One of the major goals of physical due diligence is to confirm that the environment surrounding a property is free from any harmful pollutants or contaminants. This is accomplished by commissioning a specialized report known as a Phase 1 Environmental Site Assessment.
A Phase I Environmental Site Assessment, sometimes referred to as a Phase 1 ESA or simply “ESA” is a report that is completed on behalf of lenders and buyers to review the current and historical uses of a property as part of a commercial real estate transaction. The goal of the report is to determine if any of the current or historical uses of the property have contaminated the soil or groundwater below the property to the point that it could pose a threat to the environment or the health of the individuals who occupy or visit the property. In most cases, the Phase I ESA is required by lenders and must be completed prior to consummation of a loan transaction. Often it is prepared in accordance with the requirements outlined by the Comprehensive Environmental Response Compensation and Liability Act (CERCLA) and the American Society for Testing and Materials.
What Goes into Creating a Phase I ESA?
A Phase I ESA is completed by an environmental professional who has specific training and experience in the tasks required to complete their report. When they receive an assignment, they perform the following activities to complete it:
- Review federal, state, tribal, regulatory, and any other relevant database for evidence of: underground storage tanks (USTs), aboveground storage tanks (ASTs), known or suspected cases of contaminant releases, and storage or disposal of hazardous substances.
- Site visit to observe the current use of the property and all properties within close proximity
- Review historical records such as photographs, maps, and directories to confirm historical uses of the property
- Review state and local regulatory agency records to determine if there have been any events or reports concerning contamination for the property
- Interview current and past property owners and occupants
With these activities completed, the Environmental Professional compiles their research and uses their training to determine whether or not there is any cause for concern about potential environmental contamination. While most property types are generally OK, there are a few businesses that are notorious for pollution. They include dry cleaners, gas stations, oil change stores, printing shops, and certain types of manufacturing facilities.
Findings are detailed in a physical report that is delivered to the party who ordered it (usually the lender) and other designated participants in the transaction.
What is in a Phase 1 ESA Report?
The physical report is prepared in conjunction with the standards outlined in ASTM1527-13 (NOTE: Depending on the specific use, other lending institutions like the SBA, FNMA, or HUD could have their own requirements above and beyond ASTM requirements). They are lengthy and dense documents, but they all contain one key section where the major findings are summarized. This section is called “Recognized Environmental Conditions” or “REC.” This term means the presence or likely presence of any hazardous substances – like asbestos or petroleum products – in, on, or around the property. The presence of these hazardous materials could be due to:
- A release into the environment
- A condition indicative of a release into the environment
- Conditions that pose a material threat of a future release into the environment
Recognized environmental conditions typically fall into two categories: a controlled recognized environmental condition (CREC) or a historical recognized environmental condition (HREC).
A CREC means that the property has been impacted by contamination that has been investigated and remediated; but additional contamination remains.
A HREC means that a contaminant release has been identified, investigated, and remediated.
If either of these two conditions are discovered, the conclusion of the report may recommend further investigation into the issue with a Phase II Environmental Site Assessment. While the Phase I review documents and interview key individuals, a phase II ESA dispatches the environmental consultant to the property to collect soil, groundwater, and/or soil vapor samples for further analysis to confirm or disprove the actual presence of contamination on site.
Why the Phase 1 ESA Matters
There are two reasons why the Phase 1 ESA is a critically important component of a commercial real estate transaction, financing and cost.
On the first point, the Phase I ESA is required, and typically ordered by, lenders to protect themselves in the transaction. They do not want contaminated collateral for their loan and final loan approval is often contingent upon a clean Phase 1 ESA. If it comes back with one or more recognized environmental conditions, it could threaten finalization of the loan. In some cases, the lender may walk away from the transaction. In others, they could add additional conditions that must be met prior to closing.
On the second point, the existence of environmental issues and/or environmental concerns almost always means that it is going to cost money to repair or remediate. Depending on the severity of the issue, the cost can be substantial. More importantly, the time that it takes to develop a remediation plan, get it approved by authorities, and implement it can add significant delays to a project’s timeline.
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