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By Boyd Raveling

Vice President – Pioneer Engineering & Environmental Services

For better or worse, the disposition of troubled loans and distressed assets has become a key driver in the commercial real estate industry this year.  A large number of private equity funds have sprung up to take advantage of what are perceived to be unprecedented deals in the marketplace.  Additionally, as banks look to clear up their real estate portfolios, many brokers and attorneys have positioned themselves to become facilitators in the process by acting as receivers and specialty consultants.

Distressed real estate loans provide a plethora of challenges for those looking to manage those assets.  Property maintenance and upkeep are often paramount in the minds of distressed asset stakeholders.  Additionally, maintaining ideal levels of occupancy by retaining or attracting tenants is critical when marketing a property to the investor community.  However, one crucial aspect of managing a distressed real estate loan – and one that could potentially result in enormous fines and unnecessary costs – is frequently overlooked:  the environmental condition of the site.

Often, when an industrial property user defaults on a loan and vacates a site, the former tenant is negligent in regard to the handling of potentially hazardous materials and waste.  The last thing on the mind of a manufacturer going out of business is being a responsible steward to the environment, and the disposal of “special” (i.e. petroleum-based) wastes, and those that require handling as hazardous materials, can be costly and potentially compromise the success of a project.

In the last year, Pioneer Engineering & Environmental Services has been retained by a number of clients to provide consulting services and oversight for the removal of hazardous wastes at abandoned sites. It is not uncommon for a medium- to large-size industrial tenant that has gone bankrupt to leave numerous drums of chemicals on a site, creating an unsightly impediment to resale or reletting, not to mention costing tens of thousands of dollars for disposal.

Further, Pioneer has been involved in projects where the receiver has actually exasperated an environmental issue by improperly moving and handling drums.  Once the state or federal EPA becomes involved – and many times only due to anonymous complaints – it can result in serious fines and environmental liens to cover government-mandated removal actions.

Environmental hazards are not so easily identifiable by the presence of drums and other containers, in some instances.  For example, a wastewater treatment system that has been abandoned presents a unique set of challenges. What type of material remains on the site? Has any pre-treatment been performed to date? All of these are questions that must be answered before determining the proper disposal course. Rectifying outstanding violations with the local sanitary district or other regulating bodies is critical as well.  Additionally, abandoned industrial sites often have catch basins, oil/water separators (i.e. “triple traps”) and linear trench drains that contain materials which must be handled as special or hazardous waste.

The subsurface condition of a distressed asset and/or abandoned site is also something that must be addressed before one can determine its true value and marketability. In the boom years of the early 2000s, many banks or purchasers chose not to further investigate issues raised in the initial Phase I Environmental Site Assessment (ESA). In an effort to expeditiously close the deal, potential environmental concerns related to heavy industrial use, underground storage tanks or dumping activities were often addressed by the establishment of a relatively modest escrow account.  Additionally, potential environmental remediation costs were deemed negligible to the overall property value and not further assessed in many cases.

Worse yet, many lending institutions simply ignored their own environmental policies in recent years. For example, in 2009, Pioneer was approached by a now-defunct community bank to perform a subsurface investigation (i.e. “Phase II”) on a piece of commercial real estate. When a request was made for the Phase I Environmental Site Assessment, however, it was learned that none was performed at the time of loan origination.  “We were playing a little fast and loose with our environmental policies,” was the bank’s answer. “If the site had a little hair on it, usually things would even out with rising real estate values.” And what was the long-time use of the property?  A gasoline station!

Further, an inherent potential problem of the environmental policy at many banks is the use of loan amount in determining the level of due diligence completed.  Many lenders have traditionally not performed environmental assessments for commercial loans less than $500,000. In reality, a $100,000 to $200,000 environmental clean-up has relatively little impact on the overall value of a $20 million piece of real estate. But what happens when you find out that small convenience store site you’re foreclosing on was a gasoline station in its prior life?  The necessary costs to perform soil testing and even limited remediation activities could have a profound impact on its value.

The immediate future of commercial real estate values remains a topic of much debate, and many questions persist:  Have we seen the bottom? Is now the time to buy? What kind of impact will the impending maturity of small investor and

CMBS-backed loans have on the industry?  Only time will answer these questions.  However, opportunities will continue to arise for smart investors, and the thorough assessment of potential environmental issues will inevitably be a crucial component in determining a property’s worth.

Tags | Chicago, industrial, Pioneer Engineering & Environmental Services

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