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What Is Environmental Due Diligence?
Environmental Due Diligence (EDD) is the collection of data and pre-transaction tests and reports of a real estate property to inform investors about the environmental conditions and potential risks before investing in the property or initiating mergers or acquisitions.
The evaluation is often done when it is requested by construction companies, land developers, private owners, attorneys, or any concerned party looking forward to buying, occupying, renovating, building, or using the property. A project can fail or fall into a higher risk category without a proper due diligence process.
Table of contents
- Environmental due diligence(EDD) is the evaluation of a real estate property to understand the physical conditions of the location before investors make a transaction.
- It is done before any property transaction, and the involved parties can receive fines, penalties, or lawsuits without an EDD report.
- Many environmental laws include the Environment Act 2021, the Clean Air Act 1993, the Water Resources Act 1991, etc.
- The EDD helps not just to revoke but also to understand and mitigate the potential risks before making any final decision.
Environmental Due Diligence Explained
Environmental due diligence (EDD) refers to evaluating a location, real estate property, or land before advancing towards it, such as buying, refinancing, construction, business setup, and projects. A property is essentially a geographical location, and with location and vicinity, the physical properties and characteristics vary from one place to another. Environmental due diligence lies in collecting data, verifying the documentation, assessing for infestation, and notifying the parties involved of the presence or absence of hazardous products so that property transactions, especially mergers and acquisitions (M&A), can happen smoothly with all knowledge and awareness.
The environmental due diligence report is an essential legal tool in multilevel transactions. In many cases, not performing the audit or not having the report attached to the documents can lead to shutting down the project and shelving the transaction, which eventually is a financial loss.
A property can have legal risks, climate issues, and surface-level problems. If addressed at a later time, it can become the reason for the operational loss and stagnate investment as work can be done on the property. Thus, the regulations differ from state to state, and a business enterprise must comply with all such laws. Otherwise, it can lead to severe fines, penalties, and legal actions against them.
Checklist
The checklist is the core of the process, in which each element is essential and cannot be skipped or ignored; hence, the checklist includes:
- Selection of the company's title
- Receiving, reviewing, and ordering the underlying documents
- Judgment lien searches
- Existing survey reception and review
- Ordering new survey
- Parcel maps subdivision
- Restrictive covenants, easements, and agreements
- Local improvement district information
- Verification of ownership through proper documentation
- If required, confirm releases available from current lienholders
- Delivering the title and survey objection letter to the seller
The EDD checklist accompanies the audit process to assess problems with the property's health, safety, and risks. Therefore, investors can only face substantial financial and legal risks with a proper environmental due diligence audit. Its most important components are:
- Verifying regulatory compliance
- Minimizing non-regulatory liabilities
- Reducing potential threats in property transactions
- Regulating energy and waste costs
The audit starts with:
ESA Phase 1
ESA stands for environmental site assessment, which checks the contamination of land or property. Thus, it is a fundamental process, mostly initiated from the buyer's end.
ESA Phase II
The second phase of ESA is to conduct a background check and understand the current owner's knowledge regarding the property. Thus, if there is a spill or infestation, it is considered a risk.
Soil Remediation
After ESA's first and second phases, soil remediation is scheduled to restore the ground surface to its optimal health and natural properties that align with the state's health and legal acceptability standards.
Groundwater Issues
A significant part of the land surface assessment falls under the threats and issues regarding groundwater. Therefore, it is addressed by examining and checking for interference effects, well-hydraulics, and stream interaction.
Summary And Conclusion
The audit is essential for the buyer and seller to ensure a successful real estate transaction. Therefore, taking caution is important, from collecting data to reporting risks, which is essential. Following the EDD checklist brings accuracy to results and compliance with state laws and regulations.
Examples
Let us understand the concept with some examples:
Example #1
Suppose Howard runs a tire manufacturing business. He runs a successful business yet seeks a new factory location for expansion. After much research, he finds a location he believes is ideal for his factory. The land belongs to another party that is also willing to sell it. Howard's business attorney advises him to conduct an EDD to evaluate the property's physical condition for business use.
After the environmental due diligence audit, Howard discovered that the land was contaminated and that many harmful chemicals were in the subsurface. Howard immediately revokes his decision to buy the land and starts searching for another location. It is a hypothetical example. In the real world, many factors are considered, and the process can be lengthy and complex depending on the property's geographical location.
Example #2
Another EDD example from the Maryland Department of the Environment (MDE) is a regulatory change that impacts real estate transactions and loan financing. However, multiple states will mandate reporting historical petroleum contamination exceeding specific cleanup standards.
The regulation came into effect on June 13, 2022. The regulatory change also makes it compulsory to report within two hours of the visual detection of petroleum-free products or two days. The analytical laboratory reports' receipts indicate petroleum contamination above the standard limits.
Frequently Asked Questions (FAQs)
The EDD process is spread across two phases of environmental site assessment. In the first phase, the property's soil contamination and groundwater levels are assessed, which may have been damaged from historical and current usage. In the second phase, the presence and absence of petroleum, chemical infestation, or other contaminants and hazardous products are checked on the site's subsurface.
M&A refers to mergers and acquisitions, and the EDD is an integral part. The EDD report presents a location or site's potential threats and current state, including the environmental risks that will impact the property acquisition process.
The purpose of social and EDD is to take a common approach to understand the investors' requirements and fulfill the government standards' legal compliance to ensure that the whole documentation, process, and transaction functions smoothly.
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