I had a commercial realtor ask what a Phase I would cost for a light commercial property. They then asked how much the Phase II would cost. No one can provide a Phase II cost without first performing a Phase I, which will map out Areas of Concern (AOCs) or Recognized Environmental Conditions (RECs). If I could accurately predict a Phase II cost, or anyone could for that matter, you wouldn’t need to do a Phase I. You would also likely be able to predict winning lottery numbers. Would you go into a hospital and ask for surgery to be performed without a prior Doctor’s evaluation? The correct answer is no.
We touch a few thousand sites a year, and not every property requires a Phase II, so the Phase II cost would be zero. When a Phase II is required, the cost depends on the required work. No matter the Phase II cost, the buyer is now tasked with spending more money on a property they do not own, which can delay the sale.
How do you fast-track environmental due diligence in a commercial real estate transaction? It’s pretty easy; you start it prior to listing the property for sale. Owners should have a Phase I completed prior to trying to sell the property, and if the Phase I triggers the need for a Phase II, you do the Phase II to ensure that there really are no issues. Obviously, if there are issues, you fix them, the property is then salable and fast. This gives the property sex appeal, so to speak. Why, well, doesn’t a buyer have to spend money for a Phase I, Phase II, or Phase II, all of which can add weeks or months to be completed to get to settlement? In short, it takes the environmental unknown off the table.
Why do sellers not take this rapid-fire approach, mostly due to bad advice? I was talking to a commercial realtor, who moves a lot of real estate, and asked them about doing prelisting due diligence. Bottom line: 20 years ago, it was not that unusual to have a transaction where a Phase I was not performed. Today, it is highly uncommon, regardless of whether it is a 1031 Exchange, cash deal, or bank-financed purchase, a buyer is going to do the Phase I at the advice of their attorney, realtor, or bank. Sellers can be very naive regarding how potential buyers perceive their property.
They further stated they would recommend a seller do a Phase I and whatever else they need to evaluate environmental issues on the property they are selling. Although buyers are willing to pay for a Phase I, you get a long pause when testing a property that they do not own. The big question they get is if they find a problem, will the owner do anything, and in a timely fashion.
Properties bought 20+ years ago that didn’t have a Phase I performed and owned by people who consider environmental due diligence unnecessary? Well, those owners are ostriches; they didn’t do it when they bought it and don’t see the need now, and those transactions take 2 to 3 times longer to close if they even get to the settlement table. Unfortunately, you have inexperienced realtors who lack commercial due diligence experience and fail to manage sellers’ expectations regarding due diligence. Meaning they do not have the discussion regarding doing a Phase I and Phase II if needed. Many sites require ZERO dollars to be spent on a Phase II, but you have to do the Phase I to know that.
They presented a very basic example: you list a property for $400,000 with zero due diligence from the seller, the buyer does their due diligence, finds an issue, and the seller spends $42,000 to address environmental issues. Property is sold, but the seller gets less money than anticipated. Same property, different approach, seller does Phase I, II, and III. We list the property for $442,000 (building in the cost of environmental), and we market the property accordingly. We market the property as having gone through environmental evaluation and cleanup (offering all reports for the buyer's review), offering a fast closing, and removing questions regarding environmental expenses. Super appealing to buyers who understand the value presented. It can also offer a guaranteed closing date for the 1030 Exchange crowd.
I circle back to the realtor asking what the Phase II cost will be, before a Phase I is performed. This presents a complete lack of understanding of the process. In turn, you have to explain this to a seller who has even lower knowledge. Pro tip to realtors: if your buyer asks what a Phase II will cost, reference another property you sold and what monies were spent, that presents both an answer to their question, an example sale, and reinforces your experience of the environmental due diligence process. Bottom line, sellers are often given bad advice regarding the likelihood of environmental due diligence being performed, and in doing so, they can miss out on selling a property quickly and for the real market value of the property.
Expert Due Diligence Advice
