Updated December 2020.
Completing a Phase I Environmental Site Assessment (Phase I ESA) is a common requirement for commercial real estate transactions. Even so, jumping through more hoops can seem unnecessary when you’re trying to move forward with your business plans.
In this guide, we break down the requirement and help you better understand the Phase I ESA process.
Why do lenders require Phase I ESAs for commercial real estate transactions?
Every commercial real estate transaction poses risks, so savvy lenders evaluate several factors when considering a borrower. You’ll have to answer standard questions like:
- What’s your plan for the property?
- Do you have a steady cash flow?
- Have you purchased commercial real estate before?
But one question you might not be prepared to answer, let alone prove, is, “What’s the environmental condition of the property?” This is where a Phase I ESA comes in.
Why do lenders care about the environmental condition of commercial property?
Generally speaking, property owners are the liable party responsible for costs related to known or discovered environmental contamination on commercial properties. So why do lenders concern themselves? Environmental issues can lead to more significant problems — think mandated, large-scale remediation projects — that can have a severe impact on your cash flow and ability to pay your mortgage.
Imagine this scenario where you didn’t complete a Phase I before closing.
You find an old building that used to belong to a dry cleaner, and it’s a steal — you plan to turn the eyesore into a charming retail store that will liven up Main Street.
The paperwork goes through fine. You have a stellar credit rating, references, and a clear business plan to profit in less than a year.
You sign on the dotted line and close on the property.
A few weeks later, your general contractor asks if you have had the groundwater tested — they say since it was an old dry cleaner, there could potentially be some lingering contamination. You test the groundwater, and the results reveal that contamination levels are above applicable regulatory thresholds. State regulations require remediation, which puts a strain on your pocketbook.
You call your lender to see if you can defer a couple of payments to make sure your site gets cleaned up.
Yes, remediation is your direct responsibility. But collecting payment for loans is your lender’s. If you can’t pay, their bottom line is in jeopardy. If you default on your loan and enter foreclosure, all of that responsibility bounces right back to your lender.
Here’s the same example, but with a Phase I ESA completed before closing.
You find an old building that used to belong to a dry cleaner, and it’s a steal — you plan to turn the eyesore into a charming retail store that will liven up Main Street.
The paperwork goes through fine. You have a stellar credit rating, references, and a clear business plan to profit in less than a year.
Your bank says that closing is contingent on the results of a Phase I ESA.
You make a small investment to have an environmental consultant complete a Phase I ESA, and they say the property could pose some risk. They say that dry cleaners are considered high risk for environmental contamination, and it makes sense to proceed with a Phase II ESA, which generally involves environmental sample collection and laboratory analysis.
Results from the Phase II ESA come back, and you learn that the water and soil underneath the Main Street property are contaminated, and the property will require cleanup.
You have two choices. First, you could pursue the purchase of the contaminated property based on landowner liability protections obtained by conducting your CERCLA-compliant All Appropriate Inquiry (Phase I ESA).
Resource: State by state liability protections [PDF]
Alternatively, you can walk away from the transaction. Whichever choice you choose, both you and your lender are in a much better position to make an informed business decision.
This example illustrates how it’s in the best interest of both you and your lender to complete a Phase I for at-risk properties.
If your lender thinks your property could be a potentially risky investment, they’ll help understand the Phase I ESA process. Below are some of the points to be aware of.
What is a Phase I ESA?
A Phase I (ESA) is a non-intrusive, research-intensive property investigation — it’s like a background check for properties. Phase I ESAs must be conducted by a qualified environmental professional per American Society for Testing and Materials (ASTM) standards. Your lender likely has a list of pre-qualified consultants on speed dial.
To start, the environmental professional conducting the Phase I ESA will identify the past and current uses of the property to uncover any operations that could cause a release of hazardous substances and/or petroleum products to the environment. Your consultant will also investigate historical records, including fire insurance maps, aerial photos, topographic maps, and government records. Further, they will visually inspect the property and may speak to neighbors and past occupants/owners.
You’ll receive a report with all of the findings and suggested further actions, if applicable.
How much do Phase I ESAs cost?
Phase I ESAs range anywhere from $1,500 to $5,000. The price depends on factors such as location, size of the property, and potential for contamination. These assessments are sound investments — environmental remediation activities can cost thousands of dollars more than an ESA. It’s more cost-effective to be proactive.
How long will a Phase I ESA take?
In a perfect world, every Phase I ESA would take 14 days or fewer, but that’s not always the case. Straightforward Phase I ESAs can take just a few days, while more complicated ones can take a month or longer. It all depends on several factors,including:
- The consultant’s schedule
- Property location
- Historical document availability
How long are Phase I ESAs valid for?
Phase I ESAs expire because, sooner or later, the results won’t necessarily be an accurate representation of the current state of the property. Old reports are just that — old reports.
As such, you cannot use a report completed over a year ago to represent how the property stands at the time of purchase.
Here’s the Phase I ESA validity breakdown, according to ASTM standards. If your Phase I ESA has been completed:
- Fewer than 180 days prior to property acquisition, it is valid.
- Between 180 and 365 days prior to property acquisition, it needs to be renewed.
- Over 365 days prior to property acquisition, it is invalid.
In other words, the closer to property acquisition you can have your Phase I completed, the better off you’ll be.
What happens after my Phase I ESA report arrives?
There are two primary outcomes of Phase I ESAs.
- The environmental consultant didn’t identify any current or potential sources of environmental contamination.
- The environmental consultants identified some current or potential sources of environmental contamination, and further action (e.g., water/soil/soil vapor sampling — a Phase II ESA) is recommended.
When Phase I ESAs reveal unexpected environmental issues, it’s not unheard of for purchasers to back out of the transaction. If you decide to continue with a purchase despite unfavorable Phase I ESA results, keep in mind that your lender may rework the loan conditions.
Environmental due diligence: Beyond Phase I ESAs
A Phase I ESA report can include historical information and conclusions such as:
- In 1955, a gas station was built on this property. In 1985, it was torn down and a dry cleaner was built in its place.
- The potential for environmental impacts does exist on this property due to past uses. Groundwater and soil testing are recommended.
Depending on your situation, you can continue due diligence which may include the previously mentioned Phase II ESA. And potentially, you may need to investigate the property further to define your obligations as a landowner of a contaminated property.
If you have questions about Phase I ESAs or environmental due diligence, contact us today.