A flood risk assessment gives return periods and damages; the price needs one number, built from the part insurance does not pay and the part the next buyer will deduct.
Price flood risk as three numbers added together: the present value of the expected annual damage that insurance will not pay, the exit value lost to the discount the next buyer will apply for the same risk, and any resilience works the flood risk assessment recommends. On an illustrative 24,000,000 warehouse in a flood zone, that is 617,655, 2.57 per cent of the price, or 16 basis points of yield. The figure buyers often reach for, the 3,000,000 damage of a 1-in-200 flood, overstates it 4.9 times.
Worked in full in Real Estate Transaction Due Diligence by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A flood risk assessment describes risk as return periods: the depth, and with a damage survey the cost, of a flood expected once in 20 years, once in 75, once in 200, once in 1,000. None of those is a price. The bridge is the expected annual damage, the probability-weighted average loss in a year, which is what an insurer prices and what a buyer keeps whatever it does not insure. Two things are then added that the annual number does not see: the next buyer's view of the same risk, and the cost of reducing it now.
| Input | Value |
|---|---|
| Price / net rent a year | 24,000,000 / 1,440,000 |
| Flood excess per event | 250,000 |
| Hold / discount rate | 10 years / 7.0% |
| Exit yield / flood discount at exit | 6.00% / 15 bp |
| Rental growth a year | 2% |
| Resilience works recommended (flood doors, raised plant) | 180,000 |
| Event | Annual probability | Damage | Uninsured (up to the excess) |
|---|---|---|---|
| 1 in 20 | 5.000% | 150,000 | 150,000 |
| 1 in 75 | 1.333% | 1,200,000 | 250,000 |
| 1 in 200 | 0.500% | 3,000,000 | 250,000 |
| 1 in 1000 | 0.100% | 5,500,000 | 250,000 |
The insurance premium is assumed recoverable from the tenant under the lease, as it usually is on a full repairing lease. All figures are illustrative; the damages come from the flood risk assessment and a cost survey, not from a rule of thumb.
EAD = Σ ½ × (Di + Di+1) × (pi − pi+1) + Dlast × plast
Price adjustment = PV(uninsured EAD over the hold) + PV(exit value × yield shift effect) + works
Excel, per band: =0.5*(D1+D2)*(1/RP1-1/RP2); then =PV(7%,10,-EAD)
Step 1, expected annual damage. Between the 1-in-20 and 1-in-75 events: the average of 150,000 and 1,200,000 times the 3.667-point gap in probability, 24,750. The next two bands add 17,500 and 17,000, and the tail beyond 1 in 1,000, taken at the last damage, 5,500. Total EAD: 64,750 a year. No damage is assumed below the 1-in-20 event, which the defences hold.
Step 2, the part the landlord keeps. Cap each damage at the 250,000 excess and repeat: 7,333 + 2,083 + 1,000 + 250 = 10,667 a year. Insurance carries 83.5 per cent of the expected loss. Over a 10-year hold at 7.0 per cent, the uninsured part is worth 10,667 × 7.0236 = 74,918.
Step 3, the exit. The rent grows to 1,755,352 by year 10. At a 6.00 per cent exit yield the building is worth 29,255,866; a buyer who prices the flood zone at 15 basis points pays 28,542,308. The 713,558 difference is worth 362,737 today.
Step 4, add the works. 74,918 + 362,737 + 180,000 = 617,655. The adjusted price is 23,382,345 and the net initial yield moves from 6.00 to 6.16 per cent.
Most of the adjustment is not the flood. It is the exit discount, a market effect that applies whether or not water ever reaches the building. That is the number to test hardest, against evidence of how comparable flood-zone assets have traded.
| Insurance | Uninsured EAD | Present value | Total adjustment | % of price |
|---|---|---|---|---|
| Excess 100,000 | 5,000 | 35,118 | 577,854 | 2.41% |
| Excess 250,000 (case) | 10,667 | 74,918 | 617,655 | 2.57% |
| Excess 1,000,000 | 34,417 | 241,728 | 784,465 | 3.27% |
| No flood cover available | 64,750 | 454,777 | 997,513 | 4.16% |
| Exit yield discount, bp | PV of exit loss | Total adjustment |
|---|---|---|
| 0 | 0 | 254,918 |
| 15 | 362,737 | 617,655 |
| 30 | 708,200 | 963,118 |
| 50 | 1,144,015 | 1,398,933 |
Across these ranges the exit market moves the number more than insurance terms do. Losing cover altogether, the tail risk a lender will ask about, adds 379,859 to the case, about as much as widening the exit discount from 15 to 30 basis points, which adds 345,463 on its own.
Whether a further investigation is worth commissioning before exchange follows the same break-even logic as whether a Phase II environmental assessment is worth the cost, and works found in the survey are priced as in how to price building survey capex into the purchase price.
Real Estate Transaction Due Diligence sets technical, legal and financial findings against the price before signing, and the free workbook for this case attributes what each workstream recovered.
Take the damage at each return period from the flood risk assessment, convert return periods to annual probabilities, and integrate damage over probability, averaging adjacent damages times the gap in probability. On an illustrative warehouse with damages of 150,000 to 5,500,000 from a 1-in-20 to a 1-in-1000 flood, the expected annual damage is 64,750.
No. The landlord keeps the excess on every event, the next buyer still discounts the exit price, and cover can be withdrawn or repriced. On the illustrative warehouse insurance pays 83.5 per cent of the expected damage, yet the price adjustment is still 617,655, mostly a 15 basis point exit yield discount worth 362,737 today.
Not as a price adjustment. A 1-in-200 flood has a 0.5 per cent annual probability, and deducting its full 3,000,000 damage treats a rare event as certain. On the illustrative case it overstates the adjustment 4.9 times. Use it to test insurance and lending terms, and price the expected loss.
This article is one calculation from Real Estate Transaction Due Diligence. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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