By: Leah Krause, CPEA
The ongoing economic disruptions from COVID-19 have impacted many businesses, some of which will inevitably enter the commercial and industrial real estate market. It will be essential for potential buyers to understand the risks associated with these potentially distressed operations or properties through due diligence. These risks could include:
- Not operating in compliance with all regulations due to potential cost-cutting, which could result in regulatory enforcement actions.
- Inflation of true profitability due to cost savings resulting from non-compliant operation.
- No due diligence performed before buying into a company located on contaminated property.
Thorough environmental, health, and safety (EH&S) due diligence on a potential real estate purchase is recommended for all deals, but for distressed targets, it is key to ensure you are making a good investment and mitigating unknown risks leading to potential costly consequences. Unknowingly purchasing contaminated property can result in liability for that contamination and if it is migrating to a neighboring property, then the liability could be devastating to the business.
A simple strategy for dealing with a distressed asset:
- Understand the property. If you are considering a property purchase, conduct a Phase I environmental site assessment (ESA) or desktop review. This will help you understand and mitigate environmental risks created by the previous owners/operators.
- Know if the facility is compliant. Whether it be an illegal discharge to the municipal sewer or unpermitted air emissions, a highly effective way to gauge compliance and focus resources is to conduct an EH&S audit. In the interest of having a starting point, it makes sense that a high-risk operation is the first area of focus on Day 1.
- Develop a plan. Once you identify risks during the Phase I ESA or audit, leverage existing resources with a solid plan and identify key people to prioritize aspects of the EH&S program. This will evolve your new company beyond perpetual makeshift solutions and close EH&S program gaps to improve your risk profile and increase operational efficiency.
- Implement the plan. Many EH&S programs can be established and managed in-house with existing talent. It is important to focus on EH&S as an accountability for all, not merely a box on an organizational chart. You may be surprised by existing personnel who will step up if asked, or who care about the environment or safety performance, but have not been given clear direction on how to contribute.
When acquiring a distressed asset, it is important to include an evaluation of EH&S compliance during the due diligence process. EH&S compliance can be very complex – it is understanding laws, regulations, and codes and implementing those requirements at each operating commercial and industrial facility. It is safe to assume that a distressed company diverted resources from EH&S programs to keep the business afloat, which may have costly repercussions for the new owner/operator on Day 1.
Other aspects to consider which could potentially be a higher risk for distressed assets include:
- Whether the distressed company has used any enforcement discretion or forbearance policies due to COVID-19 that provided relief if they were unable to comply with their permits or other operating conditions
- Potential business risk issues common with older facilities, such as poorly maintained asbestos-containing material or lead-based paint, or other conditions unfolding from lack of maintenance, such as mold from water damage or poor ventilation in a vacant building.
Thorough due diligence on a potential real estate purchase is key to ensuring you are making a good investment and mitigating potential unknown risks. Find a partner that can navigate these issues and help you prepare for negotiating opportunities as the deal unfolds. In other words, with proper understanding of risks, and a better understanding of how these risks affect the real value of properties, the proactive company may position themselves to enhance their portfolio, even at discounted prices, while protecting their risk profile.
For more information, see the “Demonstrating Value Through Proactive EH&S Due Diligence of Distressed Portfolios” White Paper by Amy Bauer.