Environment Business Risk
Most professionals in the Commercial Real Estate Arena are aware of the ASTM Phase I Environmental Site Assessment Report (Phase I ESA). The fourth iteration of the ASTM (1527) was published in 2021, but all iterations represent a method of due diligence to mitigate legal and business risk associated with Real Estate related Environmental Liability. Environmental Liability, even as it relates to specific real estate, could be very broad. ASTM helps by very specifically focusing on contaminated land and Superfund (CERCLA) law.
The Recognized Environmental Condition (REC) has become the defining indicator of risk that is part of the Phase I process. ASTM defines the recognized environmental condition in the E1527-21 standard as “(1) the presence of hazardous substances or petroleum products in, on, or at the subject property due to a release to the environment; (2) the likely presence of hazardous substances or petroleum products in, on, or at the subject property due to a release or likely release to the environment; or (3) the presence of hazardous substances or petroleum products in, on, or at the subject property under conditions that pose a material threat of a future release to the environment.”
After 25 years of being part of commercial real estate transactions, most real estate professionals understand the concept of the “Recognized Environmental Condition” (REC). Yet, despite this, its growing mainstream audience and the maturation of environmental laws first established in the 1970s, the concept of environmental risk is not fully understood by most stakeholders in the process, including those in our (consulting) industry. Further, the definition of REC, rather than creating clarity for users, many times creates confusion due the generic definition of a REC with respect to risk. Generic, as the concept of risk normally includes components of probability and impact while the REC addresses neither. The simple implication of a “likely” condition is not enough to define risk. While this may be intentional, to allow for more flexibility in interpretation or to make it a simpler process for mass use, this can complicate real estate transactions where, in many cases, it is unnecessary.
Risk probability is the chance of a risk circumstance existing. Risk Impact (or magnitude) is the cost of that circumstance if it does exist. Risk probability is typically described qualitatively, such as low, medium, or high. Risk probability can also be defined quantitatively as some percentage. Risk impact could also be described qualitatively or quantitatively in a similar fashion with dollars rather than percentage as the quantity.
The words high, medium, or low in terms of impact or magnitude can have many meanings as well so to define it, one would have to know the risk tolerance of the user or the value of the property or project with respect to the liability or risk. For some, large is greater than $1M, for others that is a minimum for evaluating risk. So, when defining risk, which will have a probability of occurrence and a magnitude; simple words without context cannot accurately define risk properly.
The following are well-known “High” Risk Usage RECS:
- Historical manufacturing
- Petroleum Refining
- Lead Smelter
- Metal Work:
- Machine Shops Oil Terminals
- Gasoline stations
- Former research, military, commercial, or industrial use sites
- Former mill sites
- Lumber yards Building/hardware supply
- Vehicle repair shops
- Car dealerships
- Commercial printing facilities
- Dry cleaners
- Photo developing laboratories
- Hospitals, medical or veterinary facilities
- Junkyards or landfills
- Waste treatment, storage, disposal, processing or recycling facilities
- Agricultural/farming operations
- Paint manufacturers or suppliers
Equipment with potential for high risk include
- Oil Filled Transformers (PCBs)
- On-site Septic tanks
- Leach fields
- Dry Cleaning Machine Press
- Cleaning Pits
Remedies with potentially high impact include soil/groundwater extraction and treatment off-site, treatment ex-situ and in-situ, and soil/groundwater contaminant management.
While some conditions, like simple removals, are easy to estimate, estimating compliance or closure regarding chemical quality within soil and groundwater that may be partially known or unknown, under all conditions, is an educated guess at best. Environmental Professionals (EPs) must rely on their own experience and knowledge to predict outcomes. Across the environmental services industry, however, in addition to disparities and variety of knowledge, every environmental professional will also rely on their own risk profile to provide advice. This would explain a large disparity of opinions on even simple issues.
While it is reasonable to ask a consultant, “what will this cost”, you could also ask “what is the probability and magnitude of risk” or “what is best case, worst case, or what is “likely” impact” and “what is a reasonable worst case.” An experienced consultant should be able to identify impacts qualitatively as well as quantitatively. It will then be up to the user to assess their own risk with the consultant and make decisions about purchase, negotiation, pro forma issues, return, and legacy of the asset.