When investors are shopping around for viable commercial property opportunities, there are some standard issues that need to be considered and due diligence procedures that need to be followed to make sure that the decision to move forward is a good decision. Real estate investors have been burned on investments or passed on properties that later turned out to be excellent investments, simply because their due diligence wasn’t quite diligent enough. Before investing a sizable amount of money in property, it’s always a good idea to first invest in the outside expertise and support necessary to ensure your due diligence process digs deep, asks every relevant question, and provides a comprehensive and totally transparent evaluation of the property. Your reviews and inspections should leave no stone unturned and should reveal any indicators of potential risk today and in the future. In my experience, one area of consideration that is commonly overlooked and has proven problematic is the proper analysis of environmental factors related to the property that could affect its usability and value. Let’s explore a few environmental examples …
I’ve seen more than one investor miss solid investment opportunities due to a lack of understanding about soil contamination. The first thing that’s important to know is that not all contaminants are necessarily bad, or even illegal. Some contaminants, like arsenic, chromium and toluene can occur naturally. For example, chromium was extensively used in the manufacturing of creosote telephone poles, but chromium is also a naturally occurring mineral in this and many other areas. Toluene, which is found in paint thinners, gasoline and other products, is also a natural byproduct of pine trees. The natural toluene that comes from pine trees is permitted and is not necessarily considered an environmental hazard, but the toluene that comes from refining processes is considered a hazardous material and will most likely need to be remediated.
Let’s say you were about to invest in a piece of property and found out that toluene was present above the allowable recommended levels. You pass up on that property thinking that it is going to cost too much to clean up and that the contamination will be an ongoing liability. Your competitor, Anita N. Spection, decides to invest in an extra layer of due diligence in the form of an additional toluene origination test. This test determines whether the toluene is a naturally occurring byproduct of the pine trees or an illegal contaminant produced through refining activities. Of course, Anita discovers that it is natural occurring toluene and buys up the property for a song. A year later she’s profiting from a lovely developed property shaded by several beautiful pine trees.
I should also mention that some contaminants are much easier to clean up than others. An investor may find traces of an illegal contaminant in the soil samples, but further investigation shows that the contamination is in a contained area and is sitting on the surface of the land. A few scoops from an inexpensive backhoe rental may be all that is needed to bring the property up to code. The point is, don’t overreact and give up on a property just because you see the word “contamination” on a soil sample report. Do your due diligence and get the full picture before making your decision.
Another important environmental question that should always be thoroughly answered before making investment decisions is, “What kind of dirt am I buying?” If the ground that your building sits (or is going to sit) on is not solid and reliable, then your investment is not solid and reliable either. In our geographical area there are many different types of soil. We have sandy soils, rich organic soils (“peat”), clay and many others. Our clay soils, sometimes called “Gumbo,” do present some significant foundation difficulties. Blue clay soils swell during rainy seasons and shrink during dry seasons. This constant shifting and movement in the land can cause havoc on the structural foundations of the buildings it supports.
Peat is really just vegetation that has built up over thousands of years, but it’s not stable at all. Usually, before building occurs on lands made up of peat, the peat is actually excavated and replaced with good soil, or pilings are driven down into the earth deep enough to place the building on a solid foundation. This can be very expensive.
A simple core drill test can determine what your land is made of and how deep each layer extends into the ground. The important takeaway is that before investing in a property, know what the land is made of and whether or not it’s buildable. Because of the remediation that may be required, the cost of land for $20,000 per acre may be significantly higher than a piece of land that is $30,000 per acre.
Are Your Tenants an Environmental Risk?
Another consideration that many property owners overlook is the potential environmental risks associated with certain types of renters. You have to know to whom you’re renting and whether that renter’s business creates any potential environmental hazards.
For example, the inks that most printers use are toxic – you don’t want those toxins seeping into your land or nearby water supplies. Nail salons are filled with combustible liquids and chemicals, which obviously increase fire risks.
Some industrial facilities that work with wood (cabinet makers, truss builders, stair manufacturers and the like) produce dust particles that are extremely combustible – so much so that they require special electrical outlets to keep the particles from igniting a spark. These facilities may also require some type of vacuum system, like air scrubbers or dust collectors, to remove the particles from the air.
I’m not saying that you shouldn’t allow these types of tenants to lease from you; we need printers and saw mills, and some people seem to really like nail salons. What I am saying is to be aware of the potential hazards so you can properly protect your property.
This brings me to a bit of an off-topic sidebar, but certainly an important add-on to this article. I highly recommend a regular insurance audit of your property. A good insurance audit will reveal your risk exposure before something happens and allow you to align your insurance coverage with your risk.
Lean On the Experts
The main takeaway from this article is that there are a lot of fairly obscure things that are frequently overlooked and can impact the value of your investments. Due diligence should be thorough, and that means calling on proven, reliable experts to help you. Expert professionals have the experience to ask all of the right questions and anticipate any potential problems lurking in the future. Specifically, as it relates to this article, the services of an environmental engineer are a worthwhile investment. He or she can identify the presence and make up of contaminants and the actual soil content. A reputable commercial insurance agent can help investors reveal, measure and mitigate exposure to risk.
The small investment you make up front to do your due diligence, and do it well, will pay for itself on the back end when your property investment is a reliable one with no unforeseen and expensive problems.
Grayson Powell is a Managing Partner at Coldwell Banker Commercial Sun Coast Partners (CBCSCP). CBCSCP leverages the vast experience of highly-skilled real estate professionals and developers and specialize in selling, leasing and managing retail, commercial, and investment property. To learn more about CBCSCP, visit www.cbcwilmington.com or call 910-350-1200. He can be reached by email at [email protected].
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