Wharton Real Estate Center

This article, written by ALR executive(s), originally appeared in the Wharton Real Estate Center, Newsletter Volume 7, Number 1, Fall 1994. (University of Pennsylvania)

External Environmental Problems:  What Real Estate Investors Need to Know 

Real estate investors routinely conduct extensive investigations�known as environmental audits�into the environmental factors that affect properties they wish to purchase.  Investors rely on these audits to provide them with information about the environmental problems confronting the properties they want to purchase.  Hundreds of serious problems can afflict a property, including the presence of contaminants that pose a threat to human health, violation of one of the numerous federal, state, or local environmental laws governing each property, pending regulatory action, toxic tort lawsuits, and permit violations which could result in the cancellation of a permit whose transfer is vital to the ongoing operation and economic viability of the property.

Why investors need to know about IEPs and EEPs
Internal Environmental Problems (IEPs) consist of conditions which originate from and exist exclusively on one site.  The existence of friable asbestos is an example of a widespread environmental problem affecting millions of properties.  Unfortunately, there has been little attention paid to environmental problems that originate on one property but adversly affect one or more properties.  These types of environmental problems can be described as External Environmental Problems (EEPs).

I created the term EEP to encompass all of the environmental problems which originate on one property and affect at least one additional property.  These problems have the potential to substantially reduce, and in some instances eliminate, the economic value of the investor's property. EEPs are also almost impossible for the investor to eradicate because they are not under his or her dominion and control.  I believe that investors must deal with EEPs prior to purchase by choosing one of two courses of action:  1)  avoid the purchase if you have incorporated some basic contractual provisions into the agreement of purchase and sale, or 2) demand that the purchase price be reduced to reflect the diminution in value caused by the external environmental factors. 

Type of EEPs and investment implications
Man-made EEPs include electromagnetic fields, landfills, incinerators, chemical plants, and neighboring properties which are highly contaminated or whose operations cause noise or air pollution to spill over onto the subject property.  Naturally occurring EEPs include disasters such as earthquakes and floods. 

There are myriad resources to help investors find out about both types of external environmental problems and whether they exist on a site.  A great deal of information can be obtained from various government agencies through the use of the Freedom of Information Act (FOIA).  FOIA requires federal agencies to disclose the contents of their records upon request.  If the person making the request complies with certain rules, the agency/recipient must respond to the request on a timely basis. 

Any prospective purchaser should examine the relevant federal and state environmental data bases.  These data bases provide various types of information to the regulated community.  For example, the government maintains the Toxic Release Inventory System (TRIS), which stores information from facilities regarding the quantities of more than 300 specific toxic chemicals that are discharged into the air, water, or soil.  This data base also identifies the facilities that release specified substances.  Investors should search this data base to discover whether a property they may purchase is subject to unhealthy levels of contamination originating from a nearby source. 

TRIS is only one of hundreds of data bases maintained by various state and federal government agencies.  This publicly available information provides investors with a relatively comprehensive picture of the external environmental factors that affect a property.  Securities filings submitted by public corporations can be immensely helpful to anyone contemplating the purchase of property located near a publicly owned facility.  Frequently, such facilities produce environmental problems that affect nearby properties, but thoroughly examining the securities filings may reveal these potential hazards. 

The need for this information is growing exponentially.  For example, until recently investors were not concerned by underground pipelines running through neighboring properties.  Then an underground pipeline in Edison, NJ exploded.  After this type of explosion, the ruptured pipeline's contents can migrate to other properties.  Now, many investors refuse to purchase new properties without ascertaining the existence and condition of any underground pipelines located nearby. 

Investors who discover an EEP can reduce the purchase price through contractual provisions to account for any adverse impact or legal risks associated with the EEP.  Investors may choose to avoid the deal altogether.  Conversely, investors who remain unaware of the problem will bear the economic and legal burdens stemming from a problem that they had no hand in creating.  Furthermore, when they attempt to sell the property, these investors will discover that purchasers are becoming increasingly aware of environmental problems.  Consequently, the investor may have to discount the sale price in order to compensate subsequent purchasers for the additional risks posed by any EEPs. 

How auditing helps investors to avoid the legal and economic harm associated with IEPS and EEPS 
Environmental assessments and audits can help investors ascertain the existence of any EEP, can provide the investor with a picture of the legal and economic risks posed by any existing EEPs.  The investor will then have the ability to make an informed business decision to either 1) avoid the deal altogether or  2) demand that the purchase price or other terms be altered to compensate it for the environmentally-related risks it is undertaking.

One overlooked benefit accruing to investors who conduct audits is their ability to secure financing.  Lenders are becoming increasingly reticent to lend money on properties that have environmental problems or even question marks.  This trend is certain to accelerate with the publication of the FDIC Environmental Risk Program.  The FDIC Program requires all FDIC-supervised banks to ascertain the environmental condition of properties before agreeing to accept them as collateral.  Investors who avoid the purchase of environmentally challenged properties will discover that their other properties benefit from an enhanced level of mortgageability.

Many real estate investors have become adept at avoiding the joint, several and retroactive liability imposed by CERCLA.  These investors have also learned how to side-step the economic and legal harms that are frequently associated with a variety of internal environmental factors.  Unfortunately, internal factors represent only part of the environmental challenge that confronts property owners.  A wide variety of external environmental factors plague millions of properties.  It is vital for real estate investors to learn about the existence of EEPs prior to entering into a binding agreement of purchase and sale.  This knowledge will permit investors to proceed with the informaiton that they need to make prudent business decisions.

Time and space constraints prevent me from examining many of the mechanisms that can help you to decrease environmental liability.  My book, How to Avoid Environmental Liability: A Practical Guide for Real Estate Owners, Lenders and Professionals, demonstrates how you, as a real estate investor, lender or professional, can: 1) diminish your exposure to environmentally-related liability;  2) comply with regulatory requirements;  3) participate in new business opportunities;  and 4) position yourself at the forefront of your field.  [Information about the book can be obtained by calling 610.524.6440, fax request to 610.524.6464 or Email to info@americanlandrecycling.com.  Please specify your book request.]

This article, written by ALR executive(s), originally appeared in the Wharton Real Estate Center, Newsletter Volume 7, Number 1, Fall 1994. (University of Pennsylvania)

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Modified:  03/15/03