POTENTIAL Y2K IMPACTS FOR COMMERCIAL REAL ESTATE

Companies are spending heavily to avoid the problems that could be caused by computers, software programs and electronically controlled system by their inability to handle the transition to the Year 2000. The Year 2000 problem ("Y2K") problem poses potential concerns for the commercial real estate finance industry for at least three groups, loan servicers, property managers and tenants.

The Y2K problem stems from the once common computer practice of using two digits to refer to the date, like 99 for 1999. Many computer systems may read 00 as 1900, not 2000. Other systems cannot process 00 in the date field and may reset to 1980, or just freeze. September 9, 1999 poses another possible concern because many computer programs treat an entry in a data field of 9999 as end of file or date unknown. Virtually all mainframe computers have programs with just two digits to denote the date. In addition, many computer programs that incorporate forward scheduling, budgeting and accounting may hit a glitch at the beginning of the 2^nd, 3^rd and 4^th quarters of 1999 when they attempt to open the books for the Year 2000.

The loan servicer must insure that their systems are Y2K compliant in order to properly account for payments and disbursements. Otherwise, they run the risk of liability if they are unable to service mortgages due to defective computer systems. Secondly, if the property management's billing, maintenance and management systems fail, the disruption in business could impact the value of the collateral securing the loan.

The Y2K issue has raised awareness of what has long been true in the computer industry, that hidden computer chips are far more numerous than the machines on desktops. There are risks in the billions of microchips that control all types of appliances and equipment, transportation, manufacturing, medical and control systems that have built-in programming that relies on dates. It is estimated that 4.6 billion hidden computer chips, known as microchips were sold in 1997 alone.

The extent of the problems caused by Y2K bugs in embedded microchips is likely to be relatively limited. Embedded microchips fall into three basic categories. The vast majority of chips do not require date awareness to perform their function, and therefore should not be affected by the Year 2000. The next group of microchips are those that do not need to be date aware to perform their primary function, but might require some calender knowledge to perform a peripheral function, such as printing a date on a report. The most critical group are those systems in which the microchips are date aware. These chips function differently depending on the day of the week or time of the day. These chips may fail or just operate on an incorrect schedule; however, it is unlikely that these systems would cease to function entirely, though they may not perform efficiently. Often, specific devices (such as elevators) may not have a Y2K concern themselves, but may be connected to another system (such as building control systems) that may have their own problems. For example, building management systems may instruct elevators to go to the ground floor and lock, access and security systems may prevent, or allow access at incorrect times, HVAC and lighting systems may operate at a reduced level (weekend mode), automatically scheduled maintenance tasks may not occur when required and reservations systems may lose track of bookings.

Although it is estimated that only a small percentage of systems with these microchips may malfunction because they cannot handle the transition to the year 2000, with billions in use, even a small percentage could cause widespread problems. Because they are utilized in such a wide variety of systems, it is a challenge to even identify potentially affected systems in order to test them.

Embedded microchips could cause disruptions of critical building systems such as:

• •Building management systems

• •Maintenance or PM systems

• •Building access/Security systems

• •Vertical transportation (elevators, escalators)

• •Heating, ventilation and air conditioning ("HVAC") systems

• •Variable Frequency Drives

• •Lighting control

• •Fire detection, alarms, emergency exits, sprinkler and life safety systems

• •Parking access

• •Landscaping irrigation systems

• •PBX Telephone systems

• •Reservation and Point of Sale systems

• •Computer systems

The failure of these systems could disrupt tenant operations which may entitle the tenant to withhold rent. Additionally, the commercial tenant's operations could be internally disrupted sufficiently to affect their ability to pay rent and consequently impact the owners ability to pay the mortgage.

It is recommended that Y2K building and system readiness should be included as part of the engineering inspection of the property. Specific items to address may include the following:

• •What systems (see above list) are present at the property that may be affected by Y2K?
• •Is the property owner/manager aware of Y2K issues?
• •Is there a plan in place to identify and address Y2K issues
• •Is any Y2K work currently in progress?
• •Has a survey been complete and issues identified?
• •Have the appropriate vendors and suppliers been contacted?
• •Has a Y2K simulation been performed?
• •Have upgrade/repair cost estimates been established? If so, what are they?

Lenders should take all necessary steps to insure that their internal systems are Y2K compliant and fully document these activities. Steps should be implemented to promote compliance by borrowers, such as including a Y2K compliance provision in the loan documents or alerting them to the potential consequences of Y2K failure or inaction. The lender should also work with the borrower and property managers to determine the susceptibility of the underlying tenant base at the property.

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