WHAT TO EXPECT DURING REAL ESTATE DUE DILIGENCE PROCESS AND HOW TO USE THE RESULTS TO MANAGE POTENTIAL LIABILITY
We are getting a lot of requests these days for Phase I and Phase II Environmental Site Assessments (ESAs), which is an indicator of an increase in the number of property transactions taking place. There seems to be a lot of property activity in the dry cleaning industry right now, or there is about to be. I want to explain the Phase I and Phase II ESA process because many environmental contamination issues are discovered during Phase I due diligence efforts. In fact, the property transaction process is a major business driver for the environmental remediation trades. Performed and utilized correctly, a Phase I ESA can help you make very important decisions about managing your environmental liability. If not performed correctly, or the findings not heeded, you may inadvertently step into the pathway of a big environmental problem.
WHAT IS A PHASE I ENVIRONMENTAL SITE ASSESSMENT?
A Phase I ESA is a study conducted on a property by a qualified Environmental Professional (EP) to evaluate the likelihood of environmental contamination. There is a standard that must be followed by the EP that was created by and periodically updated by the American Standard for Testing and Materials (ASTM). The protocol was established to provide a consistent method of evaluating environmental contamination issues that can be relied upon amongst and between various industries and users. When performed correctly, a Phase I ESA will satisfy the All-Appropriate Inquiry (AAI) requirement, which was established by the U.S. EPA to allow buyers of property to avoid taking on environmental liability accidentally. In other words, if you look at a property and actually try to find contamination and you don’t, then you can buy the property and not be responsible for a previous owner’s issue if discovered later.
THE PHASE I ENVIRONMENTAL SITE ASSESSMENT PROCESS IN 5 STEPS
The process of performing a Phase I is similar for every property transaction, but the effort required and price change according to the size of property, the number of years the property has been used for commercial or industrial purposes, and the overall environmental health of the property.
Step 1: Review Client Questionnaire
The first step is to document information from the client of the Phase I ESA so that the intended purpose of performing the assessment is properly documented. This is a very important and often overlooked detail. A questionnaire is sent to former owners and operators of the property containing questions about their knowledge of any environmental issues or property uses that might have led to contamination. Remember, you actually have to make an effort to find any problems for the All-Appropriate Inquiry (AAI) standard to be met.
Step 2: Review History To Determine Past Use and Regulatory Records For Site and Surrounding Properties
The next step is to review a multitude of historical and contemporary sources of information that provide a view of the environmental property conditions. These include old aerial photographs, city directory information, old phone books, historical fire insurance maps, and others that document land use through the years. Regulatory databases are also reviewed to see if the subject property has any sort of environmental footprint in the form of permits, waste manifests, hazardous material reports, etc. Essentially, if we can find anything that indicates there has been some risky land use in the past, we have to document it.
Step 3: Site Walk and Reconnaissance
It is also necessary to perform an inspection of the property and record what current land use and environmental conditions look like. If there are ongoing commercial or manufacturing processes, the EP has to observe and assess if products are being used or wastes being generated that could contributing to an environmental problem. Using the example of a dry cleaner; the EP would need to go into the store and have a look at the condition of the machine(s), see how the waste is handled, look for things like the location of floor drains that may be close to the drycleaning machine, and take notes about the general cleanliness of the facility. There can also be a lot of information gathered about past operations. Was there an old drycleaning machine in a different part of the building, did there used to be a different building altogether somewhere on the property, or was there an underground storage tank out back that hasn’t been used in decades?
Step 4: Interviews With Site Contacts and Local Agencies
Information regarding historical use is collected not only from visual evidence during the site walk, but also during interviews with people who are familiar with the activities at the property today, and in the past. Information is also requested from local agencies such as the fire department, to document if there has been a fire at the property that could have resulted in a release of chemicals to the subsurface.
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It’s not just the property itself that you have to evaluate; the potential that environmental conditions on a neighboring property may have crossed onto the property being assessed must also be considered. If you are a dry cleaner and one of your neighbors is performing a Phase I ESA on their property, their consultant is going to be looking at you! That is precisely how so many dry cleaners get pulled into this process.
Step 5: Submit Report to Client
After all these efforts, the EP then creates a standardized report that presents the findings of the Phase I ESA. Anything concerning that has been identified will be evaluated in accordance with the ASTM standard, and decisions will be made about defining that concern as a Recognized Environmental Concern (REC). Basically, if there are no RECs, then the property appears to have no environmental problems, and the purchaser of the property can put the Phase I report in their files and feel pretty good about things.
WHAT IS A PHASE II ENVIRONMENTAL SITE ASSESSMENT?
If RECs are identified by the consultant because there appears to be an environmental concern at the property, then the All-Appropriate Inquiry process mandates that a Phase II ESA be performed, which includes actual sample collection in the areas of concern. Keeping in mind that to qualify for the liability exemption discussed above, you actually have to try and find the contamination, if it exists. During a Phase II, the EP is going to go to those areas where they believe there could be a problem and collect soil, groundwater, and/or vapor samples for laboratory analysis. They will most likely only look for the chemicals that they have cause to be concerned about. If the property is a dry cleaner, this usually means that they will need to make a hole in the floor next to current and past drycleaning machines. Other common locations are out the back door, near the current and past dumpster locations, and along the sanitary sewer corridor. If these all come back clean, you can again feel pretty good about things.
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WHO NEEDS A PHASE I OR PHASE II ESA?
There are several reasons for the environmental due diligence process to be undertaken. Who needs the protection that the completion of the AAI process provides? The buyer of a commercial property clearly needs a Phase I ESA. If the buyer is using a bank loan to finance the deal, the bank will require it so that the property can be used as collateral. They want to make sure that they don’t accidentally acquire a contaminated property if the buyer defaults on the loan. For that reason, any time an owner refinances a loan where the property is already used as collateral, the bank will require a fresh Phase I ESA.
HOW MUCH DO PHASE I ESAS AND PHASE II ESAS COST?
Phase I ESAs are not that expensive for most commercial properties. It takes time to perform the necessary tasks, and the level of experience and expertise needed is pretty high. Since there are so many conducted in the market, Phase I ESAs have been commoditized and you definitely get what you pay for. I’ve seen them go for an average of $2,000 to $4,000 for properties less than an acre in size with average commercial land use, depending on regional cost variables. If the property is large, or there is a manufacturing usage, or if there are many indicators that the assessment will take more time to complete, the price will go up considerably. Most factories require a Phase I ESA that costs in the $8,000 to $10,000 range.
The cost of Phase II ESAs, where sampling occurs, totally depends on how many areas of concern need to be assessed. Using the typical dry cleaning facility example used above consisting of samples being collected near the DC machine, back door, dumpster and utility corridor, I’d say an average of $10,000 to 15,000 will let you know if there is a problem or not.
Please don’t take this the wrong way, but this is not an area where you want to automatically choose the lowest price. Please make sure that your environmental consultant knows exactly what they are doing and exactly how to use the ASTM standard to help you avoid liability. If you buy a cheap scarf, your neck might get cold; but if you buy a cheap Phase I ESA, you might regret it forever.
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