Prevailing Mindset Still One of Caution

Despite market improvements, the prevailing mindset is still one of caution as recovery in the commercial real estate market stumbles forward. This mentality manifests itself in the deal-making and loan origination spheres as a mindset of “What could go wrong with this property?” rather than “What could go right with it?” According to the latest quarterly survey of environmental professionals conducted by EDR Insight, lenders remain extremely risk averse in their environmental due diligence:

“Banks continue to fight for no environmental conditions at a property, regardless of the findings.”
“Lenders are definitely more risk averse.”
“Banks appear to be looking for reasons not to make loans.”

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Earlier this month, EDR hosted three Due Diligence at Dawn workshops in Los Angeles, San Francisco and Chicago: the 2nd, 3rd and 5th most active commercial real estate markets in the country respectively. Each program featured a panel of risk management professionals from local financial institutions of all sizes. At these events, the collective sentiments expressed by our panelists in three key areas were as follows:

The impact of the downturn on risk management:

The downturn has brought increased scrutiny by regulators to financial institutions. There is more emphasis on compliance issues. It has also brought the opportunity—good or bad—to revisit decisions made by lenders during the good times….to rethink their approach to due diligence. The downturn gave lenders the ability to test hypotheses on past risk decisions. It has also brought numerous real-life examples of the cost to remedy large and small environmental issues. What happens today that was not back in 2006 and 2007 is that loan closings are being delayed for environmental issues, simply because financial institutions are no longer willing to take on risk as they once were.

Vapor encroachment:

Vapor intrusion is not a new issue, but the attention being placed on it, mainly by regulators, attorneys and risk managers, is. The impact of vapor migration on a target property from offsite sources now receives much more scrutiny than it had in the past, and can become particularly cumbersome for a borrower who needs to address the potential risk. On multifamily properties, in particular, lenders have a very aggressive (i.e., risk averse) approach for vapor, given the potential for tenant lawsuits and owner liability due to potential vapor exposure. Some consultants today routinely incorporate a vapor migration screening into their Phase I environmental site assessment, and some do not. For lenders, it means it is crucial to determine upfront if the potential risk of vapor migration is part of the standard scope of work for a Phase I ESA or if it needs to be added.

Expectations for environmental professionals:

The lender panelists at DDD also shared valuable advice on how environmental consultants can best help them manage their risk exposure efficiently. Below are some of the responses:

  • “Help me manage expectations. I don’t want any surprises in the 11th hour about some environmental risk that may hold up the loan.”
  • “Connect the dots for me. Lay it all out on a platter and include conclusions in the Phase I ESA report that are clearly presented and logically substantiated.”
  • “Give me detailed reports so that those who are not familiar with the property (e.g., loan officer) can understand the logic behind the findings.”
  • “Communication on key information is the money!”

With the market still on shaky ground and the future of financial regulations and the Presidential election unknown, risk aversion is likely to remain high at least over the near term.

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NOTE TO READERS: EDR Insight wishes to sincerely thank the following environmental risk management professionals for contributing to our lender panels at the Chicago, Oakland and Irvine DDD events: Georgina Dannett, Jim King, Mary Clare Maxwell, Ed Morales, Jan Sheinson and Brian Walker.

We hope to see you at our Due Diligence at Dawn events in Dallas, Minneapolis and Newark next month.