Using Insurance to Protect Your Industrial and Commercial Real Estate Purchases

24 Feb Using Insurance to Protect Your Industrial and Commercial Real Estate Purchases

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Savvy buyers of Industrial and Commercial real estate always seek to maximize their return on investment (ROI). On certain properties, they use insurance to protect themselves against the discovery of unforeseen environmental issues post closure. Here’s how it works:

First, a Property is Identified

What’s hotter than an industrial property today? The current industrial market is experiencing unprecedented demand, creating a seller’s market. Due to intense demand coupled with short supply, properties are selling for record prices and tenants are paying record-setting rents. And, thus far, this inordinate demand shows no sign of waning. From this hot industrial property market has arisen what ESA refers to as “second-tier developers.”

The second tier consists of small to medium developers and investors. Some of these investors are savvy, and some are inexperienced. But all seek the same thing: to identify and buy properties for redevelopment as either apartments or industrial use and fill them with good tenants. And, because ROI is key, the investor must manage risk and control spending.

Today’s available properties tend to be those that have been overlooked for years, relegating them to a secondary or even tertiary market. In many instances, these are marginal properties that, in less lucrative times, would not attract much attention. They are marginal because they tend to have “hair” on them. When that hair is environmental in nature, risk management becomes paramount.

The Process Begins with Due Diligence

When an investor identifies a prospective property, they need to tie it up so other buyers are precluded. This requires the assistance of an experienced real estate attorney. At this stage, it is unlikely that the purchaser will know much, if anything, about the environmental nature of the property. And this is when the buyer will retain ESA to perform due diligence.

The usual form of due diligence requested is the ASTM Phase I report. However, in New Jersey, we normally suggest a Preliminary Assessment in lieu of a Phase I. (Please refer to Defining Due Diligence and Dealing with Due Diligence).

Due diligence, by definition, is a non-invasive investigation of a property to determine if any areas of environmental concern exist. Non-invasive means that no samples are taken at this stage. Subsequent to writing the due diligence report, ESA may indeed suggest that sampling be performed to determine if actionable levels of contaminants exist on site. Taking this process to its normal conclusion, if actionable impacts exist, then remediation may be performed.

Protecting Yourself from the Unknown

Let’s assume that ESA’s due diligence findings are benign. That is, by exercising with precision the due diligence process, ESA has not discovered even one potential area of concern. Typically, in this instance, the potential purchaser will accept the results and move forward with the deal.

Or say, as is more often the case, that ESA discovers one or more areas of concern that merit further inquiry. This invariably means that ESA will take either soil or groundwater samples or both. And, let’s assume that those analytical results are benign. Now what? Once again, it is likely that the potential purchaser will accept the results and move forward with the deal.

Now, let’s remember that when the buyer closes on the property, they now become the “responsible party,” meaning that, if any new impacts are discovered, they will be on the hook. So, it is important that ESA’s report is accurate and that the buyer’s decision to purchase is made in consultation with their real estate attorney.

But what if the buyer is skeptical? Or what if they are the kind of real estate investor/developer who prefers to hedge their bets? What’s the best way for them to protect themselves from discovering impacts that simply remained undetected despite a well-executed due diligence process?

Insurance Will Protect You from Most Environmental Surprises

Environmental insurance may provide the protection necessary to provide comfort to the purchaser and guarantees to the lender. Here are a few things you need to know about environmental insurance policies:

• Various forms of coverage are available. Depending upon the insurance carrier, these may include historical pollution coverage for pre-existing conditions, pollution coverage due to ongoing operations, and remediation cost-cap coverage. In addition, other forms of coverage may be available depending upon the nature of your project and the site history.
• Coverage limits are gauged in terms of both the amount of coverage and the duration for which the policy is viable. The ultimate premium cost will be a function of these two variables.
• The insurance company will want to see a copy of your due diligence report. It may be useful to have performed a file review to be certain that no old reports or former studies have been overlooked. In addition, they will want to see reports documenting any Phase II sampling or remediation you may have performed.
• Other forms of coverage that may be available include:
  • Business interruption or loss of rental income due to environmental issues
  • Changes in environmental legislation
  • Legal defense costs
  • The environmental policy may be assignable

No doubt some of you will want to know what this insurance costs and who sells it. Insurance premiums are highly variable. They can range from the tens of thousands of dollars to many hundreds of thousands of dollars or even more. It depends on the nature and complexity of your project. For further information, please call ESA CEO Stephen Fauer at 732.469.8888 x201.