The Consequences of Incomplete Environmental Due Diligence


Joseph Kim_square

Joseph Kim, Project Manager
GRS | Corteq

Joseph Kim_squareDuring commercial and industrial property transactions, oftentimes it is mandatory to perform some level of environmental due diligence (EDD) to ascertain the properties being purchased are not contaminated or likely to cause potential environmental concerns.

However, prospective buyers often make fatal mistakes by not doing sufficient level of EDD, often resulting in having to pay significant financial damages. Many people who apply for a loan to buy a property, by their own choice, do not want to conduct an appropriate Phase I Environmental Site Assessment (Phase I ESA) because they want to close the transaction as fast as possible and are usually only interested in meeting a lender’s minimum requirements.

To quickly close the deal, buyers and lenders typically try to guide EDD to their predetermined outcomes to minimize or incompletely identify environmental conditions. Simply satisfying a lender’s minimum EDD requirements does not guarantee protection from federal and state environmental cleanup liability.

The value of an environmental site assessment greatly relies on the skill of the EDD consultants performing and reviewing a Phase I ESA. In recent years, the risk of liability, competition among firms, and low profit margins for Phase I ESAs have contributed to a reduction in the number of qualified environmental consulting firms willing to perform these services.

In spite of this, and even as demands upon the consultant for information have increased, the price of Phase I ESA has dropped significantly. This problem is aggravated by the tendency to retain the lowest bidder, because the importance of qualitative differences among assessments is unknown and the real value of the EDD is under-appreciated and often interpreted as a “necessary evil” imposed by the lender. Consequently, even consultants who would like to produce a quality work product are under pressure to complete their task as quickly and cheaply as possible.

This trend presents severe risks for those who rely on environmental site assessments to make critical decisions, as well as consultants. Aside from obvious liability for remediation costs in the event that contamination is overlooked, the property’s value may be seriously undermined. Additionally, business operations at the properties could be seriously affected by remediation activities, and delays caused by such activities could result in increased holding costs and lost opportunities.

Quality of the Phase I ESAs varies greatly from company to company even though the same standard (ASTM E1527-13) is being used as a basis. Parties who order Phase I ESAs by hiring environmental consultants range from large lending institutions and real estate developers, small mom-and-pop store owners, and people investing their retirement fund on properties.

In addition, a Phase I ESA can cost as low as $1,000, to as high as $20,000, depending on the location, size, and condition of the properties. All of these variables play a role in determining the quality of Phase I ESA. These variables also confuse prospective buyers. Among so many environmental consultants promising most cost-effective and incomparable EDD services, how should a buyer make an informed decision?

From the perspective of prospective buyer, the significance of selecting a competent EDD consultant cannot be overstressed. We provide the following recommendations to prospective purchasers:

  • Even if you are buying a property without going through a lender, do your diligence and hire an EDD consultant to do a Phase I ESA.
  • Do not shop around for the lowest bidder. Try to avoid those consultants that promise a Phase I ESA for $1,000 within 1 week. Too much risk is involved with buying a property without conducting a thorough environmental assessment.
  • Request a copy of a Statement of Qualification from the company you plan to hire. Additionally, before engaging your EDD consultant, confirm that they carry liability insurance.
  • Try to hire a consultant who understands your business risk. A Phase I ESA can have various recommendations based on the type of transactions and lender’s requirements. A site-specific recommendation can be provided when a consultant understands your business risk.
  • Talk to your consultant and define clear objectives of a Phase I ESA to be conducted. A comprehensive scope of works should be developed with your consultant that focuses on the purpose of the transaction, the need of prospective buyers, and is consistent with current standards practiced.
  • There are Phase I ESA reports generally viewed as seller’s Phase I ESAs and buyer’s Phase I ESAs. A consultant hired by a seller may attempt to mitigate any on-site issues. On the other hand, a consultant hired by a buyer may try to be more conservative. Do not completely rely on seller-provided information and documents.
  • Go beyond what a typical Phase I ESA does. This can be done by hiring qualified EDD consultants, giving them sufficient time (three or four weeks) to complete the work, requesting all regulatory agency files to be reviewed, and providing them complete access to the property.

When you are in a market to buy a used car, almost everyone nowadays uses “Carfax” to check vehicle’s history. Regardless of a lender’s requirements or not, when you are spending lots of money on a property, why would you try to get away with doing an incomplete EDD, trying to save a few hundred dollars? Take your due diligence seriously and try to understand an EDD process before you buy a property. Successful environmental due diligence requires defining clear objectives to be performed, engaging the proper resources to conduct a thorough assessment, performing independent assessment of the information obtained, and communication of the findings to prospective buyers to help them make an educated business decision. Most importantly, do your research before retaining an EDD consultant – this will be the most critical variable during the EDD process. Spend a little more money to hire a qualified EDD consultant who has good reputations and is known to produce quality reports.

GRS Group is a leading provider of commercial real estate (“CRE”) services worldwide. With offices across the United States, Europe, and affiliates around the globe, GRS Group provides local market knowledge with global perspective for institutional real estate investors, occupiers and lenders worldwide. The GRS Group team has evaluated and advised on over $1 trillion in CRE transactions.

Through the company’s proprietary management process, Global Services Connection, GRS Group delivers an integrated suite of services including Financial Advisory, Transaction Management, Assessment and Title Insurance.  We provide a single point of contact, capable of leveraging the GRS Group portfolio of companies, and delivering customized solutions to assist our clients in achieving their investment goals.

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