CHARLOTE, N.C.—As the CRE market picks up steam, competitive pressures are creating a tendency to push deals through. With an eye on closing deals, many lenders don’t go beyond the basics of the due diligence process. That means Recognized Environmental Conditions (REC) can sometimes get filed away as “resolved” with little further investigation. There are several ways this happens: Certain institutions’ risk profiles make them comfortable with the risk of smaller RECs, and digging deeper to an identified REC by conducting a soil and groundwater investigation is an upfront cost that increases the deals expenses and may delay closing.
But, as Kristine MacWilliams, P.E., of Partner Engineering and Sciences sees it, without a realistic picture of a seemingly limited REC, the buyer or lender could be leaving themselves exposed to hidden risk. And, in many cases, it can also protect against substantial long-term costs and complex environmental liabilities. GlobeSt.com spoke to the technical director of Partner’s Subsurface Investigation Group to find out what levels of investigation are appropriate for a given institution, and how to best balance cost, risk and competitive pressures.
GlobeSt.com: When an issue is found in a Phase I ESA and further testing is recommended, what advice do you give to clients on how much testing to do?
Kristine MacWilliams, P.E.: It really depends. Let me compare it to how many lenders take a tiered approach to the initial environmental assessments – sometimes they only need a desktop report, other times they really need a set of environmental professional eyes on the property. Well you can take a similar tiered approach to Phase II subsurface investigations too.
To oversimplify, you could do a big scope – which would include sampling in more locations at greater depths, analyzing more media (soil, soil gas, groundwater etc) and analyzing for more chemicals – to be more comprehensive. Or you can do a smaller scope – taking just a few strategic samples and analysis to provide basic information on whether contamination is likely to be present. While limited, this give you a more decisive confirmation than the Phase I may have indicated. But “likely” is the key word here.
GlobeSt.com: What are the pros and cons of a small-scope versus a full-scope Phase II?
MacWilliams: Back to the word “likely.” Of course, the bigger scope you do, the less uncertainty you have. There’s always a risk that an environmental issue exists right in an area that was not sampled, which means that the smaller the scope of the subsurface investigation, the greater the uncertainty. But that doesn’t mean limited scope Phase IIs are a bad idea – sometimes it’s best to do a small scope first and then if the results are hot, do further testing. This way you’re not unnecessarily paying for the whole kit and caboodle, doing a large scope initial assessment and having all clean data. While good news, there may have been some unnecessary expenditures. Additional sampling lengthens the timeframe, but doing even a limited amount of testing can be well worth the added expense to identify the worst nightmare of any lender, developer or attorney – a bottomless environmental cleanup – before deal closes! On the other hand, other factors such as the type of deal (i.e., foreclosure) or the time constraints on a deal may lend themselves to doing a larger scope up front so that you do not extend the assessment time and get a greater data set and more certainty of the concerns in a shorter timeframe.
An effective way to mitigate risk is to use the Phase II in a scaled manner that identifies issues and limits cost. It depends on the site, the client’s needs and constraints like timing and budget. Many significant environmental issues can be identified with a few well thought-out soil borings that carry a modest cost. This can significantly increase unleveraged cost for portfolios, but can be scaled to greatly reduce risk at a modest cost.
GlobeSt.com: Are there standards on what the Phase II scope should include?
MacWilliams: Yes and no. ASTM E1903 provides some basic parameters, but there is a huge amount of professional judgment that goes into the actual scope. A lot more goes into the scope of work than just the number of samples taken – for example what type of drilling and sample collection is appropriate for the site and the kinds of contaminants you are looking for. That’s why it pays to be an informed client – understanding what’s involved in the assessment and the level of certainty your institution requires will help you assess that you’re getting what you need. At the same time, because risk mitigation isn’t an “exact science” there are lots of different approaches to environmental due diligence, of which more than one can work for you. Having a high degree of confidence in the advice of a consultant who understands the fine balance between cost, risk and competitive pressures will help to make sure you get the most suitable approach.