The completion of an environmental assessment isn’t enough to evaluate environmental risk. Lenders must demonstrate they understand and have accounted for the environmental risks to the collateral. Specifically, the FDIC Guidelines for an Environmental Risk Program dictate that “appropriate personnel have the knowledge and experience to determine and evaluate potential environmental concerns that might affect the institution”. To aid clients in the auditing process, Environmental reviews are completed as part of Commercial Real Estate Due Diligence to verify the accuracy and completeness of environmental reports.
Environmental Risk in Lending
Environmental Risk is the threat of contamination from the use, storage, handling and disposal of chemicals including petroleum and hazardous materials at a property. An environmental assessment evaluates the potential risk of environmental contamination to a property and determines the liability for known or potential contamination.
Environmental risks have the following impacts in the lending process:
- Financial obligations for remediating contamination or correcting compliance violations
- Diversion of client’s funds away from the lender to pay for remediation
- Liability to the lender for environmental remediation if risks are not properly identified prior to taking a property into portfolio
- Cost-recovery obstacles and difficulty with resale
- Cleanup costs can exceed property value
- Liens for reimbursement of government-funded clean up
- Limitations on future uses of property
- Negative impact on marketability and redevelopment potential for the property
- Lowered property value
- Liability related to third-party claims for causing unsafe health conditions for site occupants or for causing off-site impacts
What are Environmental Reviews?
An environmental review is the audit of an Environmental Site Assessment, Site Investigation, or similar report completed by an entity separate from the report preparer. Audits to assess the accuracy of an environmental report can be done by in-house Environmental Professionals for a lending institution or by a third-party Environmental Consultant, typically contracted by the lending institution. A memorandum or brief summary of the review findings with appropriate recommendations should always be prepared for the client as a result of the environmental review.
For regulatory oversight agencies and lending institutions, environmental reviews serve many purposes:
- Demonstrates that Lenders have assessed and have accounted for the environmental risks to collateral
- Provides a high-level description of property attributes
- Outlines potential environmental risks
- Verifies compliance with ASTM Standards and lender scope of work requirements
- Assesses the accuracy and completeness of the report(s)
- Provides concurrence with the findings and recommendations of the Environmental Consultant who prepared the report, or reasoning for disagreement
- Assesses the environmental risk from the lender perspective
Understanding the environmental risk to collateral leads to sound decisions in financing. The Lender should understand the scope of current and potential future environmental risk of a property being added into portfolio to be in compliance with the regulators and any applicable bank policies.
What are Common Factors That May Impact Report Quality?
The review of historical sources is critical to properly assess environmental risk. Per the ASTM Standard, the history of a property needs to be documented in five-year increments back to at least 1940 or to the point of first developed use. However, data gaps are commonly referenced in connection with the lack of historical resources. While consultants with local knowledge may be able to more easily fill in those information gaps, sometimes the information simply is not available. Also, consultants will sometimes review incomplete locally available historical sources and not purchase full data sets that are often available for purchase from data providers. This can sometimes lead to acceptance of collateral with environmental risk without even knowing until future environmental due diligence is completed. One thing to keep in mind is that it is typically easier to obtain quality historical research and data in urban areas. Land use is more commonly documented and property information can be more readily available through online resources.
The report should provide a full summary of site reconnaissance conditions. The more the consultant tells you about a site, the better the picture you can create of the site itself. The inclusion of captioned photographs, detailed site maps notating on-site conditions and potential concerns, as well as a written description of standard site reconnaissance observations beyond what is required by the ASTM Standard, are factors that positively impact report quality.
Reports prepared by a consultant that is not approved by the lending institution may not be protective of the lender as the lender’s preferred scope of work would not be accounted for. If considering relying on a report prepared for others, the relationship of that party to the transaction should be taken into consideration. The interests of a seller are not typically aligned with that of a purchaser or lender. Also, when reviewing or seeking reliance on reports prepared for others, the reviewer should consider limitations liability to be certain that the environmental report complies with lender requirements.
Common Deficiencies in Phase I Environmental Site Assessments
An environmental review completed by an Environmental Professional can identify deficiencies at an early stage, further reducing liability concerns for the client. Methods to rectify deficiencies are, as always, site-specific. However, it is often the case that the reviewer can often assist to bring the report into compliance by completing additional research or through communication with the report preparer. With the ASTM Standard in mind, we’ve compiled some common deficiencies identified during Phase I Environmental Site Assessment Review, as follows:
- Property history not researched to the earlier date of 1940 or first developed use
- Incorrect use of terminology in recommendations
- Lack of appropriate recommendations
- Insufficient rationale for conclusions
- Data Gaps, typically related to:
- Insufficient time for vendor to complete report
- Questionable methodology
- Lack of supporting documentation
- Vendor does not have adequate Errors & Omissions insurance
Tips for Success
Communication is the best resource for competing environmental reviews. Lenders should leverage the knowledge of the Environmental Professional(s) that completed the report. The vendor that completed the environmental assessment is the best first resource for providing site-specific information.
In addition, consistency is key. Working with the same consultants can lead to better relationships and an understanding of how to meet lender scope of work requirements, including report format/style. Especially in regions where obscure resources are commonly utilized, trusted consultants are key to providing a complete and time-effective report that is easily reviewed.
And as always….
LCS listens to your needs to develop products that are right for your lending transaction. Whether that be an individual appraisal, environmental or construction report, or a combination of services; LCS will meet your needs in the most efficient, effective way possible.