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Top 8 Takeaways from the 2020 Winter Environmental Bankers Association Meeting

Emerging risk meets rising regulatory changes

I recently attended the Environmental Bankers Association winter conference in Phoenix, AZ. The EBA meetings, held twice per year, provide a platform to discuss environmental risk management, sustainable development lending information and technical expertise. This year, there was a renewed focus on emerging environmental risk, more stringent underwriting requirements, regulatory changes, and the collective impact on commercial real estate transactions.
 
Here are eight essential areas of interest to the commercial real estate industry, and what they portend for lenders and financial stakeholders over the coming year.

2020 CRE Market Forecast 
The US economy has experienced 127 consecutive months of growth. It is growing but less smoothly than in 2019. Industrial and hotel sectors were high performers. 2019 had a slow first quarter. The lending environment was highly competitive with and aggressive debt fund lender landscape There was a 27% increase CMBS lending over 2018 and non-bank lenders were big. With no major upsets in 2019, marker fundamentals were stable. 

In 2020, property prices will continue to rise and the trend of metro growth with continue. Lending indicators point to growth and low interest rates. Banks will hold the line on risk management with more rigorous underwriting standards based on the lack of good deals out there. Retail will see more store closings. In 2019, 9,300 stores closed. This outpaces openings 2:1. Big retailers are overleveraged. Re-use will be a continuing trend. Industrial will lead in 2020. Warehouses due to the online retail trend is driving this and development is going vertical in metro areas. 

Environmental, social and corporate governance (ESG) will be in the forefront of lending strategies. ESG recognizes that green performance is linked to value. Technology will be infused into CRE bring together multiple silos.  Use of space in CRE will matter. Tenants are far more demanding than ever.

Navigating Changes to California’s Vapor Intrusion Landscape
In 2019, the San Francisco Bay Regional Water Quality Control Board (SFB RWQCB) implemented a more conservative and consolidated vapor intrusion guidance that includes updated screening levels for soil vapor gas. The new screening levels are now being adopted by most California regulatory agencies, including the Department of Toxic Substances Control. These new screening levels reduce the order of magnitude for most contaminants in soil gas by an order of 15-30. Here is a table showing the most significant changes: 
 

SFB RWQBC Soil Vapor ESLs

 

Residential

Commercial

Contaminant

Old ESL

New ESL

Old ESL

New ESL

PCE

248

15

2100

87

TCE

248

16

3000

100

Benzene

248

3.2

420

14

 
 
These new ESLs are driven by attenuation factor (how subsurface vapors are reduced by a combination of movement through soil and the eventual dilution into air) and now are more closely aligned with the US Environmental Protection Agency’s datasets. The new ESLs are meant to be used in place of old modeling tools like the Johnson Ettinger (JE) modes and takes into consideration migration through subsurface conduits.
 
How does change approaches to Phase II ESAs? Likely, further sampling will be required, and any modeling conducted must be backed up by sampling. Prior assessments may be revisited and cases that received previous regulatory closure may be re-opened. There is more consideration for temporal (seasonal) variability. Bottom line – closure is a lot harder to achieve. The “once closed, always closed” mantra is not always applicable now. The new guidance does not specially mandate a reporting of ESL exceedances but other factors during an investigation may trigger a regulatory reporting requirement. 
How are lenders adjusting to the new ESLs? Some may be adjusting their risk tolerance to balance credit and reputational risk. In the absence of official closure, they are asking their vendors to get more data and are being consistent in the solutions they are applying. Lender’s anticipate seeing timing and cost increases due to these changes, challenges with explaining these changes to credit and getting training internally.
 
Challenges to Existing Infrastructure
This presentation on the interface of property condition assessments and moisture intrusion discussed how moisture intrusion issues and structural issues are closely related. If a building façade is compromised, for example falling or cracking brick, this can allow moisture to penetrate the walls and potentially corrode steal ties and beams. Expansion joints can often be impacted by moisture intrusion and in parking garages, traffic coatings can often fail. The take away here is that when evaluating the condition of a building, a qualified architect or engineer is key during the site visit – but work with a firm that has a robust industrial hygiene capabilities that can identify moisture intrusion issues in the field. The ability to assess these issues together is key.

Evaluating Seismic Risk – More Critical Than Ever
Why do an SRA? How much risk does an earthquake pose to a building asset? One of the first steps to determine seismic is identifying what seismic zone a building is in. The 1997 Seismic zone map was commonly used but the industry is moving away from this map and towards the USGS peak ground acceleration map (PGA). The PGA map is different from the 1997 map, less areas on the west coast are high risk and more on the Midwest and southeast are high risk.

There are two ASTM standards to evaluate seismic risk, E2026 and E2557, used to determine seismic risk. ASTM 2026 is a guide and 2557 is a practice. Using these two standards, there are dozens of ways to conduct an SRA and depending on what model is used, the reports can have different results. This can be confusing for the end user, so it is important to use the model that best fits the client’s needs and risk tolerance. Other things that can impact outcome is the information provided during the assessment such as plans, access, and amount of data. Its important to note the ASTM standard in not a methodology not a list of ingredients. The standard allows for 6-10 damage loss models with different loss estimates.

Also keep in mind building stability– will it remain stable in an earthquake? Building stability is particularly important to agencies like Freddie Mac which requires retrofitting if building stability issues are identified.

The High Cost of Low Quality: Following through on Quality Management Programs to Improve Quality
Lender and third-party reviewers considerations for a high-quality Phase I ESA include the following:
 
Close the loop on unanswered questions
Dig deeper into details
Think critically
Adequately describe on-site activities
Opine on risk.
 
As a lead in to the discussion of the commoditization of the Phase I ESA, lenders warn that low pricing directly impacts quality. When report writers are limited by tight budgets, the depth of investigation and quality of research can suffer.
 
Commoditization of the Phase I ESA
Commoditization of the Phase I ESA has been a hot topic in the commercial real estate industry for several years. The average price of a Phase I has only increased by $28 or 1% over the last five years while the cost of labor has significantly increased. Price is the only distinguishing factor of a commodity – this definition implies that the quality is the same regardless of price. However, this panel pointed out that Phase I quality seems to be decreasing with price pressure. How do we as an industry avoid this effect? Take an active role in educating your clients on value, implement effective internal training processes and take control of who is making the decisions on pricing.

What to Expect when Retrofitting an Existing Building Against Vapor Intrusion
When a vapor intrusion condition exists on a vacant property that is slated for redevelopment, the solution can often involve the installation of a vapor barrier system on the slab which can be installed during construction. This becomes a lot more complex when installing these systems on existing buildings. Challenges discussed include installation these systems in tight crawl spaces, existing residential areas, identifying preferential pathways such as trash chutes and sealing them, and determining thickness of barriers. This panel discussed how creative solutions can be implemented and how regulations vary from state to state.

EBA Journal Highlights
ASTM announces the publication of E3224 to incorporate building energy into property due diligence
The existing PCA standard (ASTM E2018) does not address building’s energy performance. The new standard will include collection of building and energy-consuming equipment information, weather normalizing the building’s baseline energy consumption, and determining if a building’s energy consumption meets, is greater than, or is less than energy consumption of peer buildings
Upcoming changes to ASTM E1527
Proposed substantive changes to the current E1527 standard include the addition or clarification of notable definitions including the Significant Data Gap, Historical and Controlled Recognized Conditions and AULs/Environmental Liens in Title Records. There has been some discussion of changing requirements for Site Visits and Interviews and historical research will likely be revised to be strengthened. Additionally, environmental professionals will be encouraged to document and explain how they arrived at the conclusion present in the report. 
PFAS are creeping into due diligence reports
PFAS is not currently a classified hazardous substance under CERCLA; however, the EPA recently issued an action plan in February 2019 which included the process for classifying two types of PFAS but it is not clear when the classification will be finalized. Some states are starting to regulate PFAS in due diligence reports such as New Jersey and New York. Evaluation of PFAS is still outside the scope of E1527-13 but 15 states have guidance or interim regulations related to PFAS. Currently it is the responsibility of the environmental professional to determine on a case by case basis what approach is the most appropriate for a Phase I.

For all of your due diligence needs, especially at this time of rising complexity, make sure to engage with a knowledgeable, experienced consultant who can provide multi-disciplinary services to ensure you limit liability and end up with a successful transaction.