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Last Wednesday we were in Waltham, MA for EDR’s Boston Due Diligence at Dawn workshop. As I listened to one of the speakers, I was reminded of that old creepy Michele Pfeiffer movie, What Lies Beneath.
Tim Kemper, a program manager at The Shaw Group, gave an interesting case study of an unexpected vapor intrusion issue that arose during a brownfield property redevelopment. Here were the details:
- Long-standing client looking to buy an abandoned vacant manufacturing building on a 2-acre site.
- Past used included metal degreasing with chlorinated solvents (TCE).
- Waste materials reportedly “recycled off site and disposed to sanitary sewer.”
- There were folders of data on the target property, including many that documented small spills and releases reported to the MADEP by various owners.
- Prior owner filed bankruptcy in 1998.
Despite the consultant’s recommendation that the client find another property, the deal closed after establishing escrow for identified soil and groundwater remediation outside the building footprint.
It was during renovation that things got complicated.
The client completely renovated the site to be used as a warehouse. Red flags were raised when the process of sealing the building and heating it during a cold New England winter caused a 100-fold increase in average soil vapor TCE concentrations.
Looking back, there had been valid reasons for not suspecting vapor intrusion during the pre-transaction due diligence, including:
- Previous environmental assessments did not document any sub slab VOC sources under the building footprint.
- Groundwater levels were below MCP GW-2 standards
- Groundwater depth was more than 15 feet below grade.
- All documented small spills and releases were outside of the building’s footprint.
- The building’s concrete floor was in excellent shape.
So given the unexplained rise in TCE concentrations, they started looking around for sources. What they found was that, despite all the documentation at the target property, no one ever detected a sub slab floor drain system. And it turns out this system had been used to dispose of a significant amount of VOCs beneath the slab. The building renovations (e.g., new roof, insulation and heating system) and the resultant “chimney effect” resulted in a significant increase in soil vapor intrusion into the indoor air.
This project was clearly no picnic for the consultant or the client, and as Tim said with a bit of humor in his voice, “One thing you learn in Project Management 101 is that you never, ever surprise your client with bad news.”
Shaw installed a soil vapor extraction and remediation system and the property achieved MCP environmental closure. So, in the end, the irony was that it was vapor intrusion from an unidentified source that drove the whole cleanup cost, not the soil and groundwater contamination known at the time of purchase.
The reality is that you don’t always have the data you need to fully characterize a site’s contamination and vapor intrusion is one issue that can rear its ugly head during renovation. So in your work, particularly if it involves an old manufacturing facility, even one with a floor in excellent condition, beware of potential VI issues from sub-slab sources!
What lies beneath could be the real nightmare for your clients.
NOTE TO READERS: Tim's slide deck, including a cool time-series graph on TCE concentrations can be found here.
I moderated a webinar yesterday titled Helping Risk Managers Communicate the Value of Environmental Due Diligence.
The purpose of the webinar was to help lenders, especially at community banks, deal with the challenge of bridging the gap between environmental risk managers and loan officers/senior management to make sure environmental risk is understood up the chain at the bank. The speakers were a trio of environmental risk managers at three very different banks who deal with this challenge every single day, and were on the webinar to share their advice with professionals at other banks. Although the content was geared to bankers, there was some valuable intell in there for any environmental professionals who serve the lending community.
Here are a few highlights.
On educating:
“Understand that this is an every day process of fostering an understanding at your bank of why environmental due diligence matters. Take the lead, offer up training to key managers for the business lines, even teaming with environmental professionals to do it.”
“Communicate to colleagues that you’re all on the same team, that uncovering environmental risks upfront is to the bank’s benefit.”
“It’s not what you know that can hurt you….. it’s what you don’t know, or choose not to know.”
On working with consultants:
“Find consultants you trust, who are knowledgeable, who understand your risk tolerance, who can be trusted advisors to your bank.”
"I’m a firm believer in having a small list of environmental consultants you can craft into being the best they can be for your bank and your clients. You don’t need a large, large list.”
On the importance of due diligence:
“There’s an ever increasing regulatory compliance focus on environmental due diligence. It seems to be a very chief topic at every function I attend. The need for a proper environmental due diligence platform is more important than ever.”
“If you can convert the environmental risk to dollars, that’s something that every banker can understand….and to do that, you need good due diligence and the right tools.”
On foreclosures:
“I get bankers who want to book a gas station deal with a foot of free gas floating on top of the groundwater and I tell them: Our foreclosure folks can’t sell clean office buildings in this market. How are they supposed to sell a contaminated gas station?” [In this context, he also mentioned that someone got let go at his bank for making a bad environmental call and exposing the bank to liability.]
On expanding scope over time:
“We’re doing more mold, PCAs and dry wall assessments that we didn’t do five years ago as the bank becomes a greater and greater owner of real estate.”
On vapor intrusion:
All routinely include vapor migration/intrusion screens in their policies, "especially if it involves the exposure of the bank’s own employees."
On historic use:
“I’ve even been so bold as to personally call up at the chamber of commerce at a town up in new England to ask if it they did dry cleaning at a plaza and the old-timer said, ‘heck yeah! I used to drop my clothes off there all the time.”
There’s more dialogue on a number of topics. The use of environmental insurance. Phase IIs. Risk tolerance in the downturn. Listen to the replay if you get a chance. The Q&A dialogue at the end was particularly interesting. Great team of presenters who live and breathe environmental risk management, coming at the topic from the perspective of a community lender, regional bank and a large national one.
Funny shot below that John Rybak showed of a training photo they use at his bank. It’s a ladies retail store that’s just a thinly-veiled old gas station. The two exterior bathroom doors are a dead give-away!
Off to prep for market update presentations at our DDDs in Chicago and Washington, DC next week .
Hope to see many commongrounders there!
If you think the Phase I ESA business is tough these days, take a look at the appraisal market.
Demand from lenders for property re-appraisals is up (I’ll take that as a good sign), but there aren’t enough appraisers who specialize in commercial properties to keep up. This is causing an extreme backlog in appraisals that's starting to hold up bank lending.
A 2009 law preventing bankers and brokers from working directly with appraisers drove a lot of providers out of the business. There are now 37,887 active appraiser certificates and 13,277 licenses in the United States, according to the Appraisal Subcommittee of the Federal Financial Institutions Examination Council. On average, that’s about five appraisers for every U.S. bank (though one appraiser could hold multiple certificates). Many of these are mom and pop shops that can only handle one appraisal at a time. California reportedly has the highest ratios of appraisers to banks in the country; lowest are in the Midwest. Wonder how that would look if we compared the number of Phase I providers to lenders by state?
The upshot is that banks are paying more and waiting longer to get the valuations they need to close commercial real estate loans. What’s more is that new valuations are often lower than expected because in some metros, distressed properties are the only comparables available. So, appraisers now face the growing threat of lawsuits by banks and brokers—essentially a disincentive for any new players to enter the business. The average commercial appraisal costs anywhere from $2k-$5k according to one lender, but comes at the risk of high liability. Sounds familiar, right? So banks are paying more, waiting longer and some are shooting the messenger if they don’t like the results they’re getting, which could ultimately kill the loan. Things are tough all over, I guess!
I’ve been checking in with a number of lenders and all seem to be saying the same thing. They’re lending more. It would be too much to hope for the trend to be widespread or robust, but it’s a shift toward the positive nonetheless. Finally. And recent market information points to the same conclusion.
One risk manager from a regional lending institution shared “We are starting to make a lot of big commercial real estate loans again, albeit to our good and long-term customers.”
Another said "our institution used to do only five loans in an entire year that were more than $10 million." Now she said they’re doing environmental due diligence on two or three of them a week. (adding, “Of course they don’t all close.”)
Consistent with the encouraging conversations I had with about a dozen lenders last week, respondents to EDR Insight’s 4Q11 Benchmarking Survey of Financial Institutions characterize a lending sector that is slowly increasing originations on commercial real estate. Aversion to environmental risk remains at high levels, with few respondents indicating any relaxation of environmental due diligence standards. As in the broader market, the general sense is one of slow improvements—but with the skittishness one would expect from a market that went through the fits and starts of 2011. [More on the survey is posted here]
This anecdotal evidence also dovetailes with a number of recent reports in the news. Among the most notable, the FDIC announced that banks had their biggest increase in business lending in four years. And another cited bank executives saying they're "on the other side of write downs and are ready to return to CRE lending.”
It’s early. It’s cautious. Lenders’ risk aversion is still high. This is good news for commercial real estate. And it’s good news for our industry.
I’ll leave you with a few other findings from our quarterly lending survey:
- A significant 72% expect to see higher commercial real estate lending volume this year relative to 2011.
- 38% forecast more reliance on the services of outside environmental firms for their due diligence and only 4% expect less reliance.
So, barring some unforeseen jolt to the market, there should be healthier demand from banks either for cautious and modest increases in lending, or to support increased sales of loan portfolios, foreclosures, refis and REO.
I remember back when I was watching the meetings of EPA’s reg-neg committee as they debated and sweat out the specifics of the federal All Appropriate Inquiry rule, quite a bit of time was spent on the term "commonly known information." Those on the committee who worked in the due diligence field stressed the importance of conducting interviews with people on and around the target property, considering local sources and collecting “commonly known or reasonably ascertainable information about the property.” There were a lot of stories around the table of cases where the only source of info about contamination at a property came out of a random conversation with a patron at the local diner, by knocking on doors of adjoining properties in rural areas or finding the town librarian. In one story, it was the local centenarian, a 103-year old guy with Alzheimer's, who remembered a tank pull at an old gas station that never showed up in any government records.
This story from Boulder that I just read suggests that were it not for a local resident coming forward, a low-income housing development would have gone up on a former Allied Chemical mill site where radium-contaminated soil was apparently buried. In October 1971, the Housing Authority of the City of Boulder began breaking ground on a vacant lot to build a 34-unit, low-income housing complex. A nearby resident apparently saw the excavation and notified the Housing Authority that “a tungsten-radium mill had been in operation at the Third and Pearl site in 1918 and that the area might be radioactive.” The article goes on:
“This notification by a concerned citizen, whom later reports would identify as a former employee of the mill, seems to be the first clue that something was wrong at the construction site. It appears city officials may not have considered how the location had been used prior to purchasing the land near the mouth of Boulder Canyon and establishing the city yard and, later, the housing project.”
Granted, this happened in 1971 and there has been much improvement in government record keeping since then.
Yet, the article cites this property and another that the city of Boulder purchased more recently and in both instances, “the municipality seems to have bypassed — or disregarded — a thorough search of public records prior to spending taxpayer money to purchase seriously contaminated properties that subsequently required substantial dollars to remediate.”
And still today, more than 40 years later, the location of about “150 dump truck loads of radioactive soil” has not been confirmed. In an effort to identify disposal sites, the authors conducted an analysis of a high-res aerial photo from 1971 that shows “some type of ditch activity” on the property around the time that radium-contaminated soil was being buried at the site.
I certainly hope my town has better environmental due diligence policies in place than Boulder. And that their environmental consultants talk to some local residents before taking title to a property that might have a contaminated past.
An EP in South Carolina just asked me: "Do you have any statistics or studies on what percentage of environmental consultants now include an assessment of vapor as part of all of their Phase I environmental site assessments?" He added:
“It seems there are several companies that are sitting back to see whether the industry moves to make this included in all P1s. It seems to me that more and more consultants are including this is all P1s, regardless of whether it is dictated by the Client.”
Right he is. The latest data I have comes from EDR Insight’s 3Q11 survey of environmental professionals. In it, we asked:
Approximately what percentage of properties that undergo Phase I ESAs also have vapor intrusion screenings conducted?
The data suggest that it’s much more common for EPs to not screen for VI on any Phase Is than to do so on all Phase Is. Most, though, or 61% are doing VI screens on some percentage of their Phase Is.
In future surveys, I would expect these numbers to rise. More clients are being forced to deal with vapor migration/intrusion as attorneys and lenders require it, especially in states with reopeners.
The two speakers on our vapor intrusion webinar last week both spent a fair amount of time covering why there are very real risks associated with EPs taking a wait-and-see attitude toward vapor migration/intrusion. Given the uncertainty and fast-changing science behind it, lawsuits are rising, so environmental professionals on the call were urged to help clients get out in front rather than being surprised down the road. But there's a fair amount of client push-back when EPs broach the topic. It can be a tough sell to add something new to the scope of the analysis especially if it costs more or could kill the deal.
A tip sheet summarizing the webinar is posted here and a replay to the webinar is here.
Where do you fall on the VI spectrum?
From today’s call of the Environmental Bankers Association Risk Management Committee, here is my list of the top five developments in the real estate and lender due diligence markets.
1. Uncertainty about VI breeds fear, aversion.
Yesterday I moderated a webinar on vapor intrusion in the real world. John Sallman, an environmental professional with Terracon in Dallas, drew attention to how averse lenders are to vapor intrusion risk. Why? He said it's because vapor is a relatively new issue and much is still unknown so lenders fear it more than other types of environmental risk. Even in cases where a property has a vapor barrier installed with a passive venting system, a lender may still call for sampling to ensure that the system is working properly. Loans up for refi are also hitting snags as vapor intrusion issues surface that weren’t uncovered at origination four or five years ago.
2. Neglected, abandoned properties bring environmental issues to the surface.
This year a record $363 billion in maturing commercial real estate debt joins the wave of $170 billion in cumulative troubled loans that remain unresolved. Many of these loans are backed by properties suffer from neglect and a lack of investment. The challenge with these sites involves the dumping of hazardous waste like barrels of used auto fluids, old batteries, tires, improperly disposed of chemical containers and even biohazards. Environmental due diligence today is revealing issues that may have escaped notice at origination when standards were less conservative or uncovering new environmental conditions that arose subsequent to loan origination.
3. More options for refis.
And as more commercial real estate loans approach maturity and shop around for capital, one key change right now versus back in 2008, 2009 is that banks have more choices. The lender can take title and try to sell it themselves now that prices are no longer in free fall, or extend the loan again in the hopes that the property’s value will rise. The lender may also sell the loans to third-party investors who may negotiate with the borrower. Lenders have little appetite in this market environment for highly leveraged loans, so it’s not uncommon for lenders to ask for more capital to be put into the deal. All of this makes for a pretty interesting dynamic and should add up to new environmental due diligence activity as loans change hands this year and beyond.
4. Retail sites on the block.
One of the hardest-hit property types in this downturn is retail. A significant volume of storefronts and big box anchors at shopping centers sit vacant across the country. Borders, Blockbuster, Kmart, Filene’s Basement and Syms are collectively putting thousands of properties up for grabs. Sears recently joined the list, proving that store closings aren’t anywhere close to being over. On top of that, we could be looking at as many as 9,000 more store closings in 2012 by national and regional retailers. This means that not only will there be environmental due diligence in demand at vacant retail space, but also that lenders view retail properties as riskier bets than other safer bets like apartment buildings.
5. Trends from the trenches.
Lastly a few trends to share that came out of our latest quarterly surveys of EPs and lenders:
- Work from developers in particular really picked up in the fourth quarter and into 2012 as they look to lock in properties while prices are still low, even if they’re not quite ready to break ground yet.
- Refi portfolio work is churning along, often with very very short turnaround time windows, sometimes as short as 1 ½ to two weeks.
- Private equity work is really getting stronger, Fortune 500s are buying again and long time real estate owners are looking to sell off real estate again.
- One positive trend is that the 4Q results show that the market is starting to see a transition from due diligence performed to protect banks during foreclosure to due diligence for risk management on new loans.
- Lending forecast:
- 38% of lenders expect higher lending levels for commercial real estate in 1Q12 (Jan-Mar) compared to 4Q11. Only 11% said lower.
- for the year, 74% expect higher commercial real estate lending volume vs. last year
For anyone who didn’t attend the EBA conference in Santa Fe in January, I’m doing a retake of my luncheon presentation on February 22ndTop 10 Trends and Emerging Issues in Commercial Real Estate, Banking and Environmental Due Diligence. Hope to see many of you join us for the call!
Great presenters are both rare and refreshing. Tuesday I moderated a webinar by one of them.
In his presentation titled Phase I ESA Liability Protection: Beyond AAI Nick Albergo, the founder, President and CEO of HSA Engineers & Scientists down in Florida, hit on many of the topics we talk about here on commonground. CERCLA, business environmental risk, vapor intrusion, brownfields, AAI, Phase II environmental site assessments and continuing obligations, just to name a few.
The core of Nick’s message drew on his years of experience of being called as an expert witness on Phase I ESA litigation to educate the audience about how environmental professionals can get themselves into trouble by veering from the practice defined by ASTM E 1527-05.
Here's my top 10 list of tips Nick delivered in his 1-hour presentation:
- Don’t just default to calling something a REC to play it safe. (It could actually be worse.)
- Clearly document your role on projects.
- Never, under any circumstances, give a client a recommendation in your Phase I ESA report.
- Be cautious about recommending additional investigation and understand that doing so does not make your report incomplete.
- Tell your client when continuing obligations kick in.
- Stick with what you know.
- Stick to your scope of work, and don't ever veer beyond it.
- Focus on potential misuse of hazardous substances on sites like golf course and agricultural land.
- Understand vapor migration and when it might constitute a REC.
- Build your own defense, just in case. And run it by some folks you trust.
To learn more about what Nick had to say about the tips in this list, check out EDR Insight’s latest Research Note.
And if you have a free hour at lunch or after work or can’t sleep some night, I highly recommend that you click on the free replay and hear Nick in action. He covered each of the above in great technical detail, including case studies and examples from the field.
Are Phase IIs part of your business? Make sure you stay until the end. Nick spent a fair amount of time on why he believes the Phase II standard has finally come into its own—and why we’re going to see a lot more ASTM Phase IIs in practice.
This week I gave a luncheon presentation at the Environmental Bankers Association conference in Santa Fe, NM. I spent a few minutes talking about the metros expected to drive much of the growth in commercial real estate investment this year and how, collectively, Phase I ESA volume in these areas already outperformed 2011’s average growth of 7 percent.
Later, Mike Covert, Senior Principal and National Director of Environmental Services at Terracon approached me to say that he thinks he won the 2011 Phase I ESA Forecasting contest I launched last May. So as soon as I got back, I dug out the entries and sure enough, Mike was right on the money with his guess this year.
The forecasts that came in ranged from a 1 percent decline to a very bullish 40% growth, and averaged 16%. So the market's actual performance was less than half the group’s average. This is likely due to the sobering setbacks that were still to come in the third quarter of 2011 (e.g., the European debt crisis, the S&P's downgrade of the U.S. debt rating, etc.). After a very rocky summer, many investors, lenders and environmental consultants dialed back their expectations for the rest of the year.
So congratulations to Mike for a dead-on accurate guess in a market that’s not exactly a forecaster’s dream. In a modest reaction to the news, Mike quipped, “You know what they say: ‘A broken clock is right twice a day.’”
We’ll find out how much more optimistic EPs are about their market when I launch this year’s contest in just a few months.
Environmental professionals doing work in the Twin Cities got a nice plug in an article I just read in Minnesota’s Finance & Commerce. What caught my eye is that it featured Joe Maternowski, an attorney with Hessian & McKasy. I had the pleasure of presenting with Joe at EDR's Due Diligence at Dawn workshop the last time we were in Minneapolis. He led a spirited discussion on vapor intrusion and how it was impacting deals there.
This article highlights two of the most talked-about properties in the Twin Cities right now:
- The 430-acre former Twin Cities Army Ammunitions Plant property being eyed for the next Vikings stadium
- The former St. Paul Ford plant that closed in December
Both sites are receiving a fair amount of attention by developers with big plans, yet both would require a fair amount of environmental remediation first.
The article went on to emphasize that beyond these large former industrial sites, environmental contamination can potentially affect every real estate transaction. Joe made a great point in saying, “You don’t need heavy industry to have a big issue. A small release of dry cleaning chemicals in an underground drain can cause problems."
The article encourages buyers to contract an environmental professional to have a Phase I ESA and a “thorough professional inspection” upfront to protect themselves from liability, in addition to any further investigation that might be warranted.
Wth every corporate bankruptcy or downsizing, sites with past contamination are going on the selling block. Borders, Sears, our own U.S. Post Office and a slew of other entities are collectively putting thousands of properties up for grabs, which makes local articles like this highlighting the importance of due diligence so critical.
