New Environmental Concerns: Commercial Real Estate Lenders Nationwide Need to Be Aware of New Due-Diligence Requirements Critical to Protecting Their Interests Prior to Closing. Contamination Caused by Illicit Meth Labs and Other Property Uses Are Creating Lingering Liability
Ezovski, Derek, Mortgage Banking
If it seems like the ink on your environmental risk-management policy barely has time to dry before new developments make it obsolete, you're not imagining things. An increasing focus on environmental issues, coupled with a better understanding of the way contamination impacts human health and property values, has recently put environmental due diligence squarely in the spotlight. [??] The bad news is that it's time to update your environmental policy once again. But the good news is that today, when it comes to cost-effective, comprehensive environmental due-diligence tools, lenders have more choices than ever before. [??] So get that red pen ready: You'll want to factor the following into future commercial real estate due-diligence decisions to keep risk to a minimum.
All appropriate inquiries
On Nov. 1, 2006, the Environmental Protection Agency (EPA) codified the steps that purchasers of commercial real estate must take to qualify for liability protection under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA). The codification came in the form of a federal regulation entitled Standards and Practices for All Appropriate Inquiries, known as the AAI rule (visit www.edrnet.com/aai for more information).
By raising the bar in terms of who can conduct an environmental site assessment (ESA), what data must be researched, how long the assessment is valid and more, the AAI rule marks a significant departure from the previously accepted protocol, West Conshohocken, Pennsylvania-based ASTM International's E 1527-00 Phase I standard. Given the rule's implications on a borrower's exposure to CERCLA liability, every lender should take note.
"We recommend that all lending institutions understand the new AAI requirements and, based on their business profile, determine when to require AAI for their client base," says Daniel Grogan, an environmental professional in the Atlanta office of Alpharetta, Georgia-based MACTEC Engineering and Consulting. Grogan says that most, if not all, of the large lending institutions he works with have updated their environmental policies to consider AAI.
Alan Agadoni, a senior vice president in the Marietta, Georgia, office of Boston-based ATC Associates Inc., agrees. "Most lenders we work with have adopted ASTM 1527-05 [AAI's acceptable alternative]; however, we occasionally get requests for ASTM 1527-00 [the old standard] and modified transaction screens." Agadoni adds, however, that his company recommends clients comply with the new rule by following ASTM E 1527-05.
Of course, not all real estate deals are conducted with CERCLA liability in mind. Furthermore, with an AAI-compliant Phase I environmental site assessment carrying a price tag of at least $3,000 (depending on property type and location), not all transactions can support such an assessment.
A more practical approach for lenders is to decide whether to require AAI on a case-by-case basis. While more conservative lenders require adherence to AAI on every transaction, reasoning that if the borrower is protected the lender is as well, others base their decision on business considerations and risk-tolerance levels. Environmental consultants and attorneys can offer invaluable advice to lenders that take this approach.
Larry Schnapf, environmental attorney with Schnapf Environmental Law Center, New York, points out that AAI is not a requirement for banks to obtain a secured creditor exemption under CERCLA, but, like Agadoni, he recommends that lenders follow the rule anyway.
"If a lender is going to take actions that could cause it to lose immunity from liability--for example, if it forecloses on contaminated property and does not take steps to sell it in a commercially reasonable manner--then the lender would be like any property owner and would want to ensure that he or she complies with AAI. Bankers wishing to remain conservative should exercise caution, so that if they lose their secured creditor defense, they have another to fall back on," he says.
When lenders do require an AAI-compliant Phase I or its acceptable alternative, an ASTM E 1527-05 Phase I, they should be aware of the following:
Not every environmental consultant who hangs a shingle is qualified to conduct an AAI-compliant Phase I environmental site assessment. On the contrary--only inquiries conducted by environmental professionals who meet EPA's strict definition for experience, education and certification will qualify an individual for CERCLA liability protection.
AAI calls for extensive research. EPA's new rule requires a search of all ASTM E 1527-00 required records (the previously accepted protocol) in addition to new requirements for records from local government agencies and Indian tribes. What's more, the environmental professional must search for engineering and institutional controls.
In terms of historical research, AAI requires that the research go back as far as "it can be shown that the property contained structures, or from the time the property was first used for residential, agricultural, commercial, industrial or governmental purposes."
The environmental professional must also address and explain any gaps in data encountered during his or her research. This underscores the need to use consultants who will conduct thorough research that taps into state and local sources of property information.
Phase I site assessments expire. Like the previous ASTM standard, the AAI rule assigns a six-month shelf life to the site visit, interviews and government-records-review components. If the environmental inquiry is more than one year from the property's purchase date, however, all information must be "collected or updated within one year prior to the purchase date of the subject property." This language has implications for the banking sector's common practice of updating old Phase Is. Under AAI, every component must be current to within one year of the purchase date.
Qualifying for CERCLA liability protection does not end with pre-purchase screening. An AAI Phase I is the first step, but an owner could forfeit liability protection if applicable "continuing obligations" under CERCLA are ignored over the course of property ownership. These obligations begin the day the owner takes title to the property. They include such actions as ongoing compliance with any land-use restrictions on the property; stopping any continuing release; preventing any threatened future release; and preventing or limiting human, environmental or natural-resource exposure to earlier hazardous-substance releases.
With the additional requirements necessary for complying with the new federal regulation, lenders should be sure to choose help wisely. At the very minimum, a consultant must meet EPA's definition of an environmental professional, as the consultant will have to attest to his or her qualifications when signing off on the report. Additionally, a consultant who recognizes the nature of the particular deal, has worked with the type of property in question and who will see the transaction through its life cycle is preferable.
As with any business relationship, look for a consultant who understands your needs before you engage him or her in any actual work, says LaNeicia Stone, director of operations for EMG Corporation, Hunt Valley, Maryland.
"The key is to find someone who understands the business of real estate finance and has a good reputation in the industry," says Agadoni. "Lenders should review the consultant's implementation of AAI in their report template and scope of work to ensure compliance."
He adds that a national lender might want to work with a larger firm that has the ability to staff multiple projects or portfolios using local resources.
Grogan says lenders should select a consultant who has experience with the following:
* performing Phase I environmental site assessments;
* scoping and performing Phase II ESAs;
* local and state regulations where the property is located;
* developing a comprehensive risk profile based on regulatory drivers and the client's business needs;
* commonly requested assessment activities such as lead-based paint, asbestos, vapor intrusion, etc.; and
* site development/redevelopment activities and other associated services (geotechnical, civil site design, land planning, etc.) for cost efficiencies.
Finally, he offers, "Make sure to check the consultants' cost of services and capacity to meet deadlines."
If turnaround time is an issue, lenders should facilitate site access and consider asking whether the environmental professional uses Phase I report-writing software. These simple steps could shave days off turnaround time.
FDIC updates guidelines
Another reason for lenders to consider updating their environmental policies is that the Federal Deposit Insurance Corporation (FDIC) recently updated its Guidelines for an Environmental Risk Program to include the new protocol, after leaving it untouched for 13 years. The update not only recommends that banks establish formal environmental due-diligence policies in every instance of extending credit, but urges them to consider adopting AAI where appropriate. (For more information on FDIC's environmental guidelines, visit www.edrnet.com/index.php?option=com_content&task=view&id=67&itemid=157.)
In defining an environmental risk program, the FDIC recommends, among other things, that banks include a tiered approach to conducting an initial environmental risk analysis during the application process and a more detailed structured environmental risk assessment where appropriate. These steps may "allow the institution to avoid loans that result in substantial losses or liability and provide the institution with information to minimize potential environmental liability on loans that are made," states the FDIC guidelines.
In performing this preliminary analysis, data may include present and past uses of the target property, any actions involving environmental government agencies, and possibly a site visit. If environmental concerns are raised, a more detailed structured environmental risk assessment can be used. It is within this second tier that the FDIC envisions lenders will consider whether AAI is appropriate or necessary for each loan.
In alignment with AAI's continuing-obligations requirements, FDIC recommends that lenders monitor potential environmental concerns, such as changes in business activities at the property, over the life of the loan.
Real estate stakeholders take note: Clandestine drug labs can spell disaster for property owners left holding the bag after drug manufacturers abandon the property. Meth labs refer to the cars, hotel rooms, apartments, homes, garages and other places where the illegal manufacture of methamphetamine--the street drug also known as crank, crystal, speed and ice--takes place.
A growing national problem, these easily erected and highly toxic labs (six pounds of hazardous wastes are generated with every pound of drug produced) have been found in every state in the country--not surprising, considering the drug's addictive nature and the enticing profits crooks rake in. A $100 investment in the common household items and over-the-counter asthma and cold medications used to cook meth will yield $1,000 worth of the drug.
Not only do methamphetamines harm users--addiction is swift and devastating--it is also a problem for people exposed to the chemicals used to create the drug. In particular, meth "cooks" and first responders such as police and fire personnel can suffer various health effects before, during and after drug production. Fatigue, headaches, nausea, shortness of breath, coughing, chest pain and dizziness, lack of coordination, chemical irritation and burns are common.
Long-term exposure, even at low levels, is more severe, and may result in kidney or liver damage, neurological problems and an increased rate of cancer. For this reason, each former meth lab or dumping ground must be treated as a potential hazardous waste site and cleaned up accordingly--and it's usually the property owner who foots the bill. (According to the Washington Department of Health, half of meth labs are found on rental property.)
And cleanup isn't cheap: The Drug Enforcement Administration (DEA) estimates that it costs approximately $3,000 to $4,000 to clean up a former "small-time" meth lab; cleanup for larger sites can run into six figures. To add to the property owner's woes, not only does he or she face loss of rental income until the site is remediated, but there could also be liability, civil penalties and property devaluation.
According to Dan Hannan, corporate safety and health manager for Bay West Inc., St. Paul, Minnesota, who has responded to more than 300 clandestine drug labs, the size of the lab, its productivity and its location usually determine the extent and magnitude of the environmental and public-health-related impacts. "Evidence of dumping, burning or burial is usually obvious," he says. "Soil and water samples can be collected to determine whether impacts have occurred. If confirmed, it may be necessary to dispose of hazardous characteristic soil and wastewater," says Hannan.
Information gathered from an assessment is used to support recommendations about how to return the property to habitable condition. The report is typically presented to the property owner with proposed necessary corrective actions.
To restore these properties to habitable condition involves extensive work, which often includes throwing away carpets, drapes, furniture and other objects where meth residues linger. It also involves painting or sealing walls, floors, countertops, and the like, to create a physical barrier to leftover chemicals, as well as power-washing the home, cleaning ventilation systems and so on. Post-cleanup sampling is typically required before anyone can reoccupy the dwelling.
Currently, there is no federal regulation governing meth-lab cleanup. However, a growing number of state regulators have addressed the problem. For example:
* Colorado passed a law that requires property owners to hire professionals with specialized equipment for meth-lab remediation.
* Washington requires owners to ensure no more than 5 micrograms of methamphetamine residue per square foot are left in a structure.
* Yellowstone County, Montana, requires that former meth labs be noted as such on building deeds.
Today, records on properties tainted by toxic materials related to methamphetamine production are becoming more numerous. More than 20 states maintain clandestine drug laboratory (CDL) records. The federal government maintains its own database as well.
Commercial property stakeholders would do well to check the lists: Any property associated with an enforcement action related to former meth-lab activity has the potential for environmental contamination in any drainage system on the subject property as well as in surface-water bodies. If a state drug-enforcement agency responds to a meth lab, it will dispose of chemicals and byproducts at the property, but may not address environmental issues regarding leftover chemical residue, potential groundwater contamination and toxic fumes that can linger for years, and for which the property owner can be held liable.
"Meth labs are a big threat if not properly remediated," says EMG Corporation's Stone.
Last, but certainly not least, is the growing issue of vapor intrusion. In the 1990s, the Massachusetts Department of Environmental Protection discovered that underground pollution can vaporize and migrate into overlying structures, negatively impacting indoor air quality.
A significant liability issue for stakeholders in today's real estate transactions, vapor intrusion can not only harm human health--eye irritation, respiratory problems, headache, nausea and even cancer have been linked to the phenomenon--but it can also present a business risk by adversely impacting, or even killing, deals.
While vapor-intrusion assessments are not a routine part of most Phase Is, many environmental professionals report that their more sophisticated clients are requesting them. This is mainly because real estate and environmental attorneys are dialed in to the issue and regularly inquire as to how vapor intrusion will be handled. Too, while no clear-cut national standard for vapor intrusion exists, many states have their own guidelines.
ASTM, the group responsible for developing the Phase I standard, has approved its Vapor Intrusion Task Group to tackle the issue. Working closely with federal and state regulators, lenders and the real estate industry, the group expects to publish its highly anticipated vapor-intrusion standard by year-end, according to the group's chairman, Anthony Buonicore, also chairman of Environmental Data Resources Inc., Milford, Connecticut.
In the meantime, lenders should talk to their environmental consultants about the issue. "Screening for vapor intrusion is typically necessary if there is a recognized environmental condition with the potential for vapors to migrate into a building/structure and accumulate," says Grogan. "We don't recommend screening for vapor intrusion unless such a condition and associated risk is identified as part of the Phase I," he adds.
Agadoni agrees. "I would recommend vapor-intrusion screening based on the findings and conclusions of the site assessment," he says.
Lenders should not ignore the potential for vapor intrusion if a site assessment turns up a recognized environmental condition. Surprisingly, even properties considered closed and fit for occupancy have been reopened to examine the issue, creating liability and cost headaches for owners of properties that may have been deemed "clean" when the Phase I was conducted.
In the competitive world of commercial lending, deadlines for environmental site assessments seem to shorten considerably from year to year. To ensure that turnaround time is met, the more information a lender can give a consultant up front regarding an asset, the better.
"Some of the information we obtain through prior reports will shorten the length of time due diligence reporting takes [i.e., waiting on file reviews for issues at a property where a prior report had all the files and closure reports], thereby bringing the banker and their client to the closing table a lot sooner," says Stone.
Agadoni says that lenders should be aware that lien-search providers can take 15 business days or more to provide information, which can impact the turnaround time of an AAI-compliant report. (Lien searches are a requirement under AAI.)
If a particular deal doesn't require an AAI-compliant Phase I, other forms of due diligence, such as a desktop data package with historical reports (ordered online from an environmental information vendor) or a transaction screen assessment, can offer invaluable insight for a fraction of the time and money.
Derek Ezovski is managing director of the Property Due Diligence Group for Environmental Data Resources Inc., Milford, Connecticut. He can be reached at firstname.lastname@example.org. To learn more about EDR, visit www.edrnet.com.
RELATED ARTICLE: RESIDENTIAL REAL ESTATE NOT IMMUNE
Not at all selective, environmental contamination affects residential as well as commercial properties. In fact, today's focus on "green" living, coupled with widespread awareness of the human health risks posed by environmental contamination, can make polluted residential properties even more of a problem than commercial sites. Additionally, lenders often screen residential properties for environmental contamination with nothing more than a basic questionnaire--or skip environmental due diligence altogether.
The following recent Rhode Island case illustrates just how severe environmental contamination associated with residential properties can be.
In 1977 and 1983, two different parties--both limited partnerships--opened apartment complexes for the elderly in North Providence, Rhode Island. In the late 1990s, pollution resulting from former industrial operations at the site was discovered. The contamination was so extensive that the Environmental Protection Agency (EPA) designated the property a Superfund site--a classification reserved for the nation's most contaminated properties.
Under a consent decree, the parties, whose only real assets are the apartment buildings, must contribute $3.7 million toward the site's cleanup, which, according to the EPA, is contaminated with dioxin, polychlorinated biphenyls (PCBs), volatile organic compounds and metals. (Under Superfund law, current owners of contaminated properties can be held liable for cleanup, regardless of whether they contributed to the contamination. Today, conducting proper environmental due diligence in accordance with EPA's Standards and Practices for All Appropriate Inquiries [AAI] rule affords a purchaser liability protection.) The owners must also keep the apartments, which provide affordable housing for about 230 senior citizens, open.
(The discovery of pollution in the 1990s wasn't the first time the property was tagged as a potential problem. Prior to 1936, the property was home to the Centredale Worsted Mills, a woolens mill; from about 1943 until the early 1970s, it housed Atlantic Chemical Co.; and, finally, from 1952 until 1972, the New England Container Co. ran an incinerator-based drum-reconditioning facility at the site. Between 1970 and 1986, the Rhode Island Department of Environmental Management steered efforts to investigate the property's contamination and issue cleanup orders for violations. In the early 1980s, 400 drums were excavated and disposed of. Prior to the apartment buildings' construction, nearly 6,000 cubic yards of soil were excavated and disposed of as well.)
To generate funds for the settlements, each property's mortgage was refinanced. To help with cleanup costs, EPA has, since 1999, been searching for other potentially responsible parties. The agency also obtained a title search and reviewed Rhode Island Department of Environmental Management's files and historical records for clues into the site's history of operations and releases. Thus far, a fence has been erected around contaminated areas, and contaminated soil has been capped; both activities reduced immediate public-health threats. Additional cleanup activities are under way, with cleanup expected to be completed in 2008.
Although contamination occurred prior to the 1970s, federal Superfund law holds both parties (the two limited partnerships) responsible for cleanup. A breakdown of what the partnerships paid follows:
* EPA: $3,049,336
* Department of the Interior (natural-resource damages and assessment costs): $136,900
* Escrow account for ongoing obligations: $300,000
* State of Rhode Island: $277,063
Back when these Rhode Island apartments were purchased, environmental due diligence was not a routine part of real estate transactions. Even today, when environmental due diligence is routine, many multifamily or other residential properties do not undergo more than a cursory environmental inspection, usually in the form of a questionnaire.
Although it's tempting to cut corners or skip environmental due diligence altogether, it pays to research a property's history thoroughly. Research is especially important when the property had a former industrial use, even if there are no buildings present.
If a full Phase I environmental site assessment isn't on the schedule, tapping into current government databases and digging into historical records like Sanborn fire insurance maps and old aerial photographs (both available from commercial vendors for a reasonable cost) is a good start.
In the Rhode Island case, although the industrial activities took place well before government agencies began keeping records of such activities, the financial penalties placed on the property owners--and their lenders--could have been avoided if a thorough historical investigation had been conducted prior to purchase. Indeed, Sanborn maps, which can be obtained for a few hundred dollars or less, clearly show that the site was once occupied by Atlantic Chemical Co., a tip-off to even a layperson that residual contamination is likely.
For individual homeowners interested in their neighborhood's environmental status, screening for contamination has become easier, thanks to a handful of companies offering neighborhood environmental reports. These reports, available via home inspectors for less than $200, search myriad federal, state and local databases for environmental records on or around the home under consideration. They can provide a good idea of whether neighborhood pollution is likely--and peace of mind in most circumstances, when no nearby contamination is found.…
Questia, a part of Gale, Cengage Learning. www.questia.com
Publication information: Article title: New Environmental Concerns: Commercial Real Estate Lenders Nationwide Need to Be Aware of New Due-Diligence Requirements Critical to Protecting Their Interests Prior to Closing. Contamination Caused by Illicit Meth Labs and Other Property Uses Are Creating Lingering Liability. Contributors: Ezovski, Derek - Author. Magazine title: Mortgage Banking. Volume: 68. Issue: 2 Publication date: November 2007. Page number: 82+. © 2009 Mortgage Bankers Association of America. COPYRIGHT 2007 Gale Group.