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Commercial lending in an era of environmental awareness.

Environmental legislation that targets potentially responsible parties for remediation of contaminated properties has become a hot topic of debate in real estate and commercial lending circles. Argued by many as being unjust, the precedents set by the courts have enabled the federal government to seek clean-up costs from a number of entitles including current land owners and lending institutions, regardless of whether or not they had anything to do with causing the pollution. The latter conflict is exemplified in the well-known case of U.S. V. Maryland Bank and Trust.

Considering their new role as a potentially responsible party, many commercial real estate lenders are considering ways to minimize their risk of becoming involved with contaminated properties. A buzz-word presently heard at many lending negotiations is environmental due diligence. Generally speaking, it proposes that concerned parties should investigate the property's environmental integrity through various channels to define any areas of environmental risk and liability.

Although case work is limited, the practice of due diligence will, at least theoretically, enable a title holder to defend themselves as an "innocent land owner" in the event a serious chronic environmental concern is detected subsequent to title transfer. That is, if the owner had no knowledge of pre-existing concerns prior to accepting title, they should not be held accountable for its clean-up.

This premise is specifically applicable to lenders who foreclose on a contaminated property and assume title. These lenders are often seen by the courts as deep pockets" entities.

Considering the current state of affairs, property managers are concerned with a number of issues including the level of lender involvement in the environmental assessment process, how a lender's environmental policy will affect the loan application, what should be included in the environmental assessment to expedite financing, and what type of qualifications the environmental consultant should have.

Surveying the problem

Perhaps a reflection of the novelty surrounding the issue, a 1987 survey of 140 real estate lending and insurance organizations revealed that as little as 41 percent of the population had a written policy on how to evaluate environmental risk in property transactions. Of these institutions, only 30 percent required phase one environmental assessments 80 percent to 100 percent of the time.

Generally speaking, phase one assessments are defined as a preliminary investigation that includes a record search, a site inspection, and sometimes a limited amount of sampling.

A recent study performed by CA Rich Consultants of New York investigated to what extent 100 commercial lenders had become actively involved in the environmental assessment process. Responses were noticeably variable, particularly along lines of organizational size, length of time the policy was in effect, amount of the loan, and geographic reach of the lender's services.

Approximately 30 percent of the survey population had given their loan applicants nearly 100 percent autonomy in the assessment process. That is, the lender had left all technicalities, including the scope of the assessment and the choice of consultant, entirely up to the borrower's discretion. it was predominantly the smaller lender, and particularly thrift institutions involved with residential properties, that subscribed to this view. It was also found that these institutions had often implemented their environmental policies for less than a year.

While property managers may consider this type of policy to be advantageous to their interest because it allows them to competitively bid one consultant against the other, a word of caution is offered. just as a lender's environmental policy is designed to protect them from potential liabilities, it also protects the buyer and seller in the same way.

During the assessment process the consultant is often required to sub-contract various record search companies to gather historical information. It is reasonable to assume the lower the cost of the assessment, the less research can be performed. While a report costing a few hundred dollars may be acceptable to some lenders, the scope of the investigation will undoubtedly be limited. Considering the worst case scenario, such a limited investigation may not be interpreted by the courts as being duly diligent.

Approximately 52 percent of the lenders surveyed had outlined specific assessment requirements and cultivated a list of approved environmental conSUltants from which the loan applicant could choose.

Although lenders in this group shared a number of characteristics, the most prevalent was the length of time their policies were in effect. For the most part, they had implemented a formal environmental policy for a minimum of one to two years prior to the survey. Smaller, localized lenders were not as particular in their requirements, and unlike larger lenders, few had a standard policy linking all branch offices.

The benefits of this type of policy lie mainly with the lender's pre-approval of a competent environmental consultant. Property managers can research each firm to evaluate their ability to provide quick response time and competitive fees. This may be particularly helpful to those not familiar with environmental assessments.

Of the lending institutions surveyed, only 18 percent regularly retain their own consultant for the purpose of environmental assessments. Lenders with similar policies suggested it was based on the desire to oversee the scope and direction of an investigation that would minimize not only their own risk, but that of their clients.

The manager/lender relationship

Although some property managers may consider this compromise not to be in their interest, they should keep in mind that lenders are in the business of making loans. Consequently, they are concerned that stricter environmental policies and the added financial burden will force borrowers to seek financing from other institutions.

While this may sometimes be the case, it should be pointed out that lenders hiring their own consultants always demand technical competence and a competitive price. Also, consultants regularly working for a specific lender know exactly what information is expected from them in advance, and this often translates into a comprehensive yet expeditious investigation.

All things considered, it seems that when lenders hire their own consultant to assess the environmental integrity of a property, the property manager will very likely get a reasonably priced and well-researched report.

Despite differing levels of lender involvement in the assessment process, it is judged that the evolution of the policies will reflect concerns addressed by the lending industry's regulatory agencies and professional organizations.

Thrift Bulletin 16, issued by the Federal Home Loan Bank System, specifically recommends that thrift banks take a more active role in the assessment process by implementing a formal environmental policy, designate one or more in-house environmental consultants, and have the report submitted in the name of the lending institution. Similar perspectives are shared by the United States League of Savings Institutions, the Mortgage Banker's Association of America, the Federal Home Loan Mortgage Corp. Fannie Mae), and the Federal National Mortgage Association (Freddie Mac Multifamily Programs).

While there is no specific definition as to what due diligence should entail, the entities listed above do outline certain criteria for their members to consider. In particular, they suggest phase one environmental assessments investigate various channels, including: record searches for 50-year chain-of-title/ certificate-of-occupancy, underground storage tank inventory, documented environmental violations, compliance and accidents; site inspections and preliminary sampling for obvious signs of exterior contamination and asbestos, lead paint, urea formaldehyde, PCB transformers/light ballasts, and radon.

Other concerns commonly investigated include the historical uses of adjacent and connecting properties, the property's proximity to areas of known or suspected contamination, and the property's proximity to ecologically sensitive areas (water wells, wetlands, and so forth).

While most competent environmental consultants will include these concerns in an assessment, the true utility of an investigation is in the consultant's interpretation of the data and final recommendations. Consequently, this brings up the issue of consultant qualifications. Coming as a surprise to most, few states presently require specific certification from consultants performing phase one environmental assessments. Though this may change in the future, the property manager is urged to consider a number of criteria before contracting an environmental consultant.

As could be expected, the bottom line for evaluating one consultant over another is often found in their level of experience. Property managers and other concerned parties should ask for information regarding the abilities of the firm's project management staff, including their professional certifications and licenses; the consultant's knowledge of environmental law and demonstrated ability to negotiate with environmental regulatory agencies; the consultant's ability to sample various environmental media including building interiors, soil/soil gas, groundwater and so forth; the competence of subcontractors hired by the consultant (record search companies, laboratories, and so forth); and whether or not the consultant is covered by professional liability insurance.


It would seem the issue of environmental liability will continue to affect the relationship between property managers and commercial lenders. Though this relationship may become strained at times, environmental policies are helping property managers avoid involvement with contaminated sites, as well as helping to define concerns that need to be immediately addressed.

Considering this, what was initially interpreted as just another headache in the finance application by some, has subsequently turned into an inexpensive way to avoid highly specific problems that could turn the property manager's portfolio of real estate assets into one of major liabilities.

William J. Pierro is a geologist with CA Rich consultants of Sea Cliff, New York. He earned his B.S. degree in geology f rom Southampton College of Long Island University and has recently completed his M.B.A. degree at Hofstra University in Hempstead, New York.

In his position at CA Rich, Mr. Pierro has performed numerous environmental assessments of real estate in the New York metropolitan area. This has given him regular opportunities to interface with both commercial lenders and property managers during the assessment process.
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Author:Pierro, William J.
Publication:Journal of Property Management
Date:Jul 1, 1990
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