- Vulnerability Analysis of As-Is Building
- Vulnerability Analysis of Retrofitted Building
- Risk-Return Profile and Certainty Equivalent
- Sensitivity Studies

- Summary of Kajima Demonstration Building
- Seismic Hazard Estimation
- Kajima Seismic-Vulnerability Methodologies
- Seismic Vulnerability Functions
- Risk Profile
- Marketability Analysis
- Lifetime Property Value and Risk-Return Profile

- Summary of US Real Estate Investment Industry
- US Investor Case Study
- Summary of Japanese Real Estate Investment Industry
- Japanese Investor Case Study



Appendix A: Risk-Attitude Interview

Appendix B: Interview Script in Japanese

Appendix C: Fragility and Repair of Reinforced Concrete Moment-Frame Elements

Appendix D: Discrete-Time 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

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Consortium of Universities for Research in Earthquake Engineering
last updated 02.20.15