CREJ

April 2020 — Property Management Quarterly — Page 13 www.crej.com Management Fire Alarm & Sprinkler System Testing & Inspection We Service All Makes of Fire Alarm Systems Emergency Services & Deficiency Repairs New Construction Engineering & Design Tenant Finish Fire Alarm & Sprinkler 303.789.0016 for 24 HR Emergency Services-impactfireservices 303.789.0016 impactfireservices.com 3448 SO IRVING ST SHERIDAN CO, 80110 T he general intent of business interruption insurance is to put an owner (insured) in the same financial position the individual would have been “but for” the loss event. The formula for this is as follows: 1. Net profit not earned plus con- tinuing operating costs or fixed expenses, or 2. Loss of revenues less variable or saved costs. Insurance policies covering loss of profits typically are defined as either of the above. The two formulas gen- erate identical results. It has been my experience that explaining the concepts in formula No. 2 are easier to comprehend for first-timers. The purpose of this article is to share a few of the nuances in mea- suring various real estate properties loss of profits resulting from a cov- ered event (catastrophe, fire etc.). n Forensic accountant. Business interruption losses of size generally will result in insurance companies retaining an independent forensic accountant. Some insurance compa- nies employ their own accountants, but the majority do not. Determining loss of revenues less saved costs on the surface appears relatively black and white, but often is not. A few of the nuances on properties you may had/have exposure to follows. n Retail: Malls, strip centers, restau- rants. Typically, there rarely are any business interruption losses follow- ing hail damage. The storm that hit Colorado Mills in May 2017 was an exception. We worked several busi- ness interruption losses related to the tenants. A common measure- ment topic to be aware of for both tenant and land- lord is that rent in the lease includes percentage rent over a certain threshold. For example, let’s say a retail store was down May 2017 through March 2018. Lease terms $10,000 monthly, or 8% of annual (calendar) sales, whichever is higher per annum. To state another way, minimum rent is paid until sales exceed $1.5 million. Sales for 2018 absent the hail event was projected at $2.6 million. Sales for tenant were projected and lost at $600,000 for the first quarter. They claim saved rent is $30,000 (10,000 x three months). The proper measure is saved rent of $48,000 ($600 x 8%) during 2018. The insured would have passed the 2018 threshold by year- end; by $600,000 greater “but for” the event. Percentage rent impacts the tenant and the landlord’s business interruption measure and is miscal- culated at times. n Office buildings. It is not infre- quent to have tenants permanently leave the building after a loss event, even if the landlord offered to relo- cate them in other owned properties in the area or relocate them within the damaged building. The measure of the rent/common area mainte- nance lost is fairly straightforward. The gray area is if the lease was up during the restoration period. The landlord often will argue in favor of a lease renewal likelihood was 100%. The insurance company accountant will look for some evidence such as correspondence toward that effect or a track record of this tenant reup- ping in the past. Typically, there will be a tail on the policy called extended period of indemnity where the landlord continues to receive reimbursement for loss of profits for a stipulated period beyond the restoration period. The intent of the tenant needs to be reasonably sup- ported by both sides. n New construction. When new construction is delayed due to an insurable event there is coverage available for loss of profits common- ly referred to as “delay in opening.” The difficulty in measuring, opposed to the examples above, is that there is no history from which to base a revenue projection. Example of an apartment complex delayed for four months and the adverse impact on lease-up rates is critical. If the owner has similar owned properties and its historical lease-up rates, this would be helpful. Absent this, pro-forma supplied to the banks/investors will be a tool used. In summary it is all about the pro- jection and what can be reasonably supported for any business, what would have happened “but for” the event. s Business interruption insurance overview Peter Hagen CPA, CFF Executive vice president, J.S. Held LLC There rarely are any business interruption losses following hail damage for retail real estate, with the storm that hit Colorado Mills Mall in May 2017 being an exception.