Environmental Due Diligence

What is Environmental Due Diligence?

Environmental due diligence is a systematic procedure that evaluates a property or land for possible environmental contamination risks, such as groundwater or soil contamination. The Environmental Protection Agency (EPA) provides standards for due diligence. Environmental Professionals (EPs) shall decide the degree and form of assessment warranted, which may differ depending on the land.

The Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) provides a mechanism for deciding who ultimately is responsible for the toxic materials. The legislation authorizes regulators to fine property owners. It mandates the disposal of toxic chemicals at the owner’s expense, even if the owner was not responsible for the contamination.

Proper environmental due diligence evaluations will protect purchasers against the significant burden of environmental liability under CERCLA, even though contamination is detected after the purchase.

To learn more about the importance of environmental due diligence in the credit analysis process, check out CFI’s Environmental Due Diligence for Credit course!

Environmental Site Assessment (ESA)

Environmental Site Assessment (ESA) is a type of due diligence that takes the form of a report that is prepared for any real estate asset, identifying possible or existing environmental contamination. This analysis of a real estate asset addresses the underlying asset and the physical improvements to that asset.

Specifically, the environmental site assessment is a method of performing any reasonable review into the land’s past or current use to decide if the land is impaired by the Recognized Environmental Condition (REC). ESA is an essential part of due diligence when buying a commercial property, and it should be done before closing the deal. The purpose of ESA is to ensure that the environmental contamination liability of a purchaser is limited.

Triggering Actions for an Environmental Site Assessment

The following events can trigger an environmental site assessment:

1. A property or business is being sold or purchased

If someone wants to sell or purchase a property and/or business, due diligence is required to determine whether the property or the operating business faces any current or possible environmental liability, including lack of licenses, hazardous material contamination, violations of permits, and enforcement deficiencies.

Understanding the requirements allows the purchaser to assess the possible restrictions, obligations, and hazards associated with the land.

2. The property is being refinanced

If a property is required to be refinanced, the bank will require an environmental site assessment to access the property for possible environmental contamination risks.

3. Transfer of property to a family member after retirement

If someone is planning to retire with plans of transferring the real estate asset to family members, he/she should conduct an environmental site assessment to ensure that they are covered from environmental liability.

4. Necessitated by a regulatory agency

If a regulatory agency suspects that toxic conditions prevail on the property or land, it may order the owner to perform an environmental site assessment. Moreover, in case of a municipal body request for a change of authorization related to property usage or other discretionary land usages, the municipal body will require an environmental site assessment to be performed.

5. Desired by existing owners

The existing property or business owners may want to identify the toxic history of the real estate asset.

Phases of Environmental Site Assessment

Phase I

The due diligence process starts by carrying out a Phase I or Level I environmental site assessment, an analysis of recent and past events at and around the property to determine possible or current environmental pollution obligations. The Level I ESA may be requested by a bank or other financial entity during the borrowing period or advised by the business advisors.

The Level I environmental site assessment aims to collect appropriate evidence to provide an unbiased expert opinion on the environmental status of the property and to recognize the real or possible environmental pollution that may have an effect on the valuation of the property or have an effect on the innocent property owner after purchase.

The Phase I environmental site assessment involves the following:

1. Review historical documents to determine past use. Review the public documents, such as fire insurance maps, historical aerial photos, topographic maps, and historical city directories.
2. Conduct site visits and investigation to observe present and historical conditions and usages of the land and related properties.
3. Interview the present and former property owners, managers and tenants, or those who are familiar with the land.
4. Review regulatory records for the site and surrounding properties. Also review the federal, state, territorial, and municipal regulatory databases, such as the underground storage tanks (USTs), overground storage tanks (ASTs), suspected or known release incidents, storage of toxic substances, and management of hazardous waste, including petroleum goods, and administrative and engineering controls.

The Level I environmental site assessment does not involve real sub-surface samples, such as groundwater and dirt. There is, moreover, a requirement to be followed under the American Standard for Monitoring and Components or ASTM, which involves addressing the issues associated with soil vapor degradation and the possibility of vapor migration posing a danger to on-site and off-site tenants.

Environmental Professionals analyze the study to determine possible environmental hazards to the land, such as existing or past activities that are documented or believed to have used toxic chemicals or petroleum products in on-site operations. After Phase I ESA is finished, the EP will summarize the issues found on the property and make suggestions as to what steps are taken to resolve the issues.

A recognized environmental condition (REC) shows either familiar contamination or the subsurface’s potential to be affected by contamination. Whenever a REC is identified, it is often followed by a recommendation for Phase II ESA.

Phase II

Phase II of the environmental site assessment requires collecting soil, groundwater, or building materials samples to examine different pollutants. It offers a clearer understanding of the soil’s state, the groundwater, and the property structures. When Phase I discovers possible environmental concerns, it typically prompts further actions.

Petroleum hydrocarbons, pesticides, heavy metals, asbestos, solvents, and mold are the most commonly tested compounds in Phase II or level II environmental site assessment.

Phase III

Phase III or Level III environmental site assessment is an inquiry requiring the remediation of a site. The goal of the inquiries of Phase III is to delineate the physical extent of exposure based on the recommendations made in Phase II evaluations.

Phase III investigations can include rigorous preparation, sampling and tracking, modeling including fate and transport tests, and probability studies designed for corrective and remediation plans. It typically includes the evaluation of possible clean-up approaches, logistics, and costs. The related report outlines the actions taken to clean up the site and oversee the monitoring of residual pollutants.

Regulations controlling activities that can impact the environment come under federal and provincial authority and vary from area to area. The guidelines for determining responsibility for contamination can be complex and time-consuming.

For more information, see CFI’s Environmental Due Diligence for Credit course!

Recognized Environmental Condition

Recognized Environmental Condition (REC) is a term used to recognize environmental responsibility in the context of the Level I Environmental Site Assessment. It is also known as Areas of Potential Environmental Condition (APEC). ASTM describes the accepted environmental condition in the E1527-13 standard as the presence or probable presence of any petroleum products or hazardous substances at the property:

1. Due to discharge to the environment,
2. Under circumstances that suggest discharge to the environment, or
3. Under circumstances that represent a potential threat of discharge to the environment

RECs can originate in the property in question or property close to or adjacent to the concerned property. Similarly, REC can also exist away from the relevant site. For example, a local contamination plume may be a REC for all of the properties covering it. Observations of REC can occur during a Phase I ESA site inspection.

Also, RECs can surface during Phase I ESA interviews and analysis of the regulatory and historical records. Eliminating data discrepancies or shortcomings that prevent RECs’ detection is of the utmost significance to the benefit of the Phase I ESA. In the case of long-standing assets, completed documents help in the removal or detection of high-risk uses.

Examples of Recognized Environmental Condition

• Historical gas stations and car repair centers where underground storage tanks or other subsurface features can remain in the estate.
• Car repair shops that usually use and stock dangerous substances such as solvents, energy products, plastics, polychlorinated biphenyls (PCBs), and per-and polyfluoroalkyls (PFAs).
• Present and historical dry-cleaning firms where tetrachloroethylene (PCE) solvent may have been used.
• Foundries, processing plants, or other massive industrial facilities.
• Earlier release on or next to the relevant land. Generally, it is more obvious when environmental investigations are incomplete or where the release has not been subject to a clean-up of regulatory requirements.

Related Readings

CFI is the official provider of the Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.

In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:

• Environmental Liability
• Negative Externalities
• Non-Renewable Resource
• Types of Due Diligence
• See all commercial real estate resources
• See all ESG resources