Level of risk and consequences of flood damage
According to a recent National Flood Risk Assessment carried out by the Scottish Environment Protection Agency (SEPA), approximately 1 in 13 business properties in Scotland are at risk of flooding, with the average annual cost of damage from flooding estimated at between £720 million and £850 million. Climate change is likely to make matters worse as wetter winters and an increase in extreme weather events lead to an increase in rainfall, the main cause of flooding.
While the physical damage to buildings, stock and equipment is the most obvious financial cost associated with flooding, the loss of income and customers from any inability to access and use the property are further factors to be taken into consideration when assessing the monetary impact of flood damage.
Further, if a property is at risk of flooding this could make it difficult or impossible to obtain insurance cover. This in turn is likely to have a negative impact on both value and the terms of any loan to be secured on the property (or indeed whether it will be possible to use the property as security at all).
Investigate before investing
Needless to say, gathering information and being aware of any potential flood risks prior to committing to a particular property is the best method of avoiding unwanted surprises in this area. In any property acquisition (whether that be a property purchase or a new lease) consideration should always be given to the risk of flooding and appropriate "due diligence" enquiries made.
There is often an assumption that the only properties at risk from flooding are those close to the river or sea. And while river and coastal flooding, when taken together, account for the majority of flood incidents in Scotland (45% and 17% respectively), it's worth bearing in mind that the remaining 38% of incidents result from surface water flooding. This occurs when heavy rainfall overwhelms the drainage capacity of the area in question. A quick look on Google Maps with a view to checking how close the property is to a river or the coast will not reveal anything about the risk of surface water flooding.
As of January of this year, slightly more information can be gleaned from SEPA's flood maps, which are now available online, free-of-charge. These identify areas which are at risk from flooding and also allow the user to filter the results to show the threat posed by each river and by coastal and surface-water flooding.
However, these flood maps don't show the flood risk to individual properties, and so caution should be exercised in using these as the sole means of assessing flood risk for any particular property. Instead, consideration should be given to carrying out a proper flood risk investigation of the property in question. This becomes even more crucial if you are intending to develop the land, and not simply because the planning authorities (and any funder) will want to see that such investigations have been carried out.
There are a number of products available on the market, ranging from simple desktop searches to full flood risk assessments. Each provider will take a slightly different approach in the preparation of these reports, both in terms of the data analysed and the method of analysis used, but as a minimum you should expect the report to provide an assessment of the overall flood risk.
Ask questions of the owner and prospective insurers
Aside from flood searches, there are other diligence enquiries that should be made in order properly to assess the risk of flooding. In a property acquisition or new letting, the current owner should always be asked to provide details of any flooding incidents affecting the property or flooding insurance claims of which they are aware. These confirmations may be backed up with contractual warranties if appropriate. Of course, as full and honest answers to these enquiries could have a negative impact on value or rental levels, you may find that responses range from unhelpful to untruthful. As with most property matters, relying solely on confirmations made by a seller or landlord is not to be recommended.
It is also a worthwhile exercise to obtain an insurance quote in advance of concluding any contract for an acquisition or new lease. Insurers are taking an increasingly sophisticated approach to assessing flood risk and so it would be prudent to find out that cover would be available and on what terms.
Flood risk insurance might not be available - or only provided at great cost
On the question of insurance, it's worth noting that insurers generally operate a risk based approach to flood insurance when it comes to commercial real estate. In other words, if the insurer believes that there is a high risk of flooding in relation to a particular commercial property, it is free to set a higher premium or excess or to refuse to cover particular risks.
This is different to the approach of insurance companies in relation to most domestic properties, where political considerations have ensured that cover is currently available for most home owners - and will remain available (subject to certain exclusions) under the proposed Flood Re. scheme due to start operating in 2015. Some of the details of this scheme have yet to be finalised. Even as recently as last week, there has been the suggestion that it might now include (contrary to previous announcements) properties in the top Council Tax band.
As a result, there is generally no obligation on insurers to offer cover for flood damage to commercial property. As touched on above, if a property is uninsurable, this could have a huge impact on value and make it difficult or impossible to obtain secured funding in relation to the property.
Even if you aren't responsible for obtaining such insurance (e.g., because you are the tenant under a full repairing and insuring lease where the landlord arranges the buildings insurance) you should be alert to the possibility of flood risk cover being unobtainable. Depending on the wording of the lease, if insurance cover for flood damage can't be obtained, it is possible that the liability for making good any damage will fall to the tenant. At the very least, there is scope for dispute over who is responsible and a well-advised tenant should give consideration to requesting a carve-out for damage caused by flooding where the landlord hasn't been able to obtain insurance cover. Depending on the bargaining strengths of landlord and tenant, there may also be scope for obliging the landlord to make good any damage (or at least allow the lease to be brought to an end, with each party going their own way).
In short, flooding can have a huge impact on the value of commercial real estate and consideration should always be given to what level of diligence is required to protect your position. And while you may still go ahead with the purchase or lease (as appropriate), at least you are doing so with all the relevant information at your disposal and can potentially seek a reduction in the price or rent to compensate for the additional risk and costs involved.