Redefining Risk: How Outdated CRE Due Diligence Leaves Owners Exposed

Introduction to Albert Slap and Risk Footprint

Drew: Welcome back to the Peak Property Performance Podcast. I am your co-host, Drew Hall, and we've got a good show for you today. But before we get started, introduce Bill and introduce our special guests, let's talk about the theme. The theme today is going to be the risk that you cannot see, why commercial real estate due diligence is missing the biggest line item on the balance sheet. And before we introduce our guests, let me introduce our co-host, Bill Douglas. Bill, welcome.

Bill: Drew, always a pleasure. I'm joining today from Hilton Head, South Carolina in the middle of a family trip, but I never miss a podcast if I can help it. So, well, let's see, before we introduce our guests, I just want to remind our listeners really quickly to do all the things like subscribe, share the podcast. Remember, this is how we are spreading the word on the PPP movement and hopefully changing an industry for the much, much better. And if you think you'd provide value as a guest here, we welcome CRE thought leaders from all stages, ownership, operation, tenancy, even. Please just reach out to us at the PPP website. Again, that's peakpropertyperformance.com, or you can always find us over at LinkedIn. Everything links to everything else. So we hope to see you there. So yeah, Bill, tell us who we got with us today.

Drew: Today we have Albert Slap, the founder and CEO of Risk Footprint. So Albert, say hello to our listeners before I read your very stellar intro.

Albert Slap: Hi, Drew and Bill, and hi to all the listeners. I'm really pleased to be here and try to tell you a few stories about our experiences in CRE due diligence.

Drew: Well, as CEO of Risk Footprint, it's a platform used by commercial lenders, real estate owners, and institutional investors to understand property level exposure to good old natural hazards. Albert started his career as an environmental attorney, and we were just sharing some notes about he is in Florida now, and that's where I grew up. So we actually have a lot in common about old stomping grounds, but Albert has been working deeply in due diligence, liability and risk before building Risk Footprint to address a gap he saw in the market where critical risk factors simply weren't visible in traditional underwriting and acquisition processes. Today his work focuses on helping the industry move beyond static tool maps so operators can make better decisions before, during, and after those natural events, any event for that matter. Albert, welcome to the show. Glad to have you.

Challenges in Current CRE Due Diligence Practices

Albert Slap: Thank you very much. Well, Albert, let's start, if we could, with this notion of due diligence being broken and how visibility plays such a big part in that. So as we know, CRE due diligence still relies on outdated and not so granular proxies, FEMA maps and checklists and appraisals, instead of building-level, like building-level risk visibility. So where is that due diligence actually failing today? What are buyers and lenders assuming that they understand but they actually don't?

Albert Slap: Thanks, Drew and Bill. Let me take a moment, if you would, to kind of do a throwback to a long time ago when I was a first-year law student at Villanova Law School, and all of the students had to take property. And if you had never heard the Latin phrase, caveat emptor, let the buyer beware, we certainly learned it in the property course. Let the buyer beware. And it came from English common law hundreds, hundreds of years. Don't look a gift horse in the mouth. Don't buy a pig in a poke. I could go on and on. But lawyers in real estate had the chief role of caveat emptor and what it meant and how deep and wide it should go. But over the years, the lawyer's role, maybe because of expense, I'm not a hundred percent sure, was overtaken by the consultancies. And these were people who did not have a law license, were not certified by any bar association, did not necessarily know case law of what caveat emptor should be. And then we had, in 1980, the CERCLA Superfund Law, which created a strict liability scheme, both for owners, prior owners, buyers, lenders, if they did not do a proper due diligence for basically three things, hazardous substances, petroleum products, and underground tanks. And that was limited. And then there was also something called the property condition assessment. And that was, well, how's your roof? How's the boiler? How's the elevator working? Very kind of mundane things that are appropriate for every building. But what has been left in the dust, so to speak, but what has jumped up in supercomputing and satellite imagery and better modeling has been an explosion, if you will, of information about hazards, even at the building level. So even as the, you call them operators, but they really fall into different categories, right? You know, you have an owner of a building, you have a buyer, a borrower of a building, you have lenders, you have appraisers, you have insurers, you have a lot of different subgroups that fall into that operator. And each one of them is, in my view and in my experience, needs to step up to the plate of where our technology and modeling, and I'm putting AI to the side for the moment. I'm talking about historical modeling of how frequently a hurricane is going to hit your area, how frequently floods of various types are going to hit, tornadoes, you know, what was the different EF tornadoes that have come near your site, landslides, hailstorms, wildfires, all sorts of models. And again, I'm not talking about AI and I'm not talking about future climate change and ESG, which, you know, people are now saying, well, you know, it could happen, it might not happen, you know, what are the chances? I'm talking about historical models that are based on facts and facts and facts of what has come at our buildings over the last hundred plus years, okay? And Drew and Bill, what we have seen is that the due diligence standards have not kept pace with what technology can bring to us at our fingertips instantaneously at such a minute cost that it's not even a rounding error for the, you know, multimillion dollar buildings and properties that are changing hands today. So that's sort of a little bit of the history where my view coming from a legal background and teaching law school is that, you know, caveat emptor due diligence really needs to bump up to what's happening right now.

Drew: Is there a driving force afoot to make that change or are you championing in that something you're bringing up? I've not heard this before. So how would this change begin to happen in the industry?

Albert Slap: So in commercial real estate, let's say, and I think this, you know, can be a fairly, you know, good estimate. In the United States, in a good year, there might be 500,000 commercial real estate deals over a million dollars in value. Let's just put that out there. I think it's, you know, it's in the range. And in each one, I'm talking about not just cash, you know, not cash deals, but deals where banks are involved. So you have 500,000 commercial real estate transactions. And there's a, call it a market basket of what's in due diligence. There's a FEMA flood map, which is old out of date and not comprehensive. Familiar with that. Maybe have an earthquake score in certain areas. You have an appraisal and a title report and pretty much nothing else. And one of the reasons for that is that the competition, you know, between the buyers and the banks and they want to get deals done and there's insurance and insurance is a factor, but it's not a get out of jail free card, as we all know that the, you know, this has been enough. It's good enough. And standards and banks are very, for good reasons, conservative institutions that have rules. Rules of lending, rules of credit, and processes. Good. And they don't have rules and processes in the underwriting and credit analysis of what to do with these new reports. And I'm not here to plug my product, but just suffice it to say that there are now technology products out there that you can get in a matter of seconds that give you 10, 20, 30 plus different hazards and their scores that have nothing to do with AI and nothing to do with future climate. It's right now, what mother, what butt kicking is mother nature going, could mother nature give your building your property this year? That's what's available. And it's not in that basket and it needs to get in the basket. But now are others, you know, advocating an increase?

The Role of Standards and Organizations in CRE

Albert Slap: And let me tell you the organizations that are. First, the ASTM International, which is the standard-making organization that has the ESA Phase I, which again is the hazardous substances, petroleum products, and underground tanks, that has the standard for the property condition assessment, and now has a standard called the PRA, Property Resilience Assessment, which came out about a year ago. And it is a disciplined process for consultants to do in three stages the comprehensive due diligence that is necessary. We haven't used the word yet, mispricing, but to make sure that there is no mispricing on the front end due to these hazards. And also, if the operators are going to look at what we call resilient retrofit, that there could be a positive ROI or benefit cost to make sense out of spending some money on a new roof, or flood barriers, or raising the MEB equipment, or what have you.

Albert Slap: Let me just finish. So, the ASTM is one. Secondly, the U.S. Green Building Council just came out with their LEED Version 5, which requires in any LEED application for LEED certification a climate resilience assessment, which is very similar to the ASTM Property Resilience Assessment. And then, of course, there's other standard-setting bodies like the American Society of Civil Engineers that has upgraded their flood standard and others. So, anyway, I think that's about it.

Drew: So, it sounds like, even though there's some newer standards, even within the last year, as you said, where does that gap exist? Is it just getting access to these newer models and this new data? Or is it the cost to get to that access? Or is the industry still just in this status quo, kind of let the inertia be what it is? Or what is the barrier to getting that data, leveraging that data? What is that barrier?

Albert Slap: Well, I think the barriers are different for different groups within what you call operators. So, if you are an owner of a building and you're putting it up for sale, if you know a lot about the building, you might have to disclose that, and that could affect the sale price. If you are a buyer of the building and a borrower, you're thinking to yourself, I'm going to have insurance. And if I go deep into due diligence, I might be required by my investors or the bank to fix it up and spend money. And I'm going to buy the building, but I don't really have the money or don't want to spend the money just yet. I'll just roll the dice with my insurance.

Albert Slap: If I'm the bank, so now I've talked about the owner and the buyer, borrower, and now the bank is saying, I get it. We're the bank. We're not lending 100%. So, the borrower has skin in the game and there's insurance, and we don't have standards for all these things. We may have standards for a FEMA flood zone. We have standards for an earthquake score. Obviously, the title report has to be clean, but now you're talking about landslides, and you're talking about hailstorms in Denver, and you're talking about a bunch of other stuff. We don't have any standards for that, so let's just ignore it. And if we don't ignore it, and we set it at a higher price loan, or we require more equity, or we have pre and post-closing conditions, they're just going to go to our competitor and get money from our competitor who doesn't care about those things and is less conservative on the loan terms. So, there's that competition.

Albert Slap: And then let's just throw in there the appraisal community, which I recently blogged about on LinkedIn. They do not consider this issue in their lane of comparables. So, if they give you the fair market value based on comparables in the community, one building, building A, building B, building C, could be way different in terms of the mother nature risks that they simply don't consider. And in my view, and in the view of a number of academics that are writing about this issue, they think that they should and that the MAI and other organizations need to step up to the plate and get appraisers to start considering these differences in buildings.

Invisible Risks and Their Financial Implications

Drew: Well, Albert, let's shift to talk about that cost of invisible risk. I think that was the angle you were starting to take there, right? So, when risk isn't properly measured, where does it actually show up? I mean, financially, is that in cap rates? Is it insurance? Is it debt terms? Is it other? You hinted at some things, but I mean, can you share a deal where better data would have changed the decision early?

Albert Slap: So, I can give you one story. And again, being a vendor of a technology product for hazard assessment, we're not in all of the inner workings of pricing of loans and insurance. But there was a resort in the Galveston area, a brand new resort, a very high end resort. And they came out of their construction loan and they were looking to a bank for permanent financing. And they came to a consulting firm, a very reputable national consulting firm. And they said, look, we need more information about the flood risk and the wind risk of eight buildings, new buildings that are on the site. And so, they came to us to do more in-depth and more advanced studies of the buildings.

Albert Slap: And so, we had the building plans and diagrams and survey and elevation certificate, and we plugged it into our risk footprint system. And we also use a FEMA model called Hazus, which we've figured out ways to do potential damage loss for flood, wind, and seismic and other things. And what we found in our report showed was that because the builder, the developer had done such a good job on elevating the structures, because this was in the storm surge zone of Galveston, elevating the buildings and building them to a very hardened standard that unless there was Cat 4 or Cat 5 hurricanes that hit it, which are sort of all bets are off, that there was minimal damage. And as a result of that, which came back to the bank through our contractor, they got better loan terms in terms of the pricing and better insurance premiums.

Albert Slap: So, that can affect the kind of due diligence that is advanced. That's what I'm describing here in that Galveston use case was more in-depth and advanced due diligence. But that can be done for hundreds or a few thousand dollars using the modern technologies. And when you're talking about a resort that might be $50 million or however much the resort was going for, a few thousand dollars is a minimal amount to spend on advanced due diligence.

Drew: Yeah, absolutely. Well, I asked this before, but I think we actually, I'm not sure that we actually got to the answer for this one. In terms of that due diligence, is there something specifically, maybe it's not that specific, but is there a trend, I guess, where buyers and lenders are assuming they understand something that they don't actually understand? Either they're not getting the data or maybe they're misinterpreted, but I imagine it's more like they're not going after that data.

Data Utilization and Best Practices in CRE

Albert Slap: The data is available. I think that most of the operators, as you call them, are not taking advantage of the data. And they each have their own reasons for not wanting to dig that deep. Now, the interesting thing, what I've heard is that we talk about the ESA phase one, every, all of the 500,000, let's just say, deals in the United States over a certain amount, call it 2 million, 5 million of commercials, they get an ESA phase one, because of the superfund law and lender liability. And a new buyer might be liable in strict liability for the cleanup. Because of that legal connection in the CERCLA statute, and it essentially requires a certain level of due diligence, it's required legally, let's just say, not necessarily required by state or local law to do that level of study.

Albert Slap: So, what we're talking about today is not required in the same sense that the ESA phase one is required. And many people say, well, if it's not required of me, and it could tell me things that I may have to respond to financially, I'd rather not know. I think that to get to your point about a trend, I think that trend is about to dissipate. And I think that the ASTM property resilience assessment standard is...

Albert Slap: the new best practice. And ultimately, the people who are in the CRE community, the operators, if you will, are now grappling with the PRA standard and going pretty soon, I think they're going to go like, we just have to do this.

Drew: That's phenomenal. I was just going to say, that's phenomenal. I mean, Bill, I heard you respond. I heard you react with a wow when Albert was saying it. That feels almost like the dentist patient who says, no, I'm not going to go because he's just going to give me bad news when he can see that he's got some serious teeth problems. It's like, that's amazing that that would happen in the industry because a problem is a problem is a problem. And if you know the data is there that can identify it, waiting is probably not better, right? I mean, I don't own a large commercial real estate facility, but in my home, if there's a problem and I don't handle it, it becomes a much bigger problem. A water leak turns into rot and mold rather than just fixing a leak, for instance. So to hear somebody give the Heisman to the fact that they don't want to know more.

Bill: We've actually had a guest on the show, Albert, talk about how they were leery about sharing their data lake with their insurer because the insurer might find other things. And our point was the insurer is no longer guessing. The insurer knows the actual, it's taking the guesswork out of it. They price in guesswork. So we had a nice little debate about that, but the way you just said, owners don't want to know that, blatantly don't want to know that. That's where I went, whoa, that's a lot.

Albert Slap: Well, the interest of that is, or has been noted as a risk bill, but it's interesting because we haven't talked about the insurers or reinsurers yet. And people say to me and others, well, if I do something about it, if I learn about it, Albert, and I do something about it, am I going to get my insurance premiums reduced? Because they're going up and up. The answer is generally no. At the present time, there is one insurance company, FM, which used to be called FM Global, that has put a billion dollars into insurance, premium credits, and reductions based on resilient retrofit. And I know this because one of my clients, a real estate investment trust, had two buildings on the Schuylkill River in Conshohocken that had the lobbies flooded in the remnants of Hurricane Ida a few years ago. And they had significant damage when the Schuylkill River crested its banks and came into their lobbies of two twin office buildings. They were insured by FM, and FM said to them, if you do what our engineering department recommends, we'll actually give you money to do it back from the premiums. And they did that. And so I know it's real. It's on the FM website. Anybody can see it. The real question is that FM has a certain subset of client base, and there's many, many operators in the CRE area that don't have FM. And if they have other insurance companies that are not doing this and are simply saying, yes, we would like you to harden your building, we would like you to do this, but are we going to give you a premium, significant premium credits or reduction? No. Now, is that changing, or is that going to change, or is FM leading the pack and others are going to follow that? I hope so. And it's a topic at every one of the webinars, seminars, conferences that I go to, is what's the insurance industry doing, and how can they essentially get behind a movement to make buildings safer and more resilient? Because we know very quickly whether a building is at risk. We know very quickly if a building is vulnerable to these hazards. And once we get some boots on the ground, which we work with other companies that do boots on the ground, we're sort of the science software nerds sitting at our desks, but we work with people who have architects and engineers and consultants at flood barriers, roofing, glazing, fenestration, what have you. And they go into buildings, and very quickly, for not a lot of money, they can tell the owners, yeah, you're going to need to do, and here's some low-hanging fruit.

Drew: And let me give you another example from- Yeah, please do. I was about to ask you for one.

Albert Slap: From Philadelphia. What actually moves the needle when they understand where the risk is? What are some practical actions owners can take? So here, a good friend of mine has a very high-end condo in a new building in the city of Philadelphia, again, along the Schuylkill River. And when that Hurricane Ida came through and flooded the two office buildings up in Conshohocken, which is, I'm going to say, 10 miles to the northwest, this very upscale condo building had an underground parking garage. And the underground parking garage, the building and the garage are right next to the Schuylkill River. The garage had pumps, but in the flooding that occurred, the underground parking garage flooded to the roof. It knocked out the switch gear for the pumps and flooded the lobby. Why did it knock out the switch gear for the pumps? Because under the building code, the switch gear had to be slightly above the FEMA flood zone, which was way below the roof of the underground parking garage, and it flooded to the roof. But our models, and not the FEMA model, but models that we use from Swiss Re and others, would have shown the building to move the electrical equipment much higher to then keep the pumps of the garage running to fight off the floodwaters. So is it very expensive to raise the switch gear? Not relative to a 25-story condo building, which a studio is a million dollars. No. That HOA, if they had known, which they could have known, if they, and the builder could have, should have known, there's low-hanging fruit out there. It's not hair on fire. The one thing that I have learned in actually making buildings safer and more resilient through the whole PRA, Property Resilience Assessment process, when we've been through the whole process from the hazard assessment to vulnerability to the value at risk to the stage three feasible resilience measures, we've done this for hotels in Key West and in other places, is that we can show real improvement with real ROI and a benefit cost greater than one for hold times as short as 10 years. So that's what I'm saying, is that a lot of people think, if I do this, if I get this information, my hair is going to go on fire and I'm going to have to spend millions of dollars, and it's not true.

Bill: Well, we talk a lot on the show about operating data from the systems inside of a building, and it's nice to have you come on and talk about data relative to what mother nature might do to the property. Both are datasets, and when they're ignored, it's more expensive than less expensive. By embracing the data, you can actually, and usually do, drive down your insurance costs. We continue to say that over and over again. So thank you for championing that cause for us, Albert.

Drew: Go ahead, Drew. Well, that's such a great example. No, I just think that example is incredibly powerful because the visual of what you're describing, in my mind, I'm like, my goodness, that's amazing to me that pumps could even counter some force like that, a floor to ceiling flooding of a garage that would inevitably be a pretty large garage. That's really amazing.

Albert Slap: They could have made the switchgear submersible too. There's a cost to that. I mean, they do have options. Yeah. They could have flood protected it. Sure. Yeah. But the fact, your point is they never considered it. Right.

Architectural Considerations and Building Codes

Bill: The other way. Well, that gets back to the point, and maybe we should talk a little bit about the architects because I also blogged just recently on LinkedIn about the architects. So we talk about trends and the architects have recently updated their standard of conduct. And it's now a requirement that the AIA members, American Institute of Architects, their standard of conduct, that they look at natural hazards and also future climate and discuss that with their clients. And if the clients won't do it, they need to make a written record note that the client refused that. Because you hear in the architect community, my client said, build it to code, even though I knew that code wasn't sufficient to protect the building. And the client said, if I don't build it to code, they're just going to find another architect. But now there's more ammunition, if you will, in the code of conduct.

Albert Slap: And we just literally yesterday picked up a very large international

Albert Slap: Architecture firm to have one of our dashboard subscriptions for the risk footprint because they said, you know, they used us on an a la carte basis, but now they're getting a subscription because they said, because of the change in the standard of conduct, we're going to do it for every project. We're going to get this information for every project, which is hundreds and hundreds of them annually. So I think that you have the ASTM best practice, you have the U.S. Green Building Council LEED version five, you have a new standard of conduct for architects. The pressure to come up to, you know, what caveat emptor really means to be a true high quality best practice, not some dumbed down thing that just gets deals done faster. That I think is happening.

Drew: Oh, that's, that's amazing. Yeah. Well, the, the, you know, the statement of build it to code usually has a, a rising implication with it, meaning build up to code. But that's fascinating to know that sometimes that doesn't mean build up. It means I don't do that. Codes are, those codes are way behind. I mean, my understanding is that codes are really more like a life safety standard. They're, you know, compromises between the developer community and the local governments, but they are not what organizations like ASTM or ASCE, American Society of Civil Engineers recommends. And those standards and those best practices may eventually make it into building codes. But typically when you go, and when you go to places like Texas where there really aren't building codes, and we saw that, you know, windows blowing out a couple of years ago in Houston with that high wind derecho event, you know, building to code does not mean the building is safe and resilient. It just doesn't.

Bill: Is that like the lowest common denominator in your opinion, code? Are they outdated, are they outdated or is it the fact that nobody really wants to increase the codes? What's your opinion on that?

Albert Slap: I mean, you know, I'm not surely an expert on all building codes in all local areas. And I think that there are some more progressive communities that are trying to, I mean, even the city of Miami has new first floor elevations that are more in tune with flooding risks in Miami. It doesn't affect existing buildings and they're still allowing underground parking garages in storm surge zones in Miami, it's my understanding. So they're compromises and some of them are improved and improving, and some of them are really outdated or non-existent in areas where they're very definitely needed.

Career Insights and Personal Practices from Albert Slap

Drew: Agreed. Wow. Well, Albert, this has been a great discussion, pretty eye-opening, I would say, especially on some of these very practical examples. So one of the things we do before we wrap up, we always like to take our guests up to what we call the extra floor. So it's just a quick set of questions to help listeners get to know the human side of you, our guests. So whatever comes to mind, it's not conversational like the things we've been doing so far, just gut level response, just three questions here. Here's the first one. What's the best piece of career or life advice that you think you might've ever received?

Albert Slap: Well, I don't know if it's receiving, but I guess my best career advice is don't have a mission statement, have a mission. And when I started this technology company, I had a lot of gray hair already, and I was competing against Silicon Valley 30-somethings in this new area. And their mantra was fail fast and fail often. And mine was, I have a mission, and my mission is to help buildings become safer and more resilient for the owners, for the tenants, for the retail, for the restaurants, for the visitors. And to fail fast and fail often means you don't have a mission. You don't really care other than try to make the most money you can in the shortest amount of time. And that's not what I'm about.

Drew: That's awesome. What's one habit or practice that consistently makes you more effective, Albert?

Albert Slap: Well, I would say the habit, which is certainly changing with AI tools, is to do as much research as possible to be sure of what I'm saying and what I'm recommending. And I'm not going to lie. I mean, AI, the co-pilot, the chat GPT, the Gemini has just created unbelievable efficiencies for our company in how we do our business.

Bill: All right. Final one here, Albert. Are you an early bird or a night owl?

Albert Slap: Early bird. I'm at the gym at about 7.30.

Contact Information and Closing Remarks

Drew: Ditto. So this is not an extra floor question, but how can our listeners contact you? We will put your contact info in the show notes, but for the listeners driving down the road or on a walk or a run, how could they contact you?

Albert Slap: We have an incredible website, riskfootprint.com, and we have emails, phone numbers, examples of our reports. Everything is very, very open and no black boxes or smoke and mirrors. You can see exactly what we do, how we do it, and if it might help you. And also, unlike our competitors, you can actually buy our product on e-commerce at riskfootprint.com. So it's pretty easy.

Bill: Albert, thank you again for being on the show. And thanks to all our listeners, everybody out there. As Drew said, to open the show, please like, follow, subscribe, share this. If you think somebody would be a good guest, including yourself, reach out, but do share it. We're trying to change the industry and how data and digital help improve commercial real estate. So thank you, everyone. We'll see you on the next episode of Peak Property Performance.

Drew: Thanks, Drew. Thanks, Bill. Appreciate it.

Albert Slap: Oh, yeah. Thank you, Albert.