A flood is an overflow of water that submerges land that is usually dry. Floods are an area of study in the discipline of hydrology. They are the most common and widespread natural severe weather event.
This article will tell readers how does flooding affect real estate value.
a. Reduction of the remaining operating life period
Building structure of periodical flooded objects is more affected by negative ascendancies. Chances of occurring of building defects are higher. That is why the total operating life period is lower compared to objects that did not experience a flood event. Impairment hardly depends on the period of being underwater and the altitude of the water level related to the building. At the same time a shorter total operating life period results in a modified shorter remaining operating life period. This needs to be taken into account in the valuation calculation process and will lead to a lower market value.
b. Reduction of the amount of the rent
Basis for the calculations in the discount cash flow method is the achievable rent. In case of flood event the absolute use of space on the property (refers to land outside the house as well as inside) is limited for unknown period of time. In general the limitations in the use refer to the ground floor for the period of flooding as well as the necessary reconstruction time. The rent is to reduce or unconsidered completely depending on the level of devastation. Business building will be affected more than residential because the ground floor is usually sales floor with the highest sustainable rent. Another “adjusting screw” in the discount cash flow method can be the property yield. Flood risk could be included by increasing the rate.
c. Increase of management costs
Management costs include expenses for maintenance and repair, operating, vacancy and collection loss and administrative work. All four factors increase in case of a flood event. The amount of loadings depends again on the type of the object (business or residential), interval and water level of the flood.
d. Consideration of actual costs for 100 percent insurance cover
There is some evidence that the increase in flood risk and flooding is affecting insurability of residential properties. In general insurance cover is usually required for mortgage lending. The availability, terms and conditions attached to the insurance contract and the level of premiums are influenced by fact of flood risk (Wordsworth et al., 2005). Lamond et al. (2009) found that insurance remains available for householders. Also that flooding is not the major factor in determining the level of premiums in the UK. Calculation of the premium rate for indemnity insurance is a very individual process.
In Germany the level of flood risk influences insurance premium. Information about the level of risk can be received by using the system “ZÜRS Geo” (ZÜRS Geo, 2012) provided by GDV (2012). Insurance cover for buildings located in zone four (highest threat, flood occurs statistical once in 10 years) is hard to get and depends on the insurance company. Premiums are also high. Under the assumption of a 100 percent insurance cover, the market value reduced by the costs for this insurance type (capitalized for a specific period of time) would theoretically the threat by a flood event neutralize. But the essential question is when the next flood will occur.
e. Consideration of actual costs for restoring the original condition of the property
In case of an instant flood event the market value is to reduce by the costs that are necessary to restore the conditions without flood. An important part of this overall reduction are the costs for restoring the original condition of the property (other costs for example for psychological harm caused by a flood event are even harder to monetize). As described before the essential question is when the next flood will occur and what scale it might have.
A relevant question is if the damages caused by the flood are eliminated completely. Suspicion of hidden damages, reservation and possible aversion might justify a mercantile decreas in the market value. Another approach could be the consideration of costs for manufacturing a flood-resistant building (outside facilities excluded since generally they play a minor part) by installing flood defenses to the property to ensure peace of mind and minimize any adverse effects. That could be for example a water resistant basement (that includes also the threat through rise of groundwater level), a system preventing backwater from sewerage or installation of special demountable door, window and all opening guards (RICS, 2010). Exists already flood-resistant than this has to be considered in a positive way, e.g. through a supplement in the amount of the additionally investments.
Climate change means that natural disasters will be more common in the future and financial losses will increase. Valuation of endangered real estate has to consider the aspects of flooding and flood risk.