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CRE Finance World, Summer 2014

The Evolving Approach to Environmental Risk Management and Due Diligence Brian Cochran nvironmental issues often arise on commercial real estate transactions. Sophisticated decision-making on lending involves evaluation of a range of issues, with environmental due diligence taking center stage only when concerns are identified. Deal managers may receive a crash course in environmental matters under pressure trying to get a deal closed. With a general understanding of commonly encountered issues, the types of environmental risk, and options to manage that risk, the stress of dealing with environmental issues can be reduced. Many issues can be mitigated through pragmatic solutions for the borrower and lender that create a balanced approach to environmental risk management. However, without basic knowledge of these concerns, getting to the stage where all parties are comfortable and the fundamentals of the deal still make sense can be a challenge. What follows is a refresher on commonly encountered environmental concerns, as well as the latest hot button issues affecting the due diligence community. The approach to certain issues within the environmental risk arena has evolved in recent years. In 2013, the American Society for Testing & Materials (ASTM) Standard for Phase I Environmental Site Assessments (ESAs) was updated, solidifying some changes that were already underway and creating a new category of recognized environmental condition. In addition, the Office of the Comptroller of the Currency (OCC) issued an updated Comptroller’s Handbook for Commercial Real Estate Lending that includes a detailed discussion of requirements for environmental risk management policies. These changes may affect your next transaction, and with this update, you will be better prepared to manage the risk. Common Environmental Issues Encountered in Commercial Real Estate Transactions First, a quick summary of some of the most common “red flag” issues in environmental due diligence. • Dry Cleaners: Retail centers are often occupied by dry cleaning tenants. Dry cleaning facilities often cause contamination, even when operating in compliance with regulations. The State Coalition for the Remediation of Dry Cleaners (SCRD) estimates that 75% of dry cleaners currently in operation have resulted in contamination. It is important to note that even a retail center with no active dry cleaners currently may have previously been occupied by one or more dry cleaning tenants. Costs associated with the cleanup of these types of sites may exceed $2 Million. Migration of vapors from dry cleaning solvents and other Volatile Organic Compounds (VOCs) into buildings from contaminated soil and/or groundwater CRE Finance World Summer 2014 62 may occur. The migration of contamination from soil vapor into the overlying structure is known as vapor intrusion, and this presents a health risk to the occupants of a building as many VOCs are carcinogenic. This health risk represents a potential source of liability for property owners/landlords as well as employers within affected areas. In the event of a foreclosure, this liability could be transferred to the lender if proper precaution is not utilized. • Gas Stations & Auto Repair: Gas stations represent a variety of concerns relative to the storage of fuel, and potentially waste oil, in underground tanks. Typical gas station locations on corner lots have since been redeveloped with new businesses, and depending on the time frame of development, proper decommissioning of the fueling activities may not have occurred. Many corner-lot fast food restaurants and stand-alone drugstore locations were previously occupied by gas stations. If the fuel dispensing activities ceased prior to regulation, it is possible that the underground storage tanks (USTs) were not closed in accordance with current regulations and subsequently soil or groundwater contamination may exist unbeknownst to the current owner or lender. Many gas stations operate convenience stores that were previously occupied by an auto repair business. If the conversion of the auto repair business to a convenience store was not handled properly, subsurface features of concern such as hydraulic lifts, oil/water separators, and waste oil tanks may remain in place. • Industrial Sites: Potential concerns associated with industrial sites are directly related to their current and past operations and the chemicals they utilized onsite. Risks to the soil, soil vapor and groundwater beneath the property may be present, even if the prior business was in compliance with environmental regulations at the time of operation. Industrial solvents pose a particular risk due to their mobility in the subsurface, cost to remediate, and third party liability. Environmental due diligence is performed to review the prior process and materials used to make a judgment regarding the likelihood of contamination. It is critical to gain as much historical knowledge as possible regarding the nature of operations on industrial properties so that the level of risk can be assessed. While current or recent occupants may not pose a concern, prior occupants may have been high risk and not previously identified. • Mold, Asbestos, Lead-Based Paint & Radon: While these issues are technically outside of the scope of the Phase I ESA standard, many lenders require consideration of the risks posed by these concerns. Deferred maintenance of building components such as roofing may cause water intrusion, leading to the presence of mold. The presence of lead-based paint or asbestos-containing materials can lead to increased costs for any needed maintenance E Senior Vice President AEI Consultants Holly Neber President AEI Consultants


CRE Finance World, Summer 2014
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