If a change affects around 250,000 commercial real estate (CRE) transactions a year, you’d think that people would have heard about it. But given how phenomenally busy the CRE investment and finance space has been this year, many are not aware that there’s a big change coming – there is a new standard for Phase I environmental reports.
Most CRE transactions require a Phase I Environmental Site Assessment (ESA), which is a report that identifies existing and potential environmental contamination liabilities at a property. Every 8 years, the standard for these assessments (ASTM E1527) is required to be renewed, with revisions that are intended to clarify language, improve consistency in the report deliverables, and ensure that it reflects current “good commercial and customary practice.”
The widely used Phase I ESA standard is ASTM E1527-13 and the new standard is now ASTM E1527-21. The 2021 ESA standard is much the same as the 2013 one, but with some important changes that may affect you. So, what has changed since 2013? Well, stay with me here as the changes can get a little weedy for the average CRE professional.
First and foremost, will the new Phase I ESA standard require more work?
In short: It varies based on the property type and location. The potential for more work is higher in dense urban environments, whereas rural areas or a multifamily property with surrounding residential will likely be the same amount of work. This is mainly because the new standard expands the scope of required historical research for both the subject property and its adjoining properties, and for retail properties in particular (both subject property and adjoining). Additionally, for users seeking liability protections under CERCLA, the costs for title searches may increase. Read on for more details.
Historical Research Deep Dive (the biggest change)
The new ASTM E1527-21 standard seeks to improve the consistency and quality of the historical records review for both the subject property and its adjoining properties.
For the subject property, the existing (2013) standard states that the environmental consultant is only required to review as many historical sources as needed to “achieve the objectives” of identifying whether past uses could have led to a Recognized Environmental Condition (REC). The 2021 revised standard requires the review of at least the “Big 4” historical sources for the subject property (aerial photographs, topographic maps, fire insurance maps, and city directories) – provided they are reasonably ascertainable, applicable to the subject property, and likely to be useful in determining whether activities were conducted that would be expected to result in a release. Additionally, if the property use is industrial, manufacturing, and (now) retail, the review of additional resources (including building department records, property tax files, interviews, and zoning), may be needed if they are readily ascertainable and the Environmental Professional (EP) believes they are likely to be useful. Many quality consultants already meet these requirements for the subject property research, but these changes will raise the bar for those that provided less thorough reports as well as for retail subject properties as a whole.
For adjoining properties, the 2021 revision now requires an expanded scope of historical research of adjoining properties. Moving forward, the EP will need to review each of the Big 4 resources that have been reviewed for the subject property for all the adjoining properties or explain why the review was not completed. The research of additional resources (building department records, property tax files, interviews, and zoning) may also be needed when the EP is unable to adequately identify the historical use of adjoining properties based on the review of the Big 4 sources alone. Under the 2013 standard, the history of adjoining properties was evaluated based on information collected for the subject property; no research of additional resources was required to fill in gaps in the history for adjoining properties. Although some consultants do this when necessary to paint a clearer picture, it has not been done every time and it was done at the consultant’s discretion – at my firm, we have long emphasized the need to dig further when more clarity is needed. There has always been variability in the level of detail from one Phase I ESA to another because the ASTM standard gives leeway to the EP’s professional judgement; however, the 2021 scope changes will likely amount to more thorough research on average across the entire industry. Just how much more work? It depends mostly on the property type and location of the adjoining properties. In some cases it could amount to significantly more research, in many cases it will add varying levels of additional work, and in other cases it won’t change substantively. Here are some examples:
- A subject property in NYC with retail all around – Potentially more work for the historical review for every adjoining property. In a dense urban area like NY with high retail turnover, hundreds of addresses, and the need to go back more than 100 years, it is very possible that the scope of work and cost for this property’s assessment will increase.
- A subject property with retail/industrial adjoining half of the site – Potentially more work for the historical review of the adjoining properties. In particular, if the adjoining properties are not included in the documents received for the Subject Property’s Big 4 sources review (specifically, all adjoining addresses included in the city directory review), additional work is required to close data gaps and complete the objective.
- A subject property with multifamily or office buildings all around it – There will be little to no effect on the scope or cost presuming there was never any retail units in any of adjoining office buildings and there are not a significant number of adjoining addresses.
- A rural property with forest or agricultural land all around it – There will be little to no effect on the scope or cost.
What is driving these changes? Primarily, dry cleaners and the risk of contamination and human health concerns they represent. Dry cleaners are the leading source of environmental liability in commercial real estate transactions, with vapor migration/intrusion from the associated contamination posing a significant health threat to occupants. The ASTM committee sought to improve the level of research done to assess whether dry cleaning operations existed on site or nearby in the past, hence the added focus on researching retail uses both at the subject property and adjoining properties. Another concern was that some consultants were squeezing by doing the bare minimum level of research regardless of property type or risk, so these changes make it harder for them to do so.
More Comprehensive Title Searches
In addition to completion of the Phase I ESA, users who want to qualify for CERCLA defenses to liability must satisfy certain user obligations such as research of title records to identify environmental liens and Activity and Use Limitations (AULs). Often this is done by ordering a title search from a third-party vendor (environmental consultants are not responsible for doing this unless specifically requested by the user to engage the title search on their behalf). Revisions to the ASTM standard provide more robust guidance about the extent of research needed. Previously, searches were sometimes limited to research of the last change in title, which may not be sufficient for identifying environmental liens or AULs. In the new standard, ASTM sought to improve this by clarifying that title records must be researched back to 1980. While this change should provide the user greater confidence in the completeness of the information, the cost for the expanded scope is likely to increase significantly due to the extra level of work necessary to research the property. It remains important to work with an attorney or other knowledgeable professionals to make sure liability defenses are available if needed.
Revised Definitions, Guidance for Classifying Environmental Risks
The definitions for Recognized Environmental Condition (REC), Controlled REC (CREC), and Historical REC (HREC) have been updated for greater clarity and consistent interpretations (though the original meaning remains unchanged). Additionally, a new appendix is offered that really helps to break down the anatomy of a REC, including a logic diagram (if this, then that) and numerous hypothetical examples to help EPs and users understand how to apply the various terms.
Emerging contaminants, specifically PFAS (per- and polyfluoroalkyl substances), are a growing concern to the due diligence industry since exposure can lead to adverse health conditions. Despite EPA taking steps toward classifying PFAS as a hazardous substance, they have not done so yet. So by definition, PFAS are not considered a REC within the constructs of a Phase I ESA. However, the revised ASTM standard adds PFAS and other emerging contaminants to the list of “non-scope issues” that a user may want to evaluate as a business risk, as is commonly done with asbestos and mold.
Other Definitions & Clarifications
The terms Likely, Property Use Limitation, and Significant Data Gap are now defined in the terminology section (more on data gaps below). The meaning of the term “likely” (as in, “the likely presence of contamination”) can be found within the REC definition’s discussion and was created to offer guidance and improve the consistency of determining a REC. The new definition states that likely is something that is neither certain nor proven, but can be reasonably believed based on the logic, experience, and/or evidence found by the EP.
The new standard also clarifies that “Subject Property” is the appropriate term for referencing the site of the assessment.
Shelf Life of a Phase I ESA
EPA’s All Appropriate Inquiries rule (AAI, explained below) requires that certain components of the report be completed less than 180 days before acquiring property, including the site visit, interviews, search for environmental cleanup liens, review of government records, and EP conclusions. After one year, the entire report must be updated. Historically, the date of the report has frequently been assumed to start the clock for the 180-day countdown. The revised ASTM standard now requires the inclusion of the date upon which relevant parts of the investigation were completed to make it easier for users to recognize when updates are required.
Some other less significant but mentionable changes include:
- Significant Data Gaps – The ASTM changes require the EP to identify significant data gaps in the Findings section of the report and encourages EPs to provide an opinion as to whether additional investigation would likely help resolve significant data gaps.
- Site Reconnaissance – The new standard clarifies language about the scope and objectives of the site visit to make it easier to understand, without substantively changing the scope of work.
- Report Contents – Site plans and color photographs with captions are now required in all reports to improve reporting documentation and consistency in the industry (most consultants already do this).
- Government Databases – The new standard updates the names of government databases that environmental data providers search as some of the databases have changed over time. The scope of the databases searched hasn’t changed.
Let’s rewind a bit… Why is the ESA standard change a big deal?
Well, in order for a prospective purchaser to qualify for “innocent landowner” and other defenses provided under the U.S. Federal Superfund law CERCLA, they must conduct “All Appropriate Inquiries” (AAI). AAI looks into the current and past uses of the property for evidence of a release of hazardous substances or petroleum products at the property. How does one conduct “All Appropriate Inquiries”? The default approach is to do a Phase I Environmental Site Assessment according to the ASTM E1527 standard, which defines the industry-standard scope of work and which EPA has recognized as satisfying AAI requirements. Each time a new version of ASTM E1527 is created, revisions are reviewed by EPA to verify continued conformance with AAI.
Environmental liabilities and costs can impact property value, return on investment, borrower ability to repay loans, lender ability to recover loan funds, etc. That is why so many thousands of CRE buyers, investors, and lenders rely on ASTM-compliant investigations. These investigations help them to understand potential environmental liabilities at a property and evaluate the need for additional investigations to evaluate the extent of any release, associated impacts on health risks, property operations, and need for cleanup.
So… when will the new standard become effective and/or implemented?
Implementation is affected by two, separate events – publication of ASTM’s revised standard and EPA’s “approval” process. The ASTM revision is done – the new standard was just finalized November 1, 2021, and has been sent to EPA for review. Many clients are not ready to adopt the new ASTM standard until EPA references it. EPA’s official reference to E1527-21 as compliant with the AAI regulation is expected to take a couple of months up to a year.
So what will the industry do in between? At a minimum, users and their EPs should continue to follow the ASTM E1527-13 standard to qualify for CERCLA defenses to liability and familiarize themselves with the E1527-21 revisions. It is generally believed that EPA will conclude that the E1527-21 standard meets AAI requirements since the recent revisions strengthen and, in some cases, expand on previous requirements. However, it may be prudent to meet E1527-21 and reference both 2013 and 2021 ASTM standards in the Phase I report for the interim to ensure that the ESA satisfies both the existing and revised standards to avoid possible loss of protections should EPA’s decision take an unexpected turn. Of course one can expect a transitional period before industry-wide adoption, as was experienced in 2013 when the then E1527 revisions were published.
If you are a user of Phase I ESAs, it’s a good time to familiarize yourself with these changes and consider updating internal guidance or your company’s scopes of work. Discuss specific needs such as any non-scope business risks you wish to evaluate with your environmental consultant and let them know which standard you would like for them to follow starting January 1, 2022 until when EPA approves the E1527-21 standard as AAI compliant. If you want to dive deeper or have questions, I’ll be giving a webinar on Thursday, December 16, 2021 (11 am PST) along with several of my colleagues to talk through these changes and what we’re seeing in the industry – register here.