Building Knowledge Series: The Beginner's Guide to Environmental Due Diligence
Have you ever heard the terms "Environmental Due Diligence" or "Phase I ESA" from a real estate agent, broker, attorney or colleague? Do you know how or why Environmental Due Diligence is completed? Read on for the basics!
The Beginner's Guide to Environmental Due Diligence
What is Environmental Due Diligence?
Environmental due diligence is the process by which a property is evaluated for the potential presence of hazardous substances or petroleum contamination. Environmental due diligence is most often associated with real estate transactions. These transactions can include real estate purchases, real estate sales, property foreclosure by a lending institution, or property foreclosure by a municipality. Much like a home inspection, completing thorough environmental due diligence is a critical part of any real estate acquisition.
It has become common practice for lending institutions to require environmental due diligence prior to financing a real estate purchase, refinancing an existing loan, or accepting a property as collateral for construction loans. It may also be required if property is being held as collateral against a loan, as environmental issues would compromise the value of the property. In addition, it is becoming more common for environmental due diligence to be required by public agencies prior to release of grant funding on projects related to real estate redevelopment or improvements.
Whether or not a bank loan is involved, the environmental due diligence process is beneficial to the purchaser. The process will reduce the likelihood that the purchaser of the property will inherit environmental concerns created by the former property owners and will help the potential purchaser qualify for important legal defenses. These are known as the innocent landowner, contiguous property owner, and bona fide purchaser defenses under the Comprehensive Environmental Response, Compensation and Liability Act (CERLCA). If a due diligence Environmental Site Assessment is completed on the property prior to a real estate transaction (i.e. a purchase of the property), the provisions contained in CERCLA will help protect the prospective purchaser from being held accountable for pre-existing contamination. It should be noted that if an environmentally contaminated property is purchased without completing the proper environmental due diligence, the new owner may be legally responsible for the cleanup of the contamination.
Environmental Due Diligence Options
The process for completing environmental due diligence is referred to as All Appropriate Inquiry (AAI). The United States Environmental Protection Agency (EPA) provides AAI guidance and recommends that this process be followed when assessing properties for the presence or potential presence of environmental contamination. The USEPA AAI includes specific education and experience requirements for environmental professionals who conduct environmental due diligence. The standard for conducting environmental due diligence in accordance with AAI is laid out in the American Society for Testing and Materials (ASTM) E - 1527-13 Standard Practice for Environmental Site Assessments.
The Phase I Environmental Site Assessment (ESA) is the standard for evaluating environmental liability associated with real estate transactions. The primary reason to conduct a Phase I ESA prior to acquiring any real estate is to determine whether the property presents an environmental liability. Conducting a Phase I ESA prior to the acquisition may allow the purchaser to qualify for the CERCLA innocent land owner, contiguous owner, and bona fide purchaser defense, thereby avoiding federal liability exposure. If the potential for environmental contamination is discovered through the Phase I ESA, the potential purchaser of the property often has several options to address these risks. These options include but are not limited to:
Completing additional investigation at the property
Adjusting the purchase price
Negotiating financial responsibility for the environmental risk or cleanup
Deciding against purchasing the property
The Phase I ESA is a comprehensive option for evaluating environmental liability associated with real estate transactions but other environmental due diligence options exist. These include Transaction Screens and Records Search with Risk Assessments (RSRAs). The differences lie in the extensiveness of the research conducted and the final report as outlined below:
Report: Phase I ESA
What's Included: Site visit, government agency records review, historical records review, and interviews with the property owner/occupant
CERCLA Liability Coverage: Yes
Report: Transaction Screen
What's Included: Site visit, government agency records review, limited historical records review, and interviews with the property owner/occupant
CERCLA Liability Coverage: No
What's Included: Government agency records review, limited records review, and environmental questionnaire provided by financial institution
CERCLA Liability Coverage: No
Many financial institutions have created tiered environmental due diligence policies that allow the institution to determine which level of due diligence is required for a property transaction. Although Transaction Screens and RSRA's tend to be cheaper, it is important to note that these alternatives do not provide for CERCLA liability protection, resulting in slightly higher risk to the purchaser and lender.
It should be noted that the Phase I ESA, Transaction Screen, and RSRA processes are designed to screen a property for the potential presence of hazardous substances or petroleum contamination; however, these reports do not typically evaluate the property for the actual presence of hazardous substances or petroleum contamination. Potential environmental concerns identified through initial due diligence are typically evaluated further with a Phase II ESA. This type of study may include but is not limited to the collection of soil, groundwater, or soil vapor samples for laboratory analysis. Should the Phase II ESA confirm the presence of hazardous substances or petroleum products at concentrations exceeding state or federal regulations, additional investigation or remediation may be required.
Finding the Right Consultant for your Due Diligence Needs
To ensure a quality assessment, allow sufficient time for the process. Site investigation and cleanup processes can be complex, time consuming, and costly. Hiring a firm with insufficient experience or training can only compound your risk if the consultant fails to provide you with accurate data. A competent and experienced consultant will ensure that the appropriate environmental due diligence is completed in accordance with state and federal regulations.
A qualified environmental consultant will understand your business needs, and give you regular updates in understandable language. To streamline the process, you should tell your environmental consultant as much as you can about the property, including:
Materials and waste that have been stored, recycled, or disposed of on the property
Potential contamination areas
Water supply sources and wastewater discharge information
Ask your potential consultant any questions you have including:
How many years they have been doing environmental consulting?
What types of investigation and/or cleanups do they have experience with?
Does the firm employ USEPA AAI Environmental Professionals?
What level of insurance do they carry for errors, omissions, and liability?
Do they have references that you can check?
Are they approved with the lender you are working with?
LaBella Associates provides a variety of focused environmental services to meet the needs of our clients during property transactions. The foundation of our program is our staff’s experience with RSRAs, Transaction Screens, Phase I, and Phase II ESAs. This experience allows us to utilize a hands-on approach with the regulatory agencies and provide solutions that are compatible with client budgets. Our environmental due diligence program is designed to provide potential buyers and sellers with understandable and concise assessments.
About The Author:
Gabrielle Rinaldi is LaBella's Phase I Business Manager. A graduate of Alfred University, she resides in Webster, NY, where she enjoys hiking, traveling, soccer and snowboarding. Shoot Gabrielle an email or connect with her via LinkedIn.
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