Presentation Transcript

1. REAL ESTATE FINANCE Ninth Edition

   John P. Wiedemer and J. Keith Baker
2. Chapter 15 Environmental Issues
3. LEARNING OBJECTIVES At the conclusion of this chapter, students will be able to: • Understand the role of the Environmental Protection Agency in residential and commercial real estate development. • Describe the principal environmental problems faced by real estate developers, owners, and lenders. • Describe the types of liabilities for environment hazards, including the liabilities of parties that own a property when a hazard needs to be cleaned up versus those of an owner in “due course” who finds afterward that the real estate in question is on a hazardous site or, under a new definition, is considered a hazardous site works. • Understand how indoor air quality can affect the health of occupants and the value of real estate. • Explain the function of energy efficiency standards and their relationship to environmental laws.
4. Introduction Afairly recent requirement for loan qualification is an environmental site assessment. This is necessary due to the massive liabilities that can be assessed against an owner should environmental problems be discovered. Some environmental issues affect property; some can change its value, some limit usage, and some affect both value and usage. The one that harbors the greatest potential for liability is the cleanup of toxic waste sites as addressed under the Superfund Act. A further complication is that these problems are addressed by federal, state, and local laws, which can make compliance complicated. This kind of assessment is commonly required for commercial loans but not in such detail for home loans.
5. Environmental Assessments for Home Loans Home loans are distinguished from residential loans, as the latter includes multifamily properties. A broad exemption from liability for cleanup of toxic waste sites was granted home owners. The EPA stated that it would not hold home owners liable for cleanup costs unless that owner knowingly contaminated the property or failed to cooperate with the EPA in its cleanup efforts. Contaminants that may be found in homes such as leadbased paint, mold, and radon pose known health risks and are routinely evaluated by home inspectors and other professionals. Threats from pollution outside the home, such as groundwater and soil contamination are gaining increased attention in residential real estate.
6. Environmental Assessments for Commercial Loans Almost all commercial loan apps include an environmental assessment. This includes multifamily dwellings. The normal requirement is for a Phase I assessment. A properly completed Phase I assessment can offer a new owner an acceptable defense against claims for toxic waste cleanup costs. One problem with Phase I assessments is that critical problems, such as asbestos or lead-based paint, are not covered, as these dangers do not subject an owner to the same broad liabilities under Superfund. Efforts to overcome these limitations resulted in requirements for a site assessment intended to cover all environmental problems.
7. Environmental Requirements of the Secondary Market Afew commercial loans are moving into the secondary market. Fannie Mae and Freddie Mac require that certain environmental information be included with any loan eligible for purchase. Both rely on some added information derived from a property appraisal. Freddie Mac requires that an appraiser comment on any known environmental conditions. Freddie Mac also requires that an appraiser consider environmental factors in reaching a conclusion as to the property’s value. For multifamily loans, Fannie Mae requires its seller/servicers to perform an environmental assessment before submitting the loans. If the Phase I assessment indicates potential problems, a Phase II assessment is required(both discussed later).
8. Principal Environmental Problems Seven categories of laws and regulations most directly affect land value. 1. Laws concerned with the cleanup of toxic waste sites. 2. Laws addressing indoor air pollution. 3. Lead poisoning rules including lead-based paint in dwellings. 4. Regulations designed to protect wetlands areas. 5. The Endangered Species Act. 6. Laws and regulations governing underground storage tanks. 7. Electromagnetic forces.
9. Toxic Waste Sites Contamination can occur without visible evidence on the surface. The cost of cleanup is the responsibility of those who created the problem, plus any unfortunate purchaser who acquires the land. A landowner, unaware of and innocent of creating any contamination, is equally liable for cleanup as the party actually responsible. The burden normally falls to the party with the “deepest pockets,” almost regardless of responsibility. Much of the money spent on environmental problems has been consumed with litigation denying liability for any cleanup.
10. First Federal Action on Toxic Waste Sites Passage of the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA). Set up a Hazardous Waste Trust Fund, which became known as Superfund. CERCLA and subsequent legislation provide a federal regulatory mechanism to identify, investigate, evaluate, and clean up waste sites. They also authorize states and private parties to clean up contaminated sites and to seek reimbursement from the responsible parties. Implementation of CERCLA was assigned to the EPA.
11. Environmental Protection Agency (EPA) The EPA has defined over 700 hazardous materials and publishes this information in lists that are organized into three categories. The F-list (nonspecific source wastes). This list identifies wastes from common manufacturing and industrial processes, such as solvents. The K-list (source-specific wastes). Includes wastes from specific industries, such as petroleum refining or pesticide manufacturing. The P-list and the U-list (discarded commercial chemical products). Specific chemical products in an unused form. Some pesticides and pharmaceutical products become hazardous when discarded. CERCLA excludes petroleum and its derivatives, natural gas, mining wastes, cement kiln dust, and wastes generated from the combustion of coal & other fossil fuels as they were not cited in the Superfund Act.
12. Liability for Cleanup Costs Covers the release, or threatened release, of hazardous substances from a facility that causes response costs (investigating and testing) and remedial action (removal, neutralization, or containment). Responsibility for cleanup is strict, joint, and several. Strictliability means liable regardless of fault. Joint liability means that all the parties are liable together for all costs. Several liability means each party is singularly liable for all costs. Liability may be apportioned if there is a reasonable basis for doing so. There are no limits on the costs for which a party may be held liable. Liability for damages to natural resources is limited to $50 million!
13. Potentially Responsible Parties (PRP) The owner and operator of a vessel or a facility. Any person who at the time of disposal owned or operated any facility at which such hazardous substances were disposed of. Any person who by contract, agreement, or otherwise arranged for disposal or treatment, or arranged with a transporter for transport for disposal or treatment, of hazardous substances. Any person who accepted any hazardous substances for transport to disposal or treatment facilities, incineration vessels, or sites selected by such person, shall be liable for: All costs of removal or remedial action incurred by the U.S. government or a state. Any other necessary costs of response incurred by any other person.
14. Lender Liability CERCLA allows a lender some protection from liability under the secured creditor exemption. The intent is to permit lenders to make loans without being included as a responsible party should toxic waste cleanup become a problem. Afew court rulings placed cleanup liability on lenders if they have the “capacity to influence” a borrower’s business. The result has been much greater interest and diligence on the part of lenders to require environmental assessments on commercial loans.
15. Defenses to Cost Recovery Actions Achallenge to the quality of government evidence. Aclaim that liability is for events occurring prior to the law. A claim that the statute of limitations applies. An act of God. An act of war. The claim that the damage was caused by a third party with whom the defendant had no contractual relationship. A PRP may voluntarily perform cleanup work and file suit to recover some or all of the costs of such work.
16. Innocent Landowner Defense If the landowner makes an appropriate inquiryinto the previous ownership and usage of the property before taking title. This constitutes a due diligence assessment, also called a Phase I. The purpose is to ascertain if any prior use would indicate the presence of environmental contamination or hazardous substances. If an adequate inquiry is made and nothing of a hazardous nature is found, the buyer may be classed as an innocent landowner. This provides the landowner with a defense against future cleanup liability should contamination occur later through no fault of the owner. An innocent landowner purchased property without knowledge of contamination and “had no reason to know” of the contamination.
17. Phase I Environmental Assessments Phase Iincludes all of the following: Interviews with persons familiar with the property. Reviews of historical information. Searches for environmental cleanup liens against the property. Reviews of waste disposal and underground storage tank records. Reviews of hazardous waste records, including handling, generation, treatment, disposal, and spill records. Visual inspections of the site and adjoining properties. Discussion of specialized knowledge or experience of the defendant. An analysis of the relationship of the purchase price to the value of the property if the property were not contaminated. Review of commonly known or reasonably ascertainable information. An opinion on the likely presence of contamination at the property. A discussion of the degree of obviousness of the presence or likely presence of contamination at the property. An analysis of the ability to detect suspected contamination by appropriate follow-up investigation.
18. Phase II and Phase III Environmental Assessments If a Phase I assessment turns up indications of actual or potential contamination, a Phase II assessment will be required. The Superfund Act does not set specific requirements for Phase II. The purpose is to target those areas believed to be contaminated and includes the collection and chemical analysis of soil samples, surface, and groundwater samples as well as other relevant investigations. Phase III assessment essentially calls for a definition of the extent of contamination, determining the remedial action necessary, and the implementation of the most appropriate cleanup procedures.
19. Environmental Assessment Standards No federal standards define contamination, nor specify what authority might be qualified to make environmental assessments. A number of trade associations and other organizations have worked with the EPA to develop better standards for enforcement actions. There is a need to protect property and also to clarify more precisely what comprises a contributing cause that creates liability. Several major universities have developed degree programs to provide qualified professionals who will make more accurate assessments.
20. Leadership in Energy and Environmental Design (LEED) The U.S. Green Building Council (USGBC) provides top-quality educational programs on green design, construction, and operations. LEED is an internationally recognized third-party green building certification system. LEED professionals have obtained one of the six separate levels below. 1. LEED® Green Associate 2. LEED® AP Building Design 1 Construction 3. LEED® AP Homes 4. LEED® AP Interior Design & Construction 5. LEED® AP Neighborhood Development 6. LEED® AP Operations 1 Maintenance There are ratings systems and guidelines that match up with these six categories to allow buildings or communities to achieve LEED certification for energy use, lighting, water, and material use, as well as incorporating a variety of other sustainable strategies.
21. Leadership in Energy and Environmental Design (LEED) Savings As much as 50% reduction in energy costs, 40% reduction in water use, 70% reduction in solid waste, and 39% reduction in CO2 emissions. Productivity and Health Worker productivity is dramatically increased in a green building. Improvements in indoor air quality and day lighting improve worker health and make a building a place people want to live and work in.5 Green buildings provide a healthier indoor environment. Worker and student productivity can increase as much as 16% in a green building. Value According to the National Appraisal Institute, the value of a building increases by $20 for every $1 in energy savings. The value of green building is becoming clear to both builders and owners.
22. American Society for Testing of Materials’ Standards ASTM released voluntary standards for environmental assessments. The purpose is to measure what is meant by an “appropriate inquiry” under CERCLA’s requirements for an innocent landowner’s defense. ASTM has two methods: (1) a transaction screen process, and (2) a Phase I environmental site assessment. The transaction screen comprises a series of about 23 questions that examines a property’s history and may be sufficient for small commercial transactions prepared for low-risk properties only. The ASTM Phase I must be prepared by a professional and contains seven sections covering past and current use of the property, studies of the surrounding properties, identification of information sources, and conclusions as to whether or not further inquiry is indicated.
23. Other Environmental Risk Reduction Environmental Consultants A number of property appraisers are entering the field of environmental consulting. Their background in examining real property is helpful in making specific environmental assessments. However, the need for specialized training becomes obvious. Pollution Insurance The policies offer pollution coverage targeting low-risk operations, such as owners of office buildings, warehouses, and shopping centers. The cost for a property valued at $1 million would be an annual premium of $10,000 for a three-year policy providing $2 million in protection. Banker’s Environmental Risk Insurance Protects lenders when a loan goes into default and contamination is found on the property. The insurance either covers the cost of cleaning up the property or pays off the balance due on the loan.
24. Brownfields Program In many areas, land that has been contaminated lies untouched. Several approaches can return this contaminated land to use. In Texas, property owners can document their cleanup activities and, after inspection by state authorities, obtain a certificate that is placed on the property deed releasing future owners and lenders from liability. The EPA initiated a program to remove 25,000 sites from Superfund. This reduction in liability has brought dormant sites back to useful life. Lenders can conduct preloan activities, loan servicing activities, workout, reorganization, and foreclosure without becoming liable. Real estate professionals and developers should examine the tax-related benefits of this program.
25. Indoor Air Pollution Recent studies by the EPA have indicated that indoor air can be several times more polluted than outdoor air. EPA has estimated that half of all illnesses are directly attributable to the following seven types of indoor air pollution. 1. Formaldehyde gas 2. Asbestos used in building materials 3. Radon gas 4. Tobacco smoke 5. Biological pollutants such as bacteria, viruses, and fungi/mold 6. Volatile organic compounds 7. Combustion byproducts from wood, coal, or oil
26. Asbestos as Used in Building Materials Asbestos consists of naturally occurring mineral fibers found in rocks. For many years it has been added to such manufactured products as patching compounds, siding, roofing shingles, and vinyl floors. Asbestos strengthens material, provides thermal and acoustical insulation, and fireproofs material. Its only real disadvantage is that it can kill you! Asbestos can cause asbestosis, a disease that scars the lung tissues. It can also cause several different kinds of cancer in the lungs, esophagus, stomach, and intestines. Recent studies indicate that the real danger lies in so-called “loose” asbestos rather than that occurring in “hard” form.
27. Lead Poisoning Lead is a heavy, relatively soft, malleable, bluish-gray metal. It cannot be broken down or destroyed. Because of the ease with which it can be shaped, it has been used for centuries in the form of pipe and other building materials. More recently it has been alloyed for use as solder that can secure pipe joints and as a component of paint. Paint containing high levels of lead was found to be more durable and look fresher for a greater length of time. The damage from lead poisoning is most threatening to children in their formative years.
28. Lead-Based Paint Rule Owners of houses built before 1978must disclose to buyers or renters the presence of lead-based paint hazards. The disclosure must be attached to all contracts on pre 1978 homes. A pamphlet on lead must be distributed to potential buyers and renters. Buyers are allowed a ten-day period to conduct a lead paint inspection. Real estate agents are also responsible for compliance. The rule does not require lead paint testing, removal, or abatement. Nor does it invalidate leasing or sales contracts. Not covered are zero-bedroom units, leases for less than 100 days, housing for the elderly or handicapped (unless children live there), and foreclosure sales.
29. Wetlands Protection In years past, swampy, marshy, or water-saturated soils were thought a source of sickness—a breeding place for disease-bearing mosquitoes. But wetlands can help control flooding, filter out pollution, clean drinking water, and provide habitat for fish and other wildlife. The Clean Water Act introduced a permit system to control the discharge of any pollutant into waters of the United States. Wetlands is not a scientific term and lacks good definition. A wetland may be natural or man-made. If a wetland is disturbed, the result can be enforcement action including the assessment of administrative, civil, and/or criminal penalties.
30. Endangered Species The Endangered Species Act mandates that a protected species be determined by the “best scientific and commercial data available.” No standards exist and the agencies make their own determinations. Agencies require that economic consequences not be a consideration. The result has been a tremendous expansion of protected species. The act prohibits the killing or harassment of any listed species. Anyone can sue a landowner for violations. Similar to wetlands, the risk falls primarily on a land development. If a building permit is needed, the door may be opened to activists’ challenges.
31. Underground Storage Tanks The EPA estimates that 2 million USTs are covered by the regulations and 95% are used to store petroleum products. UST owners must provide precautions, including corrosion protection and leak detection by monthly monitoring or inventory control. Owners must provide tightness testing plus spill and overflow devices. Discovery of an UST always raises a warning flag. Insofar as lenders are concerned, USTs must be reported in a site assessment, which would become a loan application requirement. The assessment examines the possible presence of contamination surrounding the tank or tanks. If found, the assessment would call for further testing of the soil around and below the tanks.
32. Electromagnetic Forces Most environmental concerns are real and should always be considered when dealing with land and what may be built upon it. There is no doubt that some people profit from environmental scares. Whether EMF is mostly a scare tactic or a real concern is not clear. EMFs are silent, invisible and exist anywhere electrons zip through transmission lines or the innards of appliances. Thus far, no clear relationship has been established between the strength of an electromagnetic field and the incidence of cancer. The National Research Council, after three years of examining more than 500 studies, stated, “The current body of evidence does not show that exposure to these fields presents a human-health hazard.”
33. Energy-Efficient Buildings The secondary market recognizes the value of energy-efficient properties. Freddie Mac allows 2% to 4% higher qualification guidelines, while Fannie Mae and FHA allow 2% stretches for their qualifying ratios. The premise is that these properties will have lower utility expenses. The American Recovery and Reinvestment Act provides a number of energy efficiency and alternative energy generation tax incentives.
34. Conclusions Environmental problems escaped the nation’s attention for so many years that it will take time to define the true extent of contamination. The rush to prevent further damage and begin restoration has resulted in steps taken that have not always been effective. However, various environmental laws are undergoing review, and further improvements can be expected. An assortment of regulatory agencies has been seeking cooperative procedures to reduce the overlap of requirements. The problems are new, and they are serious, and landowners are at the forefront of managing their resolution.
35. Questions for Discussion Define an environmental site assessment. Discuss Fannie Mae/Freddie Mac environmental requirements as stated in their mortgage instruments. Explain the innocent landowner defense as defined by CERCLA. What is an ASTM transaction screen? Discuss the EPA’s asbestos-managing plan for building owners. What threat is considered the “new asbestos”? Where is lead most likely to be found in a household? Identify the criteria for determining existence of wetlands. What happens to land containing an endangered species habitat? Discuss a landowner’s rights in a regulatory taking of land. Explain the key liability issue that owners, investors, and lenders might face if they, their employees, or the public are harmed by environmental problems that they are responsible for creating or have been ordered to remove.