Posts Tagged ‘due diligence’

TRANSACTIONAL DUE DILIGENCE TRENDS IN FLORIDA 2006 – 2011

January 11th, 2012

Survey Results – What is the trend in environmental due diligence in Florida since the high water mark in 2006, both from a consultant and lender perspective?   Also, in 2011, who are the dominant users of environmental due diligence in Florida and what has been the average cost of due diligence this year?   Based on this informal survey of consultants and lenders whose offices focus on the Florida market, we are able to demonstrate a continuing dichotomy between consultants and Florida-based lenders from 2008 through 2011, with increased orders flowing to consultants (again, as last year, mostly attributable to special asset resolutions), while individual Florida lenders are undertaking fewer assessments associated with new loans.

With respondent consensus indicating that 2006 was the industry high water mark in terms of assessment requests (therefore, using 2006 as our assumed baseline of 1.0), the data from responding consultants indicate that the 3 year trend from 2009 to 2011 has been positive overall, with some consultants actually doing volume in excess of 2006 volumes. Consultants attribute this increase to a continued higher volume of foreclosures and special asset dispositions by lenders, as well as an increasing number of investors & REITs taking advantage of depressed real property values in the state.

To view chart entitled Consultant Due Diligence Trend Since 2006 click on attached doclink below:

Lessons Learned 17 – 4Q2011 Annual Due Diligence Trends

On the other hand, the responding lenders have experienced a marked decline in the number of assessment requests that they are making; in fact, one of responding lenders indicated that they have made NO requests for assessments in the last 2-3 years, eschewing loans on any real property which has the potential for environmental issues (As shown on the table immediately below).  The lenders which responded have experienced an overall tightening of credit policy, which means fewer commercial loans, and on generally more risk-free properties.  (Note: the lenders surveyed have not reported any foreclosure-based due diligence, therefore, that kind of lender issues are not reflected in the trend reported by the responding consultants).

To view second chart entitled Lender FL Due Diligence Trend from 2006, click on doclink above.

As the third diagram (below) illustrates from consultant responders, lenders remain the largest customer for environmental assessments in 2011 (56% of the market (down from 62% in 2010)), predominantly associated with foreclosures with a smattering of refinancing.  Investors are the second biggest customer for due diligence at 22% (down from 28% in 2010) while the Other/REIT category has increased from 1% in 2010 to 16% in 2011.  Developers have dropped from 9% to 6% of the total, as new construction continues to lag well behind historical highs.

To view third chart entitled 2011 Breakout of Due Diligence Users, click on attached doclink above.

Finally, according to respondents’ data, the weighted average cost of a Phase I environmental site assessment in 2011 was approximately $1,781, which is a modest decrease from the 2010 average of $1863.

Trends for 2012 –   Survey participants were asked what they feel the due diligence trend will be in 2012, and what factors they feel will be most influential in that trend.  Respondents all referred to the moribund economy and continued stringent credit standards.  However, there was some speculation that side-lined investor money might come back into the market.  The bases for this feeling included (a) “bargain” prices that might be perceived to be too attractive to pass up as well as (b) a determination (or perhaps hope) by institutional and private investors/owners that the market would not fall materially any further.

Specific comments included the following:

[Consultant] “We believe that Florida continues to be attractive to investors [once] the economic indicators [become] stable or improve. This would lead to an increase in Phase I ESA activity. Foreclosure backlog, if worked though, could act to reduce volume of Phase I ESAs. However, (and unfortunately) this does not appear to be likely (meaning that there appears to be a large volume of properties which have not yet entered the foreclosure process).

{Consultant}- Financial institutions, REITs and investors were among the frontrunners this year [2011].  Banks were looking at more foreclosures, and REITs and investors were taking advantage of the struggling/ sluggish economy [to act on bargains].  For 2012, as a company, an increase in transactions is always the hope.  Currently, the feeling is that the arena will be steady with some small growth; however, given it is an election year things may get sluggish nearer to that time.

<Lender> – We feel that there may be a slight loosening of credit, and, if so, our numbers should increase, [up to]  25%.  [We] would envision a mix of 33% investors and 67% owners (refinancing).

(Consultant) – About the same as 2011 to maybe slightly improved in 2012 [attributable to opportunistic purchases if buyers feel the downward trend has moderated or stabilized].

<<Lender>> Our environmental due diligence continues to depend on the type/use of property we are financing, as well as the amount financed.  We continue to concentrate more on  residential lending efforts, as is consistent with our history.  Continuing uncertainty regarding economic conditions in the commercial sector will likely result in a cautious approach to commercial lending.  Therefore, the need for environmental due diligence will be minimal [in 2012].

While this is an informal and non-scientific poll, most respondents, lenders and consultants alike, felt that negative factors like foreclosures would probably represent the largest growth segment of environmental due diligence activity in 2012.   Also, as long as the economy continues to act as a drag on real estate activities in general, and due diligence costs in particular, end users will likely continue to have the upper hand in pricing power.   This firm echoes the general consensus that until the capital sitting on the sidelines feels that the CRE market has reached its nadir, transaction volumes will remain stagnant and credit requirements will continue to be conservative.

We thank the participants for their feedback and candor. If you have any comments or questions, please do not hesitate to contact me at your convenience.

TRANSACTIONAL DUE DILIGENCE TRENDS IN FLORIDA FROM 2006 TO 2010

January 2nd, 2011

Survey Results – What has the trend been in environmental due diligence in Florida since the high water mark in 2006, both from a consultant and lender perspective?   Also, in 2010, who are the dominant users of environmental due diligence in Florida and what has been the average cost of due diligence this year?   Based on an informal survey of consultants and lenders, we are able to demonstrate a dichotomy between consultants and lenders between 2009 and 2010, with increased orders flowing to consultants, but individual lenders undertaking fewer assessments.

[To see the survey chart results that accompany the text, please click on the attached link below]

Lessons Learned 13 – 4Q2010 Due Diligence Trendsv12262010

Chart – Consultant Due Diligence Trend Since 2006 (% change)

With respondent consensus indicating that 2006 was the industry high water mark in terms of assessment requests (our assumed baseline), the data from responding consultants indicate that the 1 year trend from 2009 to 2010 has been positive, with some consultants actually doing volume in excess of 2006 volumes. Consultants attribute this increase to a higher volume of foreclosures by lenders, as well as a number of investors taking advantage of distressed real property.

Chart – Lender FL Due Diligence Trend (% change) from 2006 [use above link for associated chart]

On the other hand, the responding lenders have experienced a marked decline in the number of assessment requests that they are making; in fact, half the responding lenders indicated that they have made NO requests for assessments in the last 2-3 years, eschewing loans on any real property which has the potential for environmental issues (These lenders are not shown on the table above).  (Note: this data reflects that some participating lenders did not report any foreclosure work, as well as a preference for owner-occupied (as opposed to investment) property, therefore, they are not necessarily representative of the trend reported by the responding consultants).

Chart-  2010 Breakout of Due Diligence Users  [see attached link for associated chart]

As the final diagram illustrates, lenders clearly were the largest customer for environmental assessments in 2010 (62% of the market), predominantly associated with foreclosures with a smattering of refinancing, while investors were a distant second (28%) and developers even further back (9%).   According to respondents’ data, the weighted average cost of a Phase I environmental site assessment in 2010 was approximately $1,863.

Trends for 2011 –   Survey participants were asked what they feel the due diligence trend will be in 2011, and what factors they felt will be most influential in that trend.  Respondents all referred to the sputtering economy and tightening of credit standards; specific comments included the following:

–          “Currently, [consultant is] anticipating that there could be another slow down in the financial industry and the uncertainty with the economy.  The most influential trend will be people’s confidence in the banks and if the banks are willing to start releasing funds.  CMBS is rebuilding however, so that market could add to the due diligence arena; however, there are a lot of hungry firms out there that are still willing to give work away.  The key is to find the clients that understand quality and actually having the coverage they need under AAI.”

–          “[Lender] is not a very aggressive commercial lender – even less so in today’s market.  As such, if we perceive of any environmental concern we will often pass rather than pursue the loan with further due diligence… [we] look forward to doing so at some point in the future, although right now that future seems more distant [than] near-term.”

–          “[Consultant] foresee[s] same [activity levels] as 2010 (no increase or decline); but pre-foreclosure ESAs will continue until the banks are free of defaulting loans secured by real estate.

–          [Lender] will continue to de-emphasize development and investor loans.  Most loans will be for owner occupied projects.  Loan demand is currently low, and, for the time being, we do not see much of a change in that trend.  Certainly, if foreclosure activity increases (global market trends suggest that it might), we will need to order more Phase I’s before taking title to the property. Standards are tightening, but for good reason.  The industry was pretty loose before.  The problems are exacerbated by the number of people that are simply deciding to give [real estate] back to the lenders because they are underwater.  Those turn into foreclosures and short sales.  Appraised values are down as a result, so new buyers are unable to finance purchases and unwilling to pay cash as they are uncertain as to whether we are at the end of the cycle….  [certain commercial market loans] may be good loans but because of some sort of quirk, they are not readily marketable in the secondary market.… [It appears that] we have a couple of years of the same sort of situation to look forward in this segment.

–          [Lender foresees] about the same as 2010; maybe more Phase Is will be ordered for foreclosure purposes.

–           [Consultant feels that] the economy will continue to slowly improve during 2011 resulting in lenders making more loans, and as a result, we will see more lenders ordering Phase I ESAs in 2011.  [Consultant believes] that investors will continue to buy properties and buildings in short sales and foreclosures during 2011, and as a result, they may end up being the most active group during 2011.  Developers will slowly come back into the market, thus ordering more Phase I ESAs during 2011 than they did in 2010.  As borrowers adjust to the new interest rates and new terms of loans for 2011, [Consultant feels that] lenders will start to relax and lend money again.

–          [Consultant states that], generally, [current] business appears to be driven by cash deals, refi’s, conversions from construction to permanent loans, and foreclosures; without much changing [ in 2011]. Investors are limited to a few individual deals that are mostly cash; no raw land deals [are foreseen].

In this admittedly limited poll, most respondents, lenders and consultants alike, felt that negative factors like foreclosures would probably represent the largest growing segment of environmental due diligence activity in 2011.   Also, as long as the economy continues to act as a drag on real estate activities in general, and due diligence costs in particular, end users will likely continue to have the upper hand in pricing power.

As other opportunities present themselves to expound on this review of the due diligence terrain, both from a client and service provider perspective, this office will try to provide periodic updates on significant trends and developments.    In the interim, if you have any comments or questions, please do not hesitate to send them along.

Whether Environmental Insurance is an Adequate Substitute for Environmental Due Diligence

February 10th, 2010

Question

My loan officer was working with a borrower to finance a purchase of a gas station.  The gas station is known to have historic releases of petroleum, at least one release of which is eligible for a state government cleanup program.  The borrower wanted to use a 2 year old seller-owned 3rd party liability and cleanup environmental liability insurance policy (the key terms of which are described below) as a substitute for undertaking a Phase I assessment; we do know that the expiration of the policy occurs within three (3) months of the proposed Closing date of the purchase.  The borrower stated that he is willing to try to extend the policy for a period of time.   What elements should I consider in determining whether to accept the offered policy instead of undertaking our normal Phase I due diligence?

Response

The above-referenced insurance coverage should not be used by the lender for a variety of reasons, which are set forth below.   Environmental insurance does have a role to play in protecting the lenders’ interests in commercial real estate collateral.  However, it is not necessarily a blanket cure for all property concerns.  Environmental insurance tends to be a better tool if used on an individualized basis, instead of as a broad response to the entire issue of environmental due diligence and claim protection.

Elements of a Policy to Consider: several elements of an environmental policy must be considered when trying to decide whether to accept the policy and in what capacity (as the sole backstop for environmental concerns, or as a supplement to other due diligence).

Term

The first concern was that the policy expired during the term of the loan (in this case, only a few months into a multi-year loan term).  There was no language in the policy that allowed for automatic renewal, so there was a material possibility it might not be renewed at the expiration date.  Therefore, the protections offered by the policy would end before the bank’s exposure would, thus creating a material level of risk for the bank.  Any policy that a lender might consider ought to have a term that encompasses the entire term of the loan, in order to provide the best level of protection to the lender.

Transferability

Second, the policy was not written to accommodate a change in control of ownership of the property; it had been acquired by the seller without a transferability clause.   Therefore, the buyer and the lender would not benefit from even the short amount of coverage.  Lenders should make sure that both they and their borrowers can assume the insured role on a pre-existing policy for the best level of protection.

Type of Claim

This particular policy was written to cover specific incidents occurring in a specific period of time; only several months of which would occur during the period when the borrower would own/control the property.  Therefore, the insurance coverage offered a very narrow window of coverage, excluded historical issues, and was not suitable to protect the lender’s interests in the loan real estate.

Claim exclusions

The policy only covered issues identified in due diligence provided by the seller at the time the policy was applied for; if any issue arose that had not been identified in that original seller-generated due diligence, any damages or claims associated with the new issues would not be covered.

New coverage

Since the loan property is a gas station, with the potential for environmental mishap due to the nature of the normal operations, the borrower should be advised to undertake new due diligence (a new Phase I assessment), and to obtain a new insurance policy covering the term of the proposed loan.