CIP11-Economically Distributing Engineering Risk During a Real Estate Transaction
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Many times we are asked by clients to “Make sure the house is not going to fall down”. It is rare for a structural issue in a residence to be an imminent safety issue. It is very rare for a house to actually “fall down”-short of extreme weather conditions or the occasional exterior deck collapse. Conventional Light Frame Construction typically has large factors of safety and extensive redundancy.

Even local failures will generally remain local and not cause a collapse. Of course, there are exceptions to this, but the majority of structural issues we see in houses are NOT urgent safety concerns. The majority of issues we see are FINANCIAL Issues. A client who is considering buying a property is assuming not only the repair costs for identified issues but also the future risk of both identified and unidentified issues.

Our goals are always the same: Identify 1.)What is the problem? 2.) What, if anything needs to be done about it? 3.) About how much is that going to cost? We strive to provide clients with all the information they need to make their own decision on whether or not to proceed with the purchase and all the information and ammunition they need to negotiate for repairs to be made or credits to be issued. Many times this is pretty clear. Many other times it is not. A foundation that needs to be reinforced or replaced is easy to quantify in both scope and price. The same holds true for a reinforcement or replacement of a beam or column.

Many times, issues do not rise to the point of needing immediate action and only time will tell what the outcome and cost of the issue is. Other times, it is not time but drywall covering the problem and not allowing us to completely quantify it. Many problems are budding problems that need to be monitored. When our client owns the home and is staying in the home, they have the luxury of not spending any immediate money on the problem and monitoring it. Luxury may seem like a strong word, but we see the other end of this so much, that we truly consider it a luxury. What happens when a problem needs to be monitored or is concealed with no chance of seeing it before closing? What about when the best engineering advice we can give is, “Something is going on, It is not an immediate problem, You COULD spend XX dollars now so you never need to worry about it again, You also could just monitor the problem and may never need to spend any money on it. Depending on what is revealed or what manifests itself, it could cost between 0 and XX dollars.”

Buyer: This problem could cost me XX dollars. I want it fixed or I want a credit.
Seller: There is no immediate problem I need to fix. I’m not doing or giving a thing. If I wasn’t selling the house, I wouldn’t have to spend any money.
Engineer: You’re both right.

Now What? How do we fairly distribute economic risk in these situations?

All real estate purchases carry inherent risk. This applies to whether the property is brand new or 100 years old or anywhere in-between. We cannot remove the risk from the transaction. What we seek to do is normalize the risk. We seek for repairs or credits to bring our clients risk in line with the normal level of risk that is inherent in any home purchase.

These types of issues typically have either a time risk (there is a chance the problem will get worse with time and require repairs) or a concealment risk (there is a chance that if you remove the ceiling you will find a problem which will require repairs). Is there a fair way to quantify and distribute this risk?

The first step is determining the two extremes of outcomes within reason. Obviously, there is always the risk that additional items requiring repair may be identified when any work is done. There is always the slight risk that you will change a light fixture and discover extensive termite damage. This is “normal” risk. On a slightly bulged foundation wall with a small crack, the simplest outcome is usually patching the crack, addressing the usual or obvious causes, and monitoring the wall. The most extensive outcome would be rebuilding the wall. For arguments sake, we will assume that the simplest option would cost $2500.00 and the extensive option would cost $30,000.00. Note that we are not using “best” and “worst” case-since those terms can be highly relative to each side of a transaction.

The next step is determining probabilities of outcomes. Since the wall does not require any immediate reinforcement, it is highly likely that if monitored, action such as reinforcing can be taken prior to the wall reaching the point where it needs to be rebuilt. The responsibility for monitoring falls onto the prospective buyer, but it their house at that point and they are responsible for maintaining it so the risk of not monitoring the wall is their risk alone. We have now narrowed the risk to $2500.00-$15,000.00 to reinforce the wall with CFRP strips, re-grade the exterior, and add exterior drainage. What is the likelihood of these outcomes? The Engineer must use a myriad of factors in assessing this. We have some information on these factors in our other CIP’s but the scope is beyond this paper. We will assume that based on the Engineer’s assessment, there is a 30% chance that the wall will need to be reinforced within the next 5 years and a 70% chance that the simpler, $2500.00 option will be the likely outcome. So at a bare minimum the buyer should be credited the $2500.00. What about the potential additional $12,500.00? Do we proportion it based on the risk? i.e. 30% of it equals $3750.00. If so, is that all assumed by the seller or is that number then proportioned? What about a time horizon? We used 5 years in this example. What is a reasonable amount of time that risk should still be proportioned? When should anything that happens be solely the responsibility of the new Owner? Is there a “statute of limitations” on risk?

Is $6250.00 ($2500 + $3750) a fair credit in this circumstance? All we can do as Engineer’s is provide as much information as clear as we can. Ultimately, it is up to the buyer and seller to negotiate a solution.