Environmental Risk
Management and Best
Practices for Lenders and
Appraisers
2014 Appraisal Institute Annual
Meeting
August 5, 2014
1
Current Trends in Lending/Financing of Commercial
Real Estate
• Pressure from regulators
• New ASTM Standard for Phase I’s
• New Transaction Screen Assessment (TSA) Standard
• SBA Lending
• Lenders updating environmental/appraisal policies
• More levels/forms of due diligence than ever before on more loans
• Seems to be a big push in the CRE market again…
2
How Environmental Issues Often Seem
Environmental & Appraisals
Types of Contamination
 Building Contamination

E.g., asbestos, lead paint, radon, formaldehyde

Encapsulate, Enclosure, Removal
 Soil & Groundwater Contamination

E.g., hydrocarbons, solvents

Phase I (initial review) through III (remediation)
Appraiser Poll
Question:
Are environmental issues typically not looked at
because of ignorance or apathy?
Response:
We don’t know and we don’t care…
7
Comments from LinkedIn by Appraisers
I agree that hardly anyone outside the appraisal world reads USPAP. That
includes AMC's and Lender's that often make requests to appraisers which
are not compliant with USPAP. This leads to both appraiser and lender
frustration.
If USPAP is the governing document for appraisers, you would think at a
minimum that underwriters would be required to understand the document.
I dread taking the refresher every 2 years. It's definitely the most boring CE class. It
usually turns into 8 hours of complaining about the profession.
What is USPAP? Does any lender really care about USPAP anymore? Basically,
lender guidelines appear to always over rule USPAP.
Professor Warren, your last comment it sooooo true. We all need to wake up to what is really happening vs
debating appraisal methods among ourselves, as if the typical big boy lenders really care about appraisal
methods or quality.
That being said, it seems a bit ridiculous that we create and enforce rules that many lenders could care less
about.
Comments from LinkedIn by Environmental
Consultants
• You will always have a problem until lenders start rejecting sub-standard
Phase I ESA's. When lenders are accepting Phase I's that have zero
historical research and records reviews that cost $1200 and were done in
five days, it will not matter who does the site visit.
• Unfortunately, a significant part of the industry has a product mentality
rather than one of service. The result is a business solely driven by price,
thus tempting the industry shortcomings.
Professor Warren, your last comment it sooooo true. We all need to wake up to what is really happening vs
debating appraisal methods among ourselves, as if the typical big boy lenders really care about appraisal
methods or quality.
That being said, it seems a bit ridiculous that we create and enforce rules that many lenders could care less
about.
Appraisal Institute Survey - 2013
CRE Appraiser Concerns
 Fee pressure & expanding scope of work
 Formulary approach (forms, checklists, ratios, indices)
gaining more prominence
 Greater liability
 Increasing barriers to direct communication with lenders
resulting in appraisal report acceptance and/or perceived
report quality issues
 Over regulation of appraisal profession
11
Concerns of Appraiser Clients
 Long turnaround times
 Cost of appraisals
 Misunderstandings concerning the scope of work in
engagement letters
 Compliance with standards/regulation
 Sufficiently supported value conclusions
 Quality work product
 Shortage of qualified appraisers
 Concise valuations (do not want lengthy reports)
12
Hottest Topics for Staff Appraisers




Inadequate market analyses
Appraisal compliance with bank regulations
Not recognizing or appreciating clients’ needs
Insufficient details on market conditions and trends
affecting real property
 Going concern valuations (different methodologies
causing confusion)
 Reluctance to interact with client out of fear of
violating appraiser/client “firewall”
13
Appraiser Challenges
Take Aways




Communication Breakdowns
Tough and uncertain regulatory environment
Unsatisfied clients and frustrated service providers
Clear need (and opportunity) to bridge the gap
15
Challenges that Appraisers Face
• Challenges
– Pressure on bank appraisal/environmental
departments
– Cost to cure calculations
– Not all appraisers are competent to assess
environmental impacts (might have to call one in)
– Bidding process – appraisers would need to know this
upfront because the as-is impaired is a different kind
of assignment
– Potential project delay/cost increase
Lenders’ Reaction to Environmental Issues…
Issues Important to Lenders
• Collateral Devaluation
• Direct Liability - Loan origination to foreclosure
• Reputational Risk (Brand and Image)
• Operational & Enterprise Risk
• Credit & Trust Risk
•…but at the end of the day, the primary
issue for lenders is Business Risk
Key Changes to Phase I’s - 2013
Who Qualifies as an
Environmental Professional?
Professional/Educational
Qualifications
Relevant
Experience
Professional engineer or professional
geologist license/registration
3 years
Federal or state license/certification to
perform environmental inquiries
3 years
B.A./B.S. degree or higher in any
science or engineering field
5 years
No B.A./B.S. degree
10 years
Page 22
New: HREC Split
Redefined Historical Recognized Environmental Condition
•
•
•
Past releases addressed to unrestricted residential use
Must consider current regulatory framework (rules change)
HRECs are not RECs
Created new Controlled Recognized Environmental Condition term
•
•
Past releases addressed to non-residential standard, subject to some type of
control
CRECs are RECs and must be included in the conclusions section of the
report
de minimis” CAN be used to describe an HREC
de minimis” CAN NOT be used to describe a CREC
Agency File/Records Reviews
• Clients thought it was already being done
• Consistency needed
• New language:
• Should be conducted for property and adjoining properties
• If not conducted, explain why
• Alternate sources ok
Vapor
 E1527 has been silent on vapor
 EPA recommended the task group not ignore
the vapor pathway
 2013 revision acknowledges the vapor
pathway in “migration” definition
 Clarifies “Indoor Air” non-scope
Vapor Intrusion
Recommendations
 Task group split about 50/50
 Ultimately agreed that:

Recommendations are not required by the standard.

User should consider whether recommendations are desired.

Recommendations are an additional service

REALLY??
Regulators Are Now Talking About Environmental
http://www.occ.gov/publications/publications-bytype/comptrollers-handbook/cre.pdf
NCUA Environmental Guidance
FDIC Highlights
• FDIC emphasizes process and consistency.
• Training
• Policies and Procedures should be established;
• Environmental Risk Analysis should be conducted;
• Document due diligence;
• Track changes to policy and consistent application of policy.
• Monitoring
• Lenders must avoid “participating in management” of the business
and thereby assuming liability under CERCLA.
• Most attorneys recommend a Phase I ESA in the event of
foreclosure.
OCC Updates
• Develop policies and procedures that reflect potential
environmental risks associated with lending
• Provide for receipt and evaluation of environmental reports
prior to making final commitment.
• Ensure that persons responsible for evaluating
environmental risk possess relevant knowledge, skill and
competence.
• A bank’s policy should reflect the EPA’s AAI rule.
OCC Updates
• The policy should include:
• Analysis of current laws and due diligence requirements;
• A level of due diligence internally required on all real
estate transactions
• Risk thresholds based on property type, use and loan amount
for determining when and what type of due diligence is used;
• Varying due diligence methods depending on the type of
loan, the loan amount and the risk category, including
questionnaire or screening, site visit, government
records review, historical records review, etc.
OCC Updates
• The policy should include:
• The potential for impacts from asbestos and lead based
paint;
• Appraisal requirements for disclosing and taking into
consideration any environmental risk factors;
• Criteria for evaluating environmental risk factors and
costs in the loan approval process;
• Criteria for evaluating environmental risk factors and
costs in the loan approval process;
• Environmental documentation for commitment letters,
reps and warranty, etc.
• A means of evaluating potential environmental
liabilities for foreclosures.
Small Business Administration Update
• SBA updated its Environmental Policy
• Effective August 1, 2008 and updated six times since
(most recently in January 2014).
• Especially important for institutions with preferred
status who do SBA underwriting.
• 7A and 504 lenders must adhere to this policy.
• Has become default policy for many lenders.
SBA Environmental Due Diligence Policy
2 levels of Environmental Due Diligence for SBA
1. Phase I – for high risk properties
•
If property type/use matches the list of NAICS codes for
Environmentally Sensitive Conditions
2. Records Search with Risk Assessment – low risk properties
•
•
Includes a search of the government databases (compliant with AAI);
•
A search of historical use records, and;
•
A risk assessment by an environmental professional determining
whether the site is “High”, “Elevated” or “Low” risk
New Gas Station/Dry Cleaner Requirements
Sample SBA Policy Matrix
Minimum Due Diligence Requirements
Real Estate Loan
Type
Low Risk Loans
High Risk* Loans –
NAICS Codes
Gas Station
Dry Cleaners
Dry Cleaner (older than 5
years old)
Special Use Facilities
(i.e. Daycare)
<$150K
$150K < $5MM
Questionnaire
RSRA/TSA
Phase I
Phase I
Phase I + Evidence of UST
Compliance
Phase I + Evidence of UST
Compliance
Phase I
Phase I
Phase I and Phase II
Phase I and Phase II
More specific requirements (i.e.
Lead Paint Testing, Lead in
Drinking Water, etc)
More specific requirements (i.e.
Lead Paint Testing, Lead in
Drinking Water, etc)
Dry Cleaners
The Trouble with Dry Cleaners
Size has Mattered (but that doesn’t have
to be the case)
Regional & National Lenders
•
Resources in place to understand environmental issues on the property
• Screen all loans by an EP
• Have staff/internal resources to manage environmental risk
Credit Unions/Regional & Community Banks
•
No on-staff environmental expertise (typically)
•
Not as sophisticated with regard to environmental issues or due diligence
options available
•
Often rely only on environmental questionnaires and/or proceed without
accurate knowledge of environmental condition of property
•
Rely on external guidance to dictate their practices
Environmental Due Diligence Options
•
•
•
•
•
•
•
•
•
Environmental questionnaire (EQ)
Desktop due diligence (various levels)
Transaction Screen Assessment (TSA)
Phase I Environmental Site Assessments
Phase II, III, Remediation, etc.
Storm water Issues
Sustainability/Green Issues
Environmental Insurance
Others
Policy Matrix
Minimum Due Diligence Requirements
Real Estate Loan
Type
<$250K
$250K < $1M
>$1M
Questionnaire/Desktop
Desktop/Transaction
Screen
Phase I
Phase I/Transaction
Screen
Phase I/Transaction
Screen
Phase I
Renewals -Low
Risk
Questionnaire/Desktop
Questionnaire/Desktop
Questionnaire/Desktop
Renewals -High
Risk
Questionnaire/Desktop
Questionnaire/Desktop
Desktop/Transaction
Screen
Multi-Family
Questionnaire/Desktop
Desktop/Transaction
Screen
Desktop/Transaction
Screen
Outdated Phase I
Questionnaire/Desktop
Questionnaire/Desktop
Desktop/Phase I update
Low Risk Loan new
High Risk* Loans new
Page 43
Common Commercial Issues
• USTs
• Gas Stations
• Fuel Oil Tanks
• Spills
• Storage/disposal of
Hazardous Waste
• Vapor Intrusion
• Mold
• Dry Cleaners
• Lead, asbestos
• Radon
• Storm water Runoff
• Superfund
What the Seller Sees
What the Buyer/Lender Should See
48
Best Practices/Takeaways
 Create and follow environmental policies and procedures;
 Use commitment fees from borrowers to cover the costs of the due
diligence;
 At a minimum, obtain an environmental questionnaire and some
form of government environmental records for each commercial
transaction;
 Different types of properties require different levels of due diligence;
 Start the process as early as possible to allow enough time for
evaluation and follow-up work that may be required.
 Work with a company or expert that has experience in this area and
consider outsourcing the review process similar to other functions
that are not “core-competencies” of the bank .
Summary
• Lenders have unique processes and reasons for conducting
due diligence.
• Market pressures have reinforced long-term trend to increased
due diligence.
• Regulators enforcing risk management due to a perceived
over-concentration of risk regarding commercial real state.
• Risk Management (Credit, Collateral, Environmental, etc.) is as
critical as ever to lenders.
• Environmental and appraisals are both pieces of the puzzle
that are being revised under the current environment.
How Much and How Long??
Upcoming EBA Meetings
January 2015 – Charleston, SC
June 2015 –
Denver, CO
January 2016 – Long Beach, CA
June 2016 –
Fort Worth, TX
Convergence of Appraisal and
Environmental Services within
Financial Institutions
Eric Schwartz, MAI, SRA
Chief Appraiser
Appraisal Review Department
Amegy Bank of Texas
August 2014
Disclaimer: The opinions expressed are solely those of the author and are not
necessarily the opinions of the management or employees of Amegy Bank.
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Management of Environmental Services
Vendor Pool
 Qualifications – Who is “qualified”?
Professional Credentials
 Geographic competency
 Property competency

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Management of Environmental Services
Database Management
 In-house

Pros



Easily tailored to individual requirements
Use of existing resources
Customizable
Integration into other databases
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Management of Environmental Services
Database Management
 In-house (continued)

Cons:



Reallocation of limited resources
Functional requirements may not be understood by staff
ASTM standards may seem “foreign” to appraisers/reviewers
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Management of Environmental Services
On-line database management tools
 Real Estate Management Information Service – (eg.
RIMS)

Web based project management system




Procurement and tracking
Vendor management
Performance
Pros:



Reasonably low cost
Automated credential monitoring
Secure report upload/download/storage
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Management of Environmental Services
Features to look for:






Online service request
Ease of interface for vendor and management
Automated task and project tracking
Vendor Performance reports
Contact database management system
24/7 accessibility
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Management of Environmental Services
Synergies of task types
 Appraisals and environmental reports must be tied to the same
project. Requires a hierarchical management system similar to:

Project
 Task
• External
• Internal
 Reporting
• External
• Internal
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Management of Environmental Services
Environmental due diligence
•
Least stringent to most stringent
Environmental Questionnaire
 Desktop Due Diligence/Screening
 ASTM Transaction Screen
 AAI/ASTM Phase I ESA
 Phase I “Plus”

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Management of Environmental Services
Bank personnel and appraisers should possess some
level of competency with:
 ASTM E-1527-13: Standard Practice for Environmental
Site Assessments: Phase I Environmental Site
Assessment Process (known as ESA)
 ASTM E-1528-14: Standard Practice for Environmental
Site Assessments: Transaction Screen Process
• Reference: www.astm.org
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Management of Environmental Services
•Process Management
 Within the appraisal/real estate unit?
Maintain database of appropriate service providers
 Understand qualifications of service providers
 Internal reviews of Desktop Reports, Transaction Screens, and
Phase I


Recommendations may need to be outsourced to qualified
environmental experts/attorneys
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Management of Environmental Services
The appraiser’s role
 Eyes, ears and nose of the lender
Recognize your limitations
 You are likely not an environmental professional, but…
 Tell us what you see/smell and hear (the contact say)
 Why?.....................

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Management of Environmental Services
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Management of Environmental Services
Tell the client what you observed. If you don’t tell
the client early the assignment process, you might
get a reaction like the following from the Chief
Appraiser.
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Management of Environmental Services
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Management of Environmental Services
Some banks ask you to note if you observed any
of the following:





Storage tanks
Collection Sites
Drums/containers and/or pesticides/chemicals
Asbestos
Miscellaneous




Soil contamination
Water leaks
Water damage
Mold
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Management of Environmental Services
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Management of Environmental Services
Scope of Work - The appraiser is to contact the Client in cases of extraordinary
assignment or limitations (e.g., restricted subject access, lack of lease information for
known key tenants, discovery of significant environmental impairment, etc.) to
consider possible adjustments to the scope of work. In such cases, while the bank
account officer’s input may be useful, adjustments to the scope of work for any appraisal
assignment must approved by the Client.
Environmental Issues - It is recognized that appraisers are not qualified to detect
hazardous waste and toxic materials. Moreover, it is recognized that any comments
made that may suggest the possibility of the presence of such substance is not
confirmation of the presence of hazardous waste and/or toxic materials. Such
determination would require investigation by a qualified expert in the field of
environmental assessment. The appraiser observation is important in revealing the
possibility of “red flag” environmental situations or conditions. For this reason, the
appraiser is required to complete the Environmental Site Inspection form.
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Management of Environmental Services
•
Appraisal Institute Guide Note 6: Consideration of
Hazardous Substances in the Appraisal Process
•
Guide notes are not part of the standards of professional
practice but instead provide guidance on how the
standards may apply to specific issues.
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Management of Environmental Services
Highlights of Guide Note 6
 Explains the differences between the existence of
hazardous substance(s) and environmental
contamination;
 Consideration of the Competency Rule and Scope
of Work Rule
 Extraordinary assumptions and hypothetical
conditions
 Definitions
 Basis of proper valuation
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Management of Environmental Services
 Guide Note 6-Consideration of environmental
conditions along with social, economic and
governmental conditions is fundamental to the
appraisal of real property. (Introduction to Guide Note
6).
 Need for special consideration to the impact of
hazardous substance on the valuation of real property.
 Hazardous substances are considered environmental
contamination when their concentrations exceed
appropriate regulatory standards. (see definitions in
GN6)
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Management of Environmental Services
Guide Note 6- Competency
•
Competency rule in USPAP



Properly identify the problem to be addressed and
have the knowledge and experience necessary to
complete the assignment; or
Disclose the appraiser’s lack of knowledge or
experience to the client before accepting the
assignment….take all steps necessary…and
describe the steps take; or
Withdraw from the assignment
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Management of Environmental Services
Guide Note 6- Competency (continued)
•
•
If the assignment calls for the appraiser to take into
account the effects on value of hazardous substances,
most appraisers rely on other professionals for
assistance.
If the appraiser lacks the knowledge and expertise they
have to disclose that lack of knowledge and experience
prior to the acceptance of the assignment.
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Management of Environmental
Services
Guide Note 6 – Scope of Work
•
•
•
How and to what extent the appraisal problem will
address known or suspected hazardous materials that
may impact the property.
Assignment conditions cannot limit the scope of work
such that the assignment results are not credible for the
intended use.
Cannot allow the client’s objectives or the intended use
to cause assignment results to be biased.
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Management of Environmental Services
Guide Note 6 – Extraordinary Assumptions and
Hypothetical Conditions
•
•
Extraordinary assumptions would be employed when
you are relying on the work of others.
Hypothetical conditions are used when the appraiser
estimates the value of the property known to be
contaminated in an unimpaired or uncontaminated
condition.
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Management of Environmental Services
Guide Note 6 – Basis for Property Valuation
•
•
•
Impaired value – The “as is” value of the property
Unimpaired value – The market value developed of the
contaminated property employing a hypothetical
condition the property is not contaminated
Diminution of value – Effects of costs to remediate plus
use costs plus risk (stigma too).
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Management of Environmental Services
What’s the appraiser to do?
 If you see it….report it.
Call the client/email the client
 Take photos and send them to the client
 Write it up in your report/Put it in the letter of transmittal
 Calculate diminution in value if appropriate
 Employ a hypothetical condition or extraordinary assumption if
appropriate
 Ensure your results are credible

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Management of Environmental Services
What steps would you take if you saw this during
the property inspection?
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Management of Environmental Services
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Management of Environmental Services
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Management of Environmental Services
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Management of Environmental Services
Management of Environmental Services
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Appraisal Report Language
•
Ace Appraisal Services is not qualified to detect the existence of potentially hazardous material or
underground storage tanks (USTs) which may be present or, or near, the subject site. The
existence of hazardous materials or USTs may affect the value and marketability of the subject
property. For the purposes of this appraisal assignment, Ace Appraisal Services has assumed that
the subject property is not affected by hazardous materials which may be present on or in proximity
to the subject property.
•
Unless otherwise stated in this report, any value conclusions are predicated on the assumption
that the subject property is free of contamination, environmental impairment or hazardous
materials. Unless otherwise stated in the appraisal report, the existence of hazardous material was
not observed by the appraiser(s) and the appraiser(s) has no knowledge of the existence of such
materials on or in the property. The appraiser(s), however, is/are not qualified to detect such
substances. The presence of substances such as asbestos, urea-formaldehyde foam insulation or
other potentially hazardous materials may affect the value of the property. No responsibility is
assumed for any such conditions, or for any expertise or engineering knowledge required for
discovery. The client is urged to retain an expert in this field, if desired.
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Appraisal Report Language
•
Unless otherwise stated in this report, the existence of hazardous material, which may
or may not be present on the property was not observed by the appraisers. Ace
Appraisal Services has no knowledge of the existence of such materials on or in the
property. Ace Appraisal Services, however, is not qualified to detect such
substances. The presence of substances such as asbestos, urea formaldehyde foam
insulation, contaminated groundwater or other potentially hazardous materials may
affect the value of the property. The value estimate is predicated on the assumption
that there is no such material on or in the property that would cause a loss in
value. No responsibility is assumed for any such conditions, or for any expertise or
engineering knowledge required to discover them. The client is urged to retain an
expert in this field, if desired.
•
We have inspected, as thoroughly as possible by observation, the land; however, it
was impossible to personally inspect conditions beneath the soil. Therefore, no
representation is made as to these matters unless specifically considered in the
appraisal.
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Appraisal Report Language
Sample of Extraordinary Assumptions when appraising convenience stores, auto
dealerships and similar property types.
REALLY ACE APPRAISAL SERVICES has not observed, yet is not qualified to detect,
the existence of potentially hazardous material or underground storage tanks, which may
be present on or near the site. The existence of hazardous materials or underground
storage tanks may have an effect on the value of the property. For this appraisal,
REALLY ACE APPRAISAL SERVICES has specifically assumed that the property is not
affected by any hazardous materials and/or underground storage tanks that may be
present on or near the property. It is an extraordinary assumption of this report that the
subject property is environmentally clean
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Management of Environmental Services
If FNMA, SBA, HUD and the bank are concerned
about environmental conditions….shouldn’t you
be?
What is your client’s policy?
 Do they determine what level of due diligence based on
transaction amount and/or property type?
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Management of Environmental Services
Resources
 Guide Note 6
 Analyzing the Effects of Environmental Contamination on
Real Property (AI Seminar)
 USPAP – Competency Rule; Advisory Opinion 9
 SBA SOP 50 10 5(F) Subpart B, Chapter 4 for 7A loans
and Subpart C, Chapter 3 for 504 loans
 NAICS Codes of Environmentally sensitive industries
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Q&A
95
Contact Info:
Derek Ezovski
860.838.5388
dezovski@orms.com