When making a commercial real estate transaction, whether as buyer, borrower, or lender, you really need to do your research into the property’s current and past uses and potential environmental issues. Remember hard money loans are offered based on the value of the property. So, you want to look carefully at anything that affects the property value now and in the future.
This type of look around and document is called a “due diligence” assessment. As the purchaser or mortgage holder, you want to compile information and investigate the property you are interested in buying to make sure you are aware of any issues with the property that will affect your financial outcome. And, you want to do this before you buy.
Just as you would look for issues with the property’s title, such as judgments and liens, on the financial side; and on behalf of your future renters and buyers, check out the safety of the neighborhood at night; and again on their behalf, inspect the road for gargantuan pot holes that might eat their Prias or VWs; you also want to look at the property itself and at its current and past uses for your own sake to make sure you are not inheriting any costly environmental issues that you are not prepared for.
Cleanup Will Cost You
Environmental contamination, such as asbestos, PCB’s, radon, leaking underground storage tanks, mold, mildew, and lead-based paints on a property can cause the cost of “fixing” the property to explode so you want to be aware of these situations and prepare for them or walk away.
The official name for the investigation into environmental hazards and liabilities on a site is called a phase I environmental assessment. It determines in a methodical way if there is any environmental contamination or hazards in a building’s region or within the building itself. There are many professional firms out there that do this kind of work and one may have already been done on the property you are thinking about.
Get the History
The environmental site assessment typically addresses the history and current conditions of both the underlying land as well as physical improvements to the property. This assessment would scrutinize the land for soil contamination, the groundwater and surface water for contamination and quality.
It would look at the structure or structures on the property you are buying. Are there abandoned drums of unknown liquids or materials, an unlicensed dumping ground in the woods in back of the house, contaminated water wells nearby, or chemical residues, asbestos, mold, mildew, or other hazardous substances in the basement?
Abestos (tremolite) silky fibers, photo taken at the Natural History Museum in London by Aram Dulyan, public domain, Wikimedia commons.
The phase I environmental assessment would also evaluate if there are contamination risks on neighboring properties that might affect the value of the property you want to buy. Before you invest in the formal environmental assessment, you might want to do a little sleuthing yourself to see if you want to invest even that far You can start by performing some visual inspections and record searches yourself.
Walk around the neighborhood and take notes on what is nearby, within a half mile or a mile. Are there hazards or attractions in the vicinity?
Review Federal, State, Local, and Tribal records of the property using its GPS coordinates and review the records for properties up to a mile away.
Interview people who are knowledgeable about the property, for example, past owners, current owners, managers, tenants, neighbors.
Fires, Floods, Mud, and Spills
Examine municipal or county planning files to check for prior usage and permits granted and conduct file searches with public agencies, such as the fire department, state water board, county health department. Ask yourself, has a previous building on the site burned down? Why?
Examine historical and aerial photos for previous and current structures in the vicinity, like an old rail yard, military base, or gas station. It is a good idea and sometimes even fun to look at photos back to a time when there was only bare ground at the site.
Examine USGS maps and look at the drainage patterns and topography. We have seen enough in the news lately to make us aware of the dangers of floods, mudslides, fires, and hurricanes.
Where one of these has occurred, it is likely that another will follow sometime down the road. Ask yourself, has this property been flooded before or does it lie in a floodplain or an arroyo?
SBA and HUD
If you are considering lending money on a property, you might want to take into consideration the requirements of the US Small Business Administration’s 504 Fixed Asset Financing Program. It requires specific and often higher due diligence requirements than regular real estate transactions. These assessments are required for certain NAICS codes that associated with the prior business use of the property. There are 58 specific NAICS codes that require Phase I Investigations. These include, but are not limited to: funeral homes, dry cleaners, and gas stations. According to Wikipedia, “The SBA also requires a Phase II Environmental Site Assessment to be performed on any gas station that has been in operation for more than 5 years. The additional cost to perform this assessment cannot be included in the amount requested in the loan and adds significant costs to the borrower.”
The US Department of Housing and Urban Development also requires a Phase I ESA for any condominium under construction that wishes to offer an FHA insured loan to potential buyers.
Remediate or Remodel?
All of this detail is indeed not meant to scare you away from buying real estate to remodel and resell or to remodel and rent. It is only meant to make you aware. It is trendy and even admirable to consider buying old junked up industrial property down by the river or in the mining district and turning it into polished urban housing or shopping pavilions. If you have ambitions in this area, be sure to look around carefully, do your research, know your costs, and have money ready to remediate the site for you are probably looking at more than a quick remodel.
Disclaimer: I am not providing environmental advice or investment advice.