Chris Gregor Chris Gregor

As US investors wait to see how the new presidency will affect the commercial real estate market here, some are looking overseas for more opportune places to put their money. Many are eyeing the United Kingdom. The UK property market, especially in the greater London area, has long been a top destination for capital from overseas. Caused by the recent Brexit vote, economic and social instability has impacted the local currency and real estate prices, potentially making it a good time for foreign investors to get in on the UK market.

Of course, investing in foreign real estate markets brings its own set of challenges. In order to effectively manage risk, investors must understand local nuances and regulations that could affect their deal. If you’re considering purchasing (or lending on) an asset located in the United Kingdom, how do you analyze the property from an environmental standpoint? What are the relevant environmental regulations that exist in England, Scotland, Wales and Northern Ireland? Can you perform the environmental due diligence to US standards, or are there specific UK or European Union standards to which the assessment must be performed?

UK vs US Environmental Due Diligence  As in the United States, environmental issues can cause a real headache for commercial real estate investors in the United Kingdom. In order to protect yourself against costly cleanups, delays or lowered asset values, it is key to perform thorough environmental due diligence to understand any risks associated with an asset upfront. Many of our US investor clients are looking for “American style due diligence” for their UK investments, but there are some important differences.

In the US, environmental due diligence grew out of commercial mortgage lending. Contamination became a risk to net operating income and thus the ability for the borrower to service their debt, so lenders required the performance of environmental assessments to ensure there were no hidden issues. Further, there is a strong regulatory driver for environmental due diligence: US regulations provide for strict joint and several liability, which makes foreclosing and possessing contaminated land a much more complicated path.

The story is different in the United Kingdom, where the environmental due diligence industry has grown out of development. Consideration of various public interest and safety factors such as surface/controlled waters, sites of special interest, former mining and landfill sites led to planning applications incorporating an environmental component that must to be completed prior to the granting of planning consent. In the UK, environmental regulations are more “polluter pays” in principal, but there are legal pathways for a lender and a non-polluting owner/operator to become liable for contamination.

Assessing Environmental Risk in the United Kingdom So if you are an institution or bank looking to invest, either equity or debt, in a UK-based asset, what kind of environmental due diligence process must you perform? This depends on the kind of transaction you are doing.

If the property is part of a development or construction project, then a Conceptual Site Model and Preliminary Risk Assessment will need to be completed as part of the Phase I Environmental Site Assessment (ESA). If you are not looking at a development deal, then you can take the Phase I ESA, make your analysis and proceed.

Outside of the planning process, however, your risk appetite can also direct your level of environmental due diligence. Strict desktop studies can be performed. A word of caution about desktop studies: the term “desktop” in the UK is often used in reference to a full Phase I ESA including a site inspection. On multi-asset deals, one often sees portfolio due diligence in which desktop studies (no site inspection) are performed across the whole portfolio of assets with full Phase I ESAs (with site inspection) being performed on those sites that do not pass muster at the initial review level. Here, it is key to be aware that more limited data will impact the robustness of conclusions you can make from a limited scope environmental due diligence report.

Should You Use ASTM? US investors and lenders are generally familiar and comfortable with the assessments produced by ASTM E1527-13, the standard used for Phase I Environmental Site Assessments. They understand how to analyze their risk based on the results and conclusions of that report, and they understand how this assessment matches up with the applicable US regulations pertaining to the environment and associated potential liability. So, does it make sense to analyze a UK-based property by those same standards? And does appropriate and sufficient data exist in the UK to fulfill the ASTM scope of work?

Availability of environmental data in the UK is generally sufficient to perform an assessment to ASTM E1527-13. Historical maps and various forms of third-party databases tend to be available (particularly in England). These inputs, combined with an expert on-site reconnaissance and proper research with the local authority, can provide a good picture of the asset. But, objectively, given the differences in local regulations, one will find that there is less data and it is less organized in the United Kingdom than it is in the US. Data redundancy and the even chronological spread of information suffer, leading to more data gaps and limitations than would typically be found in a US-based ASTM Phase I ESA.

US investors should note that certain environmental risks (which may be of the ASTM scope of work) do not receive the same level of attention in the UK as they do in the US – mold, vapor intrusion and permitting issues being some examples – and an assessment may need to be explicitly requested by the US investor. Conversely, there are items that are of greater importance to the UK market such as mining and landfills, refrigerants, unexploded ordinance, and invasive species. It is important that these “Non-Scope” items are appropriately tailored for your asset location.

The Right Approach

While investing in the UK may bring some challenges, US investors can achieve comfort with the right approach. The good news is that the answer to any differences, limitations and uncertainty is simple: know your asset. It will pay to work with a consultant who understands your business and your risk tolerance. Find someone who can understand what you are doing with your investing/lending scheme and can analyze how the risks associated with an asset may impact that scheme. The data is usually there, one just needs to know how to get it and further, how to apply it to your deal.