Earth to investors... Featured

8:00pm EDT August 29, 2006
Looking for a new office in the metro Detroit area? Want to purchase undeveloped property outside of town to build a facility? Whether you’re thinking about converting a strip-center space to accommodate your business or starting from scratch on barren land, a bank will ask you to investigate the property’s past before financing a real estate loan.

“You should do your homework on any commercial real estate you buy as a risk mitigation tool,” says Craig Johnson, president and CEO of Franklin Bank, Southfield, Mich. “You don’t want to realize later that there was a leaking tank under the property.”

Brand-new buildings and decadent landscape can cover up what lies beneath. Contaminants can leach into groundwater, contaminate soil and offgas into the environment without your knowledge.

Basically, ESAs protect anyone who enters into a real estate agreement. The borrower generally picks up a $1,500 to $2,000 tab for a Phase I study (Phase II tests can cost up to $5,000), but this investment serves as a type of insurance.

Environmental Site Assessments (ESA) are a matter of due diligence. “They alleviate risk for the banker and the borrower,” says Johnson. “Whether you are paying cash or acquiring property through a land contract or some other mechanism, you need to do your homework. Get advice from an environmental attorney, a reputable environmental consulting firm, or go to a bank and ask for recommendations.”

Smart Business asked Johnson to explain why even business owners who do not obtain bank financing for real estate should engage in ESAs.

Why do banks require ESAs?
If for some reason the borrower doesn’t pay back the loan and we have to foreclose on the property and become the owner, we want to make sure it is clean. The type of environmental study a bank will require depends on the loan size and known prior uses of the property. If it is vacant, residential land, we may only ask for a transaction screen. That is a database record search that reports who owned the property historically and whether there were underground tanks or documented environmental issues. If the screening is questionable, then we’ll ask for a Phase I and/or Phase II study.

What happens during a Phase I assessment?
Phase I tests are an assessment of the overall property. They involve physical site inspection and interviews with current and past land owners. An engineering firm or environmental consultant performs the assessment. They might review aerial photographs, maps and city directories, and agency records, including local fire, health, building and water quality. A visual survey will note any asbestos-, lead- and PCB-contaminated materials.

When must a borrower also obtain a Phase II study?
If the Phase I assessment identifies potential risks, the next step is a Phase II. Generally speaking, the Phase I won’t tell you what the problem is, it will just tell you there is a problem. Phase II digs deeper. The engineering firm will send out drill trucks to collect soil samples and analyze them for contaminates.

Can a business owner still purchase the property if it is contaminated?
Yes; the important part is that you disclose environmental information with the bank. For example, we worked with a dry cleaner that created environmental issues with regard to their cleaning solvent. Chemicals leached into the soil. We ordered an environmental consultant to review the property, and he gave us an estimate of how much it would cost to clean it up. We escrowed for this amount and closed on the loan.

Also, in Michigan there is a mechanism called a Baseline Environmental Assessment (BEA). A buyer can purchase a piece of land that contains known contaminants and be indemnified from any cleanup risks. BEAs allow for properties to transfer at full market value.

Say you wanted to purchase a former gas station site. The gas tanks were demolished and removed, but there was a leak. The buyer can get a BEA and buy the property knowing that he will not be liable for subsequent cleanup costs. Also, the government-sponsored BEA program allows the bank to be more comfortable with the buying and selling of properties that contain known contaminants.

Where can a business owner find a consultant to conduct ESAs?
Your bank can suggest several reputable engineering firms or environmental consultants. Banks align themselves with firms that provide true value.

CRAIG JOHNSON is president and CEO of Franklin Bank, Southfield, Mich. Reach him at (248) 386-9860 or clj@franklinbank.com.