Almost every commercial mortgage requires an environmental assessment. If you’ve never been through one, the process can seem mysterious and concerning.
Let me walk you through exactly what happens during environmental assessments, what they cost, and how to handle any issues that arise.
Why Lenders Require Environmental Assessments
Think about the lender’s risk. If they lend on a property with contaminated soil or groundwater, and the property goes into foreclosure, they could inherit environmental cleanup liability. Cleanup costs can exceed the property’s value.
Environmental due diligence protects lenders from taking on contaminated properties. It’s not optional—it’s a standard condition in virtually every commercial mortgage.
For you as the borrower, environmental assessment also protects you. You don’t want to buy contaminated property either. Finding issues before closing gives you options.
Phase I Environmental Site Assessment Explained
The Phase I ESA is the standard first level of environmental due diligence. It’s a document review and site inspection, not physical testing.
Document review: The consultant reviews historical records about the property including past uses, aerial photos, fire insurance maps, environmental databases, and regulatory filings. They’re looking for any past activities that might have caused contamination.
Site inspection: The consultant visits the property to observe current conditions. They look for evidence of contamination—staining, odors, unusual vegetation patterns, abandoned storage tanks, or industrial materials.
Interviews: They interview people familiar with the property—current owner, tenants, neighbors—to learn about historical uses and practices.
Report: All findings are compiled into a report that concludes whether Recognized Environmental Conditions (RECs) exist. RECs are potential sources of contamination that warrant further investigation.
Phase I assessments don’t include soil or water testing. They’re desk studies and visual inspections.
What Phase I Assessments Look For
Environmental consultants investigate several categories of potential contamination.
Petroleum products: Underground storage tanks (current or historical), above-ground tanks, oil spills, fuel storage areas. Petroleum contamination is common and can be expensive to clean up.
Hazardous materials: Asbestos in building materials, lead paint, PCBs in old electrical equipment, mercury, or other hazardous substances.
Industrial chemicals: Solvents, degreasers, paints, or chemicals from historical industrial use of the property.
Agricultural chemicals: Pesticides, herbicides, or fertilizer storage areas on farm properties.
Waste disposal: Evidence of historical waste dumping or burial of materials.
Neighboring properties: Contamination from adjacent properties can migrate onto yours through groundwater. Consultants investigate nearby land uses.
The goal is identifying anything that might have contaminated soil, groundwater, or building materials.
Timeline and Cost for Phase I
Phase I assessments typically take 2 to 3 weeks from assignment to report delivery. Sometimes faster for rush fees, sometimes slower if historical records are hard to obtain.
Costs range from $2,500 to $5,000 for typical commercial properties. Larger properties, more complex sites, or properties with extensive industrial history can cost more.
The lender usually orders the assessment and adds the cost to your closing costs or loan amount. Sometimes they require you to pay the consultant directly.
Budget for this cost in your purchase planning. It’s non-negotiable for most lenders.
Reading Your Phase I Report
When you receive the Phase I report, focus on the key sections.
Executive Summary: Typically the first few pages, summarizing findings and conclusions. This tells you quickly whether issues were identified.
Recognized Environmental Conditions (RECs): This section lists any potential contamination concerns. If it says “No RECs identified,” you’re in good shape. If RECs are listed, you need to understand what they are and what they mean.
Recommendations: What does the consultant recommend? Further investigation? Specialized assessments? Immediate action?
Detailed findings: The body of the report documents everything the consultant reviewed and observed. This supports their conclusions.
Most Phase I reports conclude with no significant concerns. Properties move forward to closing without environmental issues. But when RECs are identified, additional work is required.
Common Phase I Findings
Let me walk through typical issues that arise and what they mean.
Underground storage tanks (USTs): Active registered tanks typically aren’t major concerns if they’re in compliance. Abandoned or unregistered historical tanks are bigger problems. You might know nothing about a tank buried 50 years ago, but the Phase I might identify it through historical records.
Heating oil tanks: Many older commercial buildings had heating oil tanks. Some were removed properly, others abandoned in place. Abandoned tanks can leak and contaminate soil.
Asbestos in building materials: Buildings built before 1990 often contain asbestos in insulation, floor tiles, or roofing materials. If asbestos is intact and undisturbed, it’s generally not a problem. If it’s damaged or deteriorating, it requires management or removal.
Adjacent contaminated properties: If a neighboring property has known contamination (former gas station, dry cleaner, industrial facility), there’s risk it has migrated onto your property through groundwater.
Historical uses: If your property was previously a gas station, dry cleaner, auto repair shop, or industrial facility, there’s elevated risk of contamination even if the use ended years ago.
These findings don’t automatically kill deals, but they trigger additional investigation.
When Phase II Assessment Is Required
If the Phase I identifies RECs, lenders typically require a Phase II Environmental Site Assessment. This involves physical testing.
Soil sampling: Drilling test borings and collecting soil samples for laboratory analysis. Tests look for petroleum products, heavy metals, or industrial chemicals.
Groundwater sampling: Installing monitoring wells and collecting groundwater samples to test for contamination.
Building materials testing: Collecting samples of suspected asbestos-containing materials or lead paint for laboratory analysis.
Vapor intrusion assessment: If soil or groundwater contamination exists, testing for vapors migrating into buildings.
Phase II assessments are more expensive and time-consuming than Phase I. Costs typically range from $5,000 to $20,000 or more depending on the extent of investigation required.
Timeline is 3 to 6 weeks or longer depending on how many samples are needed and lab turnaround time.
Understanding Phase II Results
Phase II reports present laboratory results showing contaminant concentrations found in soil, water, or building materials. These are compared to regulatory standards.
Below standards: If contaminants are found but below regulatory limits, the property is typically considered acceptable. No remediation required.
Slightly above standards: Minor exceedances might require management (monitoring, institutional controls, disclosure) but not necessarily cleanup.
Significantly above standards: Major contamination requires remediation (cleanup) to bring levels into acceptable ranges.
The consultant’s recommendations section explains what’s required based on findings.
What Happens If Contamination Is Found
Discovering contamination doesn’t automatically kill your deal, but it creates decisions and negotiations.
Option one: Seller remediates. You can require the seller to clean up the contamination before closing. They pay for cleanup, you close once the property is clean. This protects you but can delay closing significantly.
Option two: Negotiate price reduction. If cleanup costs $50,000, you might negotiate a $50,000 price reduction and handle cleanup yourself after closing. This keeps the deal moving but creates work and risk for you.
Option three: Walk away. If contamination is severe or cleanup costs exceed the deal’s value, walking away might be smartest. Most purchase agreements have environmental conditions that let you back out if contamination is discovered.
Option four: Remediation with holdback. Seller begins cleanup before closing. At closing, funds are held back in trust to complete the work. This balances moving forward with protecting everyone.
The right approach depends on the severity of contamination, cleanup costs, and your risk tolerance.
Lender Perspectives on Environmental Issues
Lenders have different tolerance levels for environmental issues.
Zero tolerance: Most lenders won’t finance properties with active contamination requiring cleanup. They want clean properties or properties with managed issues.
Minor issues acceptable: Small amounts of asbestos in good condition, properly registered USTs, or minor historical issues that have been closed out by regulators are usually acceptable.
Institutional controls acceptable: Some lenders will finance properties with contamination that’s contained and managed through institutional controls (groundwater monitoring, deed restrictions, risk management plans) even if not fully cleaned up.
Case-by-case: Much depends on the specific lender, the specific issue, and the overall deal strength.
Understanding your lender’s position helps you evaluate whether discovered issues will kill financing.
Strategies to Minimize Environmental Risk
You can reduce the likelihood of environmental surprises.
Research before buying: Look up the property’s history. What was it used for? What were neighboring uses? Properties that have always been simple office or retail with no industrial history have lower environmental risk.
Ask the seller: Request any environmental reports the seller has. Many commercial properties have been assessed before. Review those reports for any past issues.
Drive the neighborhood: Look at surrounding properties. Gas stations, dry cleaners, automotive shops, industrial facilities nearby? These create higher risk.
Check regulatory databases: Provincial environmental databases list contaminated sites. Search for your property and surrounding areas.
Budget conservatively: Include environmental assessment costs and potential remediation in your budget. Don’t assume everything will be clean.
Managing Environmental Issues You Inherit
Sometimes you buy a property knowing it has managed environmental issues. This is workable if you plan properly.
Understand ongoing obligations: What monitoring, reporting, or management is required? What does it cost annually?
Get regulatory clearance: Ensure any historical contamination has been properly addressed and closed out with environmental regulators. Get documentation.
Maintain required programs: If the property requires ongoing groundwater monitoring or institutional controls, you must continue these. Factor the cost into your operating budget.
Plan for future: If contamination is being managed but not fully cleaned up, know what will eventually be required and budget accordingly.
Insurance considerations: Some insurers won’t cover properties with known contamination, or charge much higher premiums. Understand this before buying.
Managed environmental issues can be acceptable, but only if you fully understand and budget for them.
Asbestos: A Special Case
Asbestos deserves special mention because it’s so common in older commercial buildings.
Asbestos in good condition generally doesn’t trigger major concerns. It can remain in place if it’s not friable (crumbly) and isn’t being disturbed. Management plans document its location and condition.
Damaged or deteriorating asbestos requires removal or encapsulation. This can be expensive—sometimes tens or hundreds of thousands of dollars for large buildings.
Renovation triggers removal: If you plan significant renovations, you’ll need to remove asbestos from areas being renovated. Factor this into your renovation budget.
Most lenders are comfortable with asbestos-containing materials that are in good condition and properly managed. Active asbestos problems requiring immediate remediation are deal-killers.
Who Pays for Assessments
Typically the buyer pays for environmental assessments, either directly or through closing costs. This makes sense—you’re the one doing due diligence.
However, costs are sometimes negotiable. In seller-friendly markets, buyers pay. In buyer-friendly markets, sellers might cover assessment costs.
If Phase II is required because of seller’s historical use of the property, you might negotiate that the seller pays for it. But there’s no standard rule—it’s whatever you negotiate.
Timeline Impact on Your Transaction
Environmental assessments affect your closing timeline. Plan accordingly.
Phase I typically takes 2 to 3 weeks. Build this into your purchase agreement timelines. You can’t close until the lender receives and approves the Phase I.
If Phase II is required, add another 3 to 6 weeks minimum. Your closing might need to be extended.
If remediation is required, the timeline extends further—potentially months.
Build adequate time into your purchase agreements to accommodate environmental assessment. A 30-day closing is tight for commercial properties. 60 to 90 days is more realistic when including all due diligence.
Your Environmental Due Diligence Action Plan
When buying commercial property:
- Ask seller for any existing environmental reports
- Research property history and surrounding uses
- Expect Phase I to be required by your lender
- Budget $3,000 to $5,000 for Phase I
- Allow 3 weeks in your timeline for Phase I
- Review Phase I report carefully when received
- If Phase II is required, budget additional $10,000 to $20,000 and 4 to 6 weeks
- Evaluate Phase II results with environmental consultant and lender
- Negotiate remediation or price adjustment if contamination is found
- Only close when you’re comfortable with environmental status
Moving Forward
Environmental assessments are standard parts of commercial real estate transactions. Most properties have no significant issues and transactions proceed smoothly.
When issues arise, they create complications but usually not deal-killers. With proper evaluation, negotiation, and planning, environmental issues can be managed.
At Creek Road Financial Inc., we work with clients through environmental assessment processes regularly. We know which lenders are more flexible with environmental issues, how to evaluate Phase I and Phase II reports, and how to structure deals when contamination is discovered.
Environmental due diligence protects you from inheriting expensive environmental liabilities. Take it seriously, work with qualified environmental consultants, and don’t close on properties with unresolved environmental problems. Done right, environmental assessment is valuable protection, not just a hurdle to overcome.