Ten Ways to Avoid Costly Phase II Environmental Property Testing

An environmental consultant’s recommendation for costly Phase II Environmental Site Assessment testing is among the most confounding…and most widely misunderstood…element of environmental due diligence faced by real estate owners, brokers, and commercial real estate lenders. However, there are possible means to defuse such recommendations and proceed to the settlement table. You need not consult with a spiritual master…a short list of tested strategies has been provided below.

Buddha and The Traveler (?)  (artist and date unknown)

 (1) Talk the Testing Recommendation over with the Consultant. Your Phase I Environmental Site Assessment is your environmental consultant’s opinion based on facts. Because an opinion is not a fact, it can be changed. It’s not uncommon for multiple environmental consultants to offer differing opinions on the same set of observations and facts. In most circumstances, the decision offer a recommendation to test is based on conservatism; environmental consultants vary on how conservative they are with their opinions. The same holds true for users of Phase I Environmental Site Assessments; some users are extremely risk-averse, and others are willing to gamble some on environmental liability.

For example, Federated Environmental reviewed another consultant’s Phase I Environmental Site Assessment on an manufacturing property in the Midwest. Among other observations, the consultant identified a concrete cutout area in the building floor that they speculated may have been an underground storage tank (UST) location many decades earlier. Review of the report revealed no actual supportive evidence that the concrete cutout area was a former UST location. The consultant simply observed a concrete cutout area and as a gut reaction recommended costly drilling inside the building. After discussing the matter with the consultant, the Phase I Environmental Site Assessment was changed and the recommendation for testing removed from the report.

Sometimes a second environmental consultant can review the original consultant’s Phase I Environmental Site Assessment and offer advice as a third party. Professional environmental consultants’ ultimate goal is to facilitate real estate transactions while reducing environmental risk for all parties, including themselves, so most consultants are not bothered by second or third party reviews.

(2) Skip the Testing and Risk It. This strategy is becoming increasingly common particularly among commercial lenders with a strong credit borrower  and end-of-month production quotas looming.  On the surface it sounds like a foolish gamble. Realistically, however, it’s not a bad strategy given the following loan circumstances (a) it’s a commercial loan not subject to SBA loan criteria, (a) the borrower is a strong credit and the loan is likely to perform, (b)  the appraisal is realistic and reliable, (c) the loan-to-appraised value is favorable, and (d) the cost to cure the environmental concern is not much as compared to the value of the loan and the real estate.  One Federated Environmental client reviews our reports and asks, “Is this a real environmental concern or just a nuisance I can deal with later if I have to?” Perhaps not as artfully worded as it could be, it’s still spot on.  In a commercial real estate world characterized by multi-million dollar properties and regulatory agencies not enforcing the regulations as aggressively as they used to sometimes just “letting it ride” is the best way to go. It’s a craps shoot, but it’s a craps shoot where you’ve assessed your potential downside risk.

(3) Challenge the Practicality of the Testing. Is it practical to test? Will it potentially create more problems than it will fix?

Federated Environmental once inspected a five-story apartment building with occupied commercial units on the ground floor in Brooklyn, N.Y. and constructed in 1998. Old fire insurance maps depicted a petroleum storage tank on-site from 1970 through 1995…right before the apartment building was constructed. No permits, reports, or other information was available on this former petroleum tank.  The prior property owners were unavailable to interview. Worse yet, based on the maps the petroleum storage tank was located within the footprint of the existing apartment building. As such, the building was constructed on top of the former tank location. The apartment building had no basement or crawlspace.

Environmental testing of the property would have required drilling soil core samples through the floor of the apartment building and within the occupied commercial units. It would have made a dusty mess, upset the tenants and commercial unit occupants, and potentially damaged the building.  In this instance, the lender forwent the environmental testing and closed the loan.

(4) Challenge the Consultant’s Level of Thoroughness. Does it appear that every avenue of potential information has been exhausted? Have they reviewed the building department permit file? Have they done a file review of state regulatory agency files? Interviewed neighbors and prior owners? All files?

Environmental consultants are no different than any other people…sometimes their investigations can be somewhat less than thorough or complete. In reviewing their report, have they completely examined whatever state regulatory agency municipal files or records that may be available such as building permits, notices of violation (NOVs) from building inspectors, certificates of occupancy (COs), code enforcement official records, plumbing and electrical inspections, fire department records, land use maps, tax maps, library historical records and history books, historical society records, old newspaper articles, and other materials? Many municipalities archive old permits…some of which may eliminate the need for expensive testing.  Can your consultant develop a logical argument that precludes the need to spend thousands of dollars on testing?

(5) Make like a Private Investigator.  Interviewed neighbors and prior owners? Has the consultant interviewed enough people? Interviewed municipal officials who might recall the property and the circumstances?

Many environmental consultants are scientific types and are more likely to avoid a conversation than a non-scientific type. However, a huge wealth of information is very often available if they seek people associated with the property…neighbors…prior owners…prior occupants…the builder…the garbage man…the oldest person in town…the former mayor. The list endless.  Sometimes, just sometimes, you locate a person who has the answer you’re looking for. Is interviewing a dozen people worth savings thousands of dollars in testing? You bet it is.

Federated Environmental once inspected a small commercial property in a town with very poor historical resources. All standard historical sources were exhausted and the site history was incomplete. We knew that a commercial building was on-site in the 1950s and 1960s but did not know what kind. Was it a dry cleaners? A gasoline station? A radiator repair shop? Printers? We contacted the former chief of police who was retired and at home. He told us the property was a hotdog and milkshake stand. When asked how he knew, he said he took him prom date there in 1957. Problem solved.

(6) Double-check how the loan is secured. Is the loan actually secured by the real estate (the ground) or just the improvements on it?

Sometimes, just sometimes, lenders will require as a matter of course a Phase I Environmental Site Assessment. If the consultant recommends a Phase II Environmental testing project, your lender will likely require that as well. Hey, hold on. Is the loan actually secured by the real estate (the ground) or just the building on the ground. Are you mortgaging a commercial unit on a second or higher floor? If so, your lender may be asking you to test property you will never own and they will never own and does not secure the loan. In fact, if you do test, you’ll be testing someone else’s property . Be sure that the actual ground securing the loan is part of your transaction before spending thousands of dollars on a red herring.