Depreciation enters significantly into the financial performance of commercial buildings. Typically, property, exclusive of land, is depreciated over 39 years. Certain improvements or renewable materials (e.g., carpets) may be depreciated more quickly. These calculations have been part of the financial landscape for years.

What is not as generally known is that many of the costs embedded in a new, or even an existing, building can be segregated into categories that also allow for more rapid depreciation. This tax benefit is not new but is often overlooked by building owners and even many of their accountants.

If you own a commercial or apartment building that has been bought, built or reonovated recently without a Cost Segregation Study (CSS), you may have missed a significant opportunity for cash savings.  the good news is, you still may be able to utilize this modern tax planning tool.  CSS is the latest element added to the typical due diligence process of having a consulting engineer perform a building inspection with an optional environmental site assessment.

Whereas due diligence focuses on reducing future liabilities of physical or environmental problems with a property, a CSS focuses on impriving the project’s cash flow through reclassifcation of the property’s asset lives with the purpose of accelerating depreciation expenses, and thus lowering federal taxes.

The benefit of a CSS can be substantial, with potential net present value savings of more than $50,000 for every $1 million of property value.

Even if years have passed since purchasing the property, the IRS allows the taxpayer to recapture lost depreciation all in one year without having to file amended returns by simply filing Form 3115 to notify the IRS of the change in accounting after the retroactive CSS.

Though the advantages of improved cash flow in the early years of a real estate investment are obvious, many side benefits of a CSS are realized in multi-tenant properties.

When a tenant prematurely vacates a space, a CSS can be used as the basis to document the value of the space’s assets to be written-off and to use the tax savings to fund marketing of the space or future tenant fit-up.

All real estate investors have different tax circumstances, therefore, it is very prudent to obtain the advice of your tax consultant before initiating a CSS.

Most of the area’s commercial brokers and accounting firms are becoming familiar with this powerful tool.  After a little research, the rewards can be very worthwhile.

Maintain proper drainage

A cost effective approach to basement waterproofing is to maintain with perimeter surface drainage conditions.  The importance of proper drainage and landscaping (mature trees) around a foundation cannot be over emphasized.  Poor drainage around the foundation is the most common cause of foundation problems and basement moisture problems.  Drainage and moisture control around the home include proper ground slopes away from the foundation.  It also includes keeping your gutters clean and the downspouts functional.  Not doing so, allows the water from the roof to overflow the gutters.  This water then runs along the foundation and in turn can cause basement seepage or foundation movement.

New Construction Basement Waterproofing

In new construction, cast-in-place concrete foundations are more resistant to water penetration than concrete block. Bituminous waterproofing should be used, at a minimum, to seal the outside of any foundation wall, however. An effective perimeter drain system should be installed to collect water from around the foundation and under the slab.

The National Association of Home Builder’s booklet on dry basements entitled, “Basement Water Leakage – Causes, Prevention, and Correction,” recommends perimeter drains on the inside and outside of the foundation. These drains should either flow downward to a gravity outlet (natural drainage) or to a sump where the water can be discharged with a sump pump.

A building built in a wet site should take advantage of additional waterproofing; a membrane system. One example of a membrane system consists of multiple layers of impervious material applied in a hot tar mopped system to the outside of the foundation. Special attention should be paid to the joint between the wall and the footing. The concrete floor and walls (whether block or concrete) should be reinforced to minimize cracking.

Existing Construction Basement Waterproofing

A water problem in an existing basement can only effectively be dealt with by:

• rewaterproofing the outside of the foundation walls and/or
• upgrading the exterior foundation drainage system

Both approaches require excavation around the outside of the foundation.

There are alternatives which will intercept the water using a channel-like system around the interior of the foundation wall to collect and guide the water into a sump and discharge it using a sump pump. These systems do not correct the water problem but they do control the water once it has entered the basement in a way that minimizes problems related to water entry. Such systems, while dealing more with the symptom than the cause, are typically less expensive because they can be accomplished from the inside.

Ultimately, when dealing with a basement water problem, the tried and true conventional methods working from the outside are still the most reliable.

Basement waterproofing and existing building, or rewaterproofing, the outside of a basement wall requires excavation to the full depth of the wall, careful cleaning of the wall surface and proper application of bituminous waterproofing. A multi-layered membrane system should be used if the surrounding water conditions are severe. At the same time, a perimeter drain system should be installed, similar to the recommendations noted above for a new foundation. If there are cracks in a wall, the cracks should be chipped out to form a V-groove along the length of the crack approximately one inch deep. The V-groove should then be sealed with a good quality epoxy or silicone caulking, filled with mortar and covered with bituminous waterproofing.

Epoxy injection

An effective, but sometimes expensive alternative, is epoxy injection into the crack. This can be done from the inside. The epoxy bonds with the concrete and creates a somewhat permanent seal against water penetration. The limitations to this system are cost and effectiveness, depending on the size of the crack. The smaller the crack, the less likely it is that full penetration injection is possible. However, before undertaking expensive excavation around the outside of a foundation, you may want to get proposals from local epoxy companies to compare the cost and potential effectiveness.

Basement water is controllable but there is no easy answer. Only the more complex and sometimes expensive approaches are truly reliable.

Peaceful Coexistence

Peaceful coexistence is sometimes an appropriate resolution to a basement water problem. While keeping water out of a basement may seem ideal, there are risks. Preventing water from entering an older stone or concrete block foundation can cause water to accumulate on the outside of the foundation walls increasing water pressure on the walls themselves. The result can and has been total failure of the foundation wall. Where the construction of the foundation wall is marginal or questionable, the better approach to water control is to permit the water to enter, collect it into an interior drainage system, guide it to a sump and pump it away.

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Buyers of commercial real estate are concerned with the financing and economics of their acquisition.  Until recently, the condition of the building was only a relatively minor concern.  That is changing with PCA due diligence.

The initial impetus for carefully evaluating the condition of the building were the failures and foreclosures at the start of the decade.  Financial institutions were forced to deal with buildings that were not maintained and needed substantial work.

Next, regulations such as The Americans with Disabilities Act (ADA) created certain imperatives for building owners to upgrade facilities.  Seismic codes were, and continue to be re-written.  New environmental and ecological concerns surfaced.

Then, changes in the way buildings are financed created a need for a more formal and complete look at the condition of the building and the capital reserves required to maintain it.  As more commercial mortgages are securitized, the rating agencies on Wall Street – Moody’s, Standard & Poor’s, etc. – now require that property condition surveys be part of the due diligence process.

The Evolution of a Practice

The first type of engineering service to be almost universally required was the Phase I Environmental Site Assessment.  Initially, there was no standard for the service.  Vague requirements made it difficult for commercial developers, owners, and financial institutions to be confident that their environmental due diligence would be defensible in court.  Enter the American Society for Testing and Materials (ASTM) and the development of E1527: Practice for Environmental Site Assessments.

Property condition surveys and reserve studies have not yet become so standardized.  Firms in the business, each have their own format.  Each financial institution has their own scope.  FannieMae and FreddieMac individually created their own guidelines for multifamily properties.

Appropriate qualifications have not been defined.  Financial institutions require firms are acceptable to the rating companies.  The rating companies look to the financial institutions to select qualified firms.  Finding the best firm for the job can be difficult.

But things are changing, just as they did for environmental inspections.  The effort at standardization is being driven by the rating companies themselves.  Standard formats have been developed.  Most engineers in the field are aware of these formats and can provide them in a timely fashion.

Such consistency enables the engineer to understand the scope of services requested, and makes it easier for all to review the reports.  Some of the key features of the engineering study are:

• A review of documents, interviews with owners and occupants, and a site visit
• The development of a list of current deficiencies and a list and schedule of repair/replacement costs for building components, and a projection of these costs during the life of the mortgage plus two years.
• Commentary on the condition of the building and any observed or recorded code violations or safety hazards.

What to Expect in the Future of PCA Due Diligence

With PCA Due Diligence, clear expectations for both environmental and engineering services, commercial building owners, buyers, and financial institutions can expect to see some significant changes in the way service is provided.

First, necessary services are being consolidated under one roof.  Buyers can now purchase both engineering surveys and environmental assessments from the same company.  Consolidation simplifies the process, reduces costs, and shortens the time frame in which services are provided.  Criterium Engineers has offered both services for a number of years.  Firms are looking to consolidate other services as well, such as appraisals and surveys.

The second trend is to provide broad geographic coverage.  Firms experienced in this work have tended to have only one or a very few offices.  That required that they send people all over the region or country.  The result was higher cost and lower quality since the engineer was not necessarily familiar with local conditions.  Companies that specialize in this work are now trying to build networks to cover broader geographic areas.  The Criterium network of 65 national offices – 6 in northern New England – is a perfect vehicle for providing high quality, rapid and consistent service, at an affordable rate.

How Can I Be Sure of Getting the Best Service?

There are a number of things that owners and buyers can do to ensure the best and most expedient service.

1. Ask whether the engineering firm is familiar with the due diligence requirements for Commercial Mortgage Backed Securities (CMBS), Real Estate Investment Trusts (REITs) and the like.  Even if you are not going this route, the financial institution may use the standards of the rating agencies when reviewing your application.
2. Inquire as to the qualifications of the individual doing the work; the person on site. Some firms, in trying to provide broad geographic coverage, may use poorly qualified or inexperienced individuals.  The eyes and ears of the engineer are the most valuable part of the service.  And be sure to inquire if licensed engineers or architects are being used.  There is a difference.
3. Be sure to provide accurate and reliable information to the engineer. Construction drawings, maintenance records, and access to maintenance staff should all be readily available during the site visit.

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