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Buying Contaminated?Effectively managing environmental issues that affect property purchases

December 1, 1999

11 Min Read
Buying Contaminated?Effectively managing environmental issues that affect property purchases

Buying Contaminated?

Effectively managing environmental issues that affect property purchases

By Michael D. Frede

Many people involved with real estate in the self-storage industry are familiar withhow environmental liabilities can significantly affect the profitability and viability ofa self-storage development. However, recent changes in environmental regulations havecreated new opportunities for purchasing sites previously considered to be environmentally"risky." Developers can now more seriously consider buying a contaminated sitebecause environmental issues, when effectively managed, are less likely to hinder theoverall business plan.

Originally, the liability for environmental contamination was to be borne by the entitythat caused the contamination. However, the reauthorization of the Superfund Act in 1986(SARA) shifted the liability to the current property owner, whether he caused thecontamination or not (it cost the government too much to chase down the responsibleparty).

This simple change caused a tidal wave of changes in the public and private sectors.The lending industry was now more at risk because it was forced to choose betweenforeclosing on contaminated property (and taking on the responsibility of the siteconditions) or writing off a loan. The environmental-consulting industry, almostnonexistent prior to that point, absorbed a huge increase in work it wasn't overlyexperienced at, and implemented programs for the research and development of newtechnologies. The legal industry was forced to establish new precedents in lawsuitsbrought to allocate the responsibility for the costs of contamination between current andpast landowners. Lawmakers were forced, without adequate technological data, to implementnew policies that would protect our natural resources without significantly affecting thelending industry or private-property owners.

Also, the rapidly changing regulations threw a scare into the entire real-estateindustry because the future risks could not be defined. As time has passed, pressure fromlenders and private-property owners, as well as experience gained by the consultingindustry, have demonstrated that the original regulations were too strict. Their strictpolicies caused many contaminated sites that didn't really pose a risk to human health orthe environment to be remediated.

Typical Environmental Conditions

The inexperienced developer typically thinks that environmental risks are rare(something that happens to the other guy) and are limited to large industrial properties,such as steel mills, chemical plants--and "those large facilities with smokestacks." However, the most common properties with contamination--and those mostlikely to affect self-storage developers--are existing or former gasoline stations, drycleaners, auto-repair businesses, paint shops, etc. Although these types of propertiesusually are not a Love Canal kind of situation, they can have contamination thatpreviously would cost hundreds of thousands of dollars to investigate andremediate--enough to bankrupt a smaller developer or at least significantly affect thefinancial viability of a self-storage project.

Another common type of environmental condition is land that has been filled.Frequently, the fill contains materials that can cause contamination (e.g., chemicalbarrels, foundry sand, asphalt debris and wood chips from utility facilities). Inaddition, many properties are contaminated because they lie near other contaminated sites.Contaminants will migrate downward with rainwater infiltration until they reach thegroundwater table, then migrate horizontally as the groundwater flows through the soils orbedrock. In either case, the presence of contamination is an issue that needs to beevaluated, whether it was caused by the owner or originated on site or not.

New Purchaser Advantages

In recent years, regulators have developed a more relaxed attitude that has resulted inreduced economic risk for many contaminated properties so they may become financiallyviable development options. Regulators have been convinced that not all contaminationneeds to be remediated. Liability-limitation statutes have eased concerns that futureregulatory changes may result in undefined risks that make lenders, lawyers and developersnervous.

Many states have written new rules that also limit the maximum cost of remediation whenspecified investigation guidelines are followed. Regulators are also willing to offerthird-party indemnification letters when contamination is found on a site that is provento originate off site. Court cases have established precedents that define responsibilityfor contamination; this helps lenders and owners identify their risks. Also, lenderliability has been reduced when they demonstrate that they were not involved in theoperations of the business.

Many states have developed alternatives to costly remediation efforts, such asinstitutional controls (e.g., well and construction restrictions and deed notices) andengineering controls (e.g., covering an area with pavement) so that health concerns arestill addressed. Many public agencies have established special "brownfield"grant and loan programs to not only assist, but encourage, the development of contaminatedproperty, although these programs have limited access for the private, for-profitdevelopment sector. In fact, the local government entity routinely assists in numerousways when someone is willing to develop a contaminated parcel.

In addition, the insurance industry has created policies that can be purchased byproperty owners to replace financial uncertainty with specified costs. Although premiumsfor such policies can be pricey, these policies place a ceiling on potential cleanupcosts. With all these advantages, purchasing and developing a property with environmentalissues is not as costly and risky as it used to be.

Recommendations Before Purchasing Property

Prior to purchasing any property, you should become familiar with its history andgeological conditions. It is prudent to identify any unusual environmental andconstruction costs for budgetary reasons. It is also prudent to protect the largeinvestment needed to develop a site from unexpected costs. Prior to providing a loan,lending institutions will complete an environmental-screening questionnaire to determinethe necessity for a Phase I environmental site assessment. A Phase I consists ofhistorical research and a site reconnaissance, and its purpose is to evaluate thepotential for contamination to exist from past site or nearby activities. Completion of anASTM Standard Phase I is necessary to qualify for the "innocent landownerdefense."

If the Phase I concludes that there is a potential for contamination to exist, a PhaseII should be conducted. A Phase II consists of collecting soil and/or groundwater samplesat specific areas for specific chemicals to confirm the presence or absence ofcontamination. A Phase II does not define the size of the contaminated area or determineif remediation is warranted.

If the Phase II confirms the presence of contamination, a complete remedialinvestigation/feasibility study (RI/FS) is necessary to determine the need and costs forremediation. Usually, the buyer and seller will enter into negotiations to determine whowill be responsible for completing the RI/FS, and how the selling price may be affected.An RI/FS consists of a thorough scope of soil and/or groundwater sampling to define theextent and degree of contamination, determine the necessity for remediation, and identifythe most appropriate method of remediation, if needed. Prior to this phase, the regulatoryagency has not been involved in the process. This is the point that the new regulatoryattitude, which affects the need and scope of cleanup actions, can significantly reduceproject costs.

Unlike other industries, the self-storage industry can take advantage of some of theemerging alternatives to costly remediation methods. One alternative consists of paving anarea of contamination to inhibit the infiltration of rainwater or melting snow. Sincestorage-facility sites are covered with pavement and buildings, this option is a naturalfit. Also, environmental problems don't create the stigma that would exist with many othertypes of businesses, such as restaurants, day-care centers and office buildings.

Market forces (i.e., perceived liability risks) that can affect the costs of a projectstill exist, but those forces are increasingly less significant as the private real-estatemarket continually gains experience in dealing with environmental issues, and primelocations become more scarce. Also, what an owner can gain in reduced costs needs to beweighed against the increased time it may take to obtain a "closure letter" fromthe regulatory agency because additional requirements for investigating and monitoring asite may be requested before the regulator is comfortable with the conditions.

Conclusions

Recent changes to environmental laws have created more financially viable propertiesbecause of the lower cleanup standards. More entrepreneurial and private companies canreadily take advantage of these changes. Buyers do not have to walk away from an otherwiseattractive property because, not only are potential remediation costs lower, but limitedgrant and loan programs and liability-limitation laws can reduce out-of-pocket costs.

A savvy, knowledgeable buyer can use the historical attitudes that promote lowerproperty values on contaminated sites to obtain otherwise viable sites that others haveavoided at below-market prices. This can increase the potential net-operating income andequity of the development. Environmental risks still exist, but are more manageable thanin the past and actually can be less significant in the financial viability equation thanmany other factors.

Michael D. Frede is a registered professional engineer, and the president and ownerof King Development LLC and Drake Environmental Inc. Mr. Frede has more than 15 years ofconsulting experience in the fields of geotechnical and environmental engineering. He hasconducted geotechnical and environmental investigations in 32 states.

Mr. Frede wishes to extend his appreciation to two professionals who contributedtheir valuable time and knowledge to assist him in producing this article: Mr. John M. VanLieshout, environmental attorney with the Milwaukee, Wis., office of Reinhart, Boerner,Van Deuren, Norris & Rieselbach, S.C.; and Mr. R.K. Kliebenstein, vice president ofintegration, Extra Space Storage, Las Vegas, Nev.

Definitions

ASTM--American Society for Testing and Materials: an organization thatdevelops consensus standards and related technical information for industry.

Closure letter--A letter from the governing regulatory agency indicating thatadditional investigation or remediation of a contaminated property is no longer necessary.Closure letters are either unconditional or conditional, and their requirements vary fromstate to state. An unconditional closure effectively places no restrictions on theproperty--the property may be treated the same as a property that was never contaminated.A conditional closure places one or more restrictions on the property that are typicallyenforced by a deed restriction or notification. Such restrictions may limit certain usesof the property (such as for potable water) or may require certain actions (such asmaintaining a cap or barrier to isolate contamination).

Innocent landowner defense--That defense to the ComprehensiveEnvironmental Response, Compensation and Liability Act (CERCLA) provided in 42 USCß9601(35) and ß9607(b)(3). One of the requirements to qualify for this defense is thatthe party make "all appropriate inquiry into the previous ownership and uses of theproperty consistent with good commercial or customary practice." (ASTM, StandardPractice for Environmental Site Assessments: Phase I Environmental Site AssessmentProcess, E 1527-97, p. 5.)

Remediation--The implementation phase of a site cleanup that follows aremedial investigation/feasibility study (RI/FS); may consist of active or passive methodsto eliminate soil and/or groundwater contamination.

RI/FS--Consists of a remedial investigation, an in-depth studydesigned to gather the data necessary to define the extent and degree of contamination,followed by a feasibility study, consisting of the analysis of potential cleanupalternatives for a site and, possibly, an evaluation to determine whether a proposedremedial method will be effective considering the environmental conditions of the subjectsite.

SARA--Superfund Amendments and Reauthorization Act (1986); federal lawreauthorizing and expanding the jurisdiction of CERCLA.

Site reconnaissance--A site visit during which visual and physicalobservations are made to the subject property and any structure(s) located on the propertyto the extent not obstructed by bodies of water, adjacent buildings or other obstacles(ASTM, p. 13).

Superfund:--The program operated under the legislative authority ofCERCLA and SARA that funds and carries out the Environmental Protection Agency's solidwaste emergency and long-term removal and remedial activities.

Third-party indemnification (i.e., liability exemption)--In the caseof environmental contamination, an owner's legal exemption from the liability associatedwith the presence of contamination on the owner's site when the contamination originatesfrom off site.

Brownfields
What they are, how to use them to your advantage

By Michael D. Frede

KingDevelopment LLC was created by the owners of Drake Environmental Inc. to purchase andremediate contaminated properties to either sell or develop with self-storage facilities.King Development focuses on a specific type of contaminated property; brownfields.Brownfields are abandoned or underused industrial or commercial properties where siteupgrading or redevelopment is hindered by known or perceived environmental contamination.

At all government levels, the interest in cleaning up and returning brownfields toproductive use has moved this specific environmental issue to a major public-policy issue.The Environmental Protection Agency estimates there are 450,000 brownfields in the UnitedStates. In the State of Wisconsin alone there are an estimated 8,000 brownfields, 1,500 ofwhich are believed to be tax delinquent. If left as is, these properties present health,economic, environmental and social challenges to the communities in which they arelocated.

Some brownfields exist because property owners have been unable or unwilling to incurthe costs to investigate or cleanup their land when contamination is suspected or known toexist. Consequently, the property is abandoned, which forces the lender (if a mortgageexists) or government entity (if back taxes exist) to consider foreclosure. Many lendersand government bodies will not foreclose on environmentally questionable property due toliability, and the property may remain abandoned for years. When the environmentalconditions go uncontrolled, a property becomes an eyesore and adversely affects the taxbase.

The process that King Development follows varies from site to site. Due to thecompany's unique experience in investigating and remediating contaminated properties, itcan select the most financially feasible brownfield sites to purchase. Then, in somecases, it will purchase the property directly from the current owner at a discountedprice, depending on the estimated costs of investigation and cleanup, site preparation,and any back taxes or liens that exist. For some properties, King Development may workthrough a foreclosure action with the government body to obtain ownership. In these cases,the company will also be able to purchase the property at a discounted price, especiallysince all liens and back taxes are usually eliminated.

An important factor that makes brownfields projects financially viable is theregulatory changes that have recently occurred in the area of cleanup standards. Thesechanges have greatly reduced the costs necessary to remediate contaminated land. In manysituations, no remediation is warranted because the investigation results demonstrate thatthe conditions do not exceed the new cleanup standards and are not harmful to human healthor the environment. Consequently, closure letters from the regulatory agencies, whichstate that no further investigation or cleanup is necessary, are more easily obtained.

In summary, King Development is able to identify properties that can be purchasedand brought into environmental compliance at a cost less than the fair market value.Because King Development evaluates the environmental and economic conditions prior topurchasing a selected property, which provide an indication of the financial viability ofthe property as a self-storage facility, additional equity and higher net-operating income(NOI) can be achieved.

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