Soft Story Ordinance – Real Estate Finance and Owner Issues

The Mandatory Soft Story Retrofit Ordinance is not San Francisco’s first attempt at improving the future seismic performance of the building inventory.  In the 1990’s the City passed and executed a similar ordinance for unreinforced masonry buildings.  The ordinance had mixed success but proved to be challenging for lenders, building owners and tenants.  The new San Francisco Seismic Ordinance  targets the multifamily housing inventory.  The City has a goal of improving the seismic resiliency of the multifamily apartment housing inventory to ensure the residents will have a home to shelter should a significant earthquake affect the Bay Area in the coming years.

Lenders and building owners (borrowers) can be classified into a few distinct categories.  It is important to note that prior real estate due diligence efforts on the property may not have revealed the soft story condition.  This may be due to the fact that the lender does not require a seismic risk assessment (known as a Seismic Probable Maximum Loss Report for new loans and refinance transactions and/or the prior seismic risk assessments did not properly address building stability and the potential for localized collapse due to the soft story. 
Soft Story Building

San Francisco’s mandatory Soft Story Retrofit Ordinance requires a seismic retrofit of existing buildings identified as having a soft-story hazard.

Here are some of the key issues and considerations for lenders and borrowers in these categories:

1. Lender has a current note (loan) on a property that is on the soft story list

  • The lender may choose to assist the owner with retrofit finance through a second or whole asset refinance
  • The borrower may not have sufficient equity for a second, which could put the lender at risk of loan default and foreclosure
  • The borrower has cash to pay for the retrofit, not impacting the first note

2. Lender is considering lending on a property that is on the soft story list and has not been retrofitted

  • Fund the loan and require the borrower to retrofit within specific time.  Hold back funds and pay out through construction
  • Fund the loan and require the borrower to obtain a second to pay for retrofit
  • Require the borrower to perform retrofit before loan funds.  Proceeds of loan not used for retrofit work
  • Require earthquake insurance until retrofit is complete (not a good means to mitigate the threat to life safety the soft story condition presents

3. The owner wishes to retain the asset and perform the retrofit

  • Owner has sufficient cash to perform retrofit work
  • Owner requires financing for retrofit work in the form of commercial bank second, refinance of the first with holdback, private financing
  • Owner has insufficient cash and equity to perform retrofit, possibly impacting obligation to pay on first note
  • Owner has illegal units or potential ADA upgrade requirements due to the ordinance, increasing the cost and scope of the project

4. Owner wishes to dispose of the asset, in part due to the burden of the retrofit ordinance

  • The cost of retrofit, impact of ADA and zoning are too prohibitive to continue ownership
  • Buyer needs to perform retrofit or be subject to the terms of lender until completed
  • Property subject to the ordinance, and not previously retrofitted, may impact value
Partner has worked with a number of different lenders and building owners and learned that the process is confusing for both parties.  In a following blog we will discuss the suggested sequence of events to ensure the structural investigation and rehabilitation is designed and constructed appropriately and cost-effectively.

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