Why do I need a Phase I Environmental Site Assessment?

I’ve seen this question come up on BiggerPockets, why do I need to do a Phase I Environmental Site Assessment (ESA)?

The technical answer is you do a Phase I ESA because you want to qualify for one or more of the Landowner Liability Protections (LLPs) listed in the federal Comprehensive Environmental Response, Compensation and Liability Act (CERCLA). The follow up to that is usually, what the heck does that mean? I’m not a lawyer so for more details you can discuss with your attorney; however, the quick and short of it is performing all appropriate inquiry (AAI) prior to acquiring real estate (or prior to entering into a lease) can provide evidence in defense of potential liability associated with past spills/releases of petroleum or hazardous substances. The AAI is accomplished by following a specific and standardized protocol, typically the ASTM Standard Practice E1527-13. In other words, if the Phase I ESA is done properly it may be a key component to your legal defense against liability from past pollution. Again, I’m not a lawyer, but from what I understand CERCLA liability (and equivalent state legislation) is not determined solely based on who caused the pollution, it can reach out to anyone who has an interest in the property, including current and past owners, lenders, investors, etc. (I believe they call this joint and several liability). Basically, this means that one party that has some liability could be liable for the full extent of the damages. Think about a past owner who is now a dissolved entity or bankrupt corporation, if they have no assets then your entity would be fully responsible for costs associated with their past pollution. In other words, by purchasing land without a defensible Phase I ESA you could be purchasing the liability for whatever has happened on that land in the past as it could relate to petroleum or hazardous substances. Therefore, reason number one is to protect your asset, but there is more to it than just liability protection for you. In addition to protecting you or your legal entity when buying a property, a Phase I ESA may be required by your lender or investor(s) to protect their interests in the asset since they don’t want to get involved in a situation where the prior owners and your entity go bankrupt and they’re holding a lien on an asset that is worth less than the remaining costs of a cleanup. Likewise, if you’re operating a lending or investment fund (think private money lending) you’re going to want a Phase I ESA to protect your entity in any deals you fund (as recommended by your attorney).

The second point I’ll make on this is something an investor should be considering from the start (begin with the end in mind), who will I be renting this property to and what will they want? A commercial property is typically leased to another business who will have their own interests in mind when selecting a property to lease. In addition to protecting your asset and lenders/investors, a Phase I ESA can be an important component of marketing your property for lease. Other businesses are less likely to want to rent/lease space where there is potential for their employees to be affected by past releases of petroleum or hazardous substances or where they may be held potentially liable for past releases/spills. These potential lessees (if they are wise) may request to perform a Phase I ESA prior to entering into a lease on your property. Think about it from their perspective, if they’ll be using hazardous substances or petroleum as part of their operations they will want to be able to defend themselves from liability for past spills/releases that may appear similar to a spill they cause during their lease. If you didn’t perform a Phase I ESA prior to purchasing the property you could be liable for what they find. Therefore, it’s best to stay in front of these sorts of issues and know as much as you can prior to purchasing the property. The last thing you want to purchase is a cheap property you know little to nothing about that has a murky environmental history (think old mill building or defunct shopping plaza) that has more environmental liability than it’s worth and that nobody wants to rent from you. That is the type of situation that ends up with a building that is fenced off and boarded up and in disrepair, turning a potential fix and flip diamond in the rough into a brownfield nightmare.

Considering each of these reasons is an important part of your due diligence activities that should be completed prior to purchasing real estate. There are many options when retaining an environmental professional to perform a Phase I ESA and a wide range of costs. Considering the risks and liabilities involved it is prudent to fully understand the qualifications of the company you’ve selected (is the cheapest option the best option?). The usefulness of your Phase I ESA may be limited by the qualifications of the person(s) performing it. In other words, if a future buyer, renter or state/federal regulator obtains information that was not obtained or not adequately evaluated in your original Phase I ESA it could identify a past spill/release of petroleum or hazardous substances that you were not aware of and could be held liable for. Therefore, it is in your best interest to have a suitable Phase I ESA prepared by a well-qualified environmental professional prior to purchasing real estate.