Real Estate Financing and Refinancing: Environmental Risks for Borrowers and Lenders
May 13, 2015
-Ed Morales, Senior Vice President, Marsh
-Dianne Crocker, Senior Analyst, EDR Insight
-Jared Dubrowsky, Vice President, Marsh
-Samantha Runyon, Senior Vice President, Marsh
As commercial real estate lending starts to slowly ramp up, it’s time to revisit the environmental risks associated with commercial properties—and how they can best be managed. Environmental conditions, unknown pre-existing factors and new releases can surface during the due diligence prior to loan origination and refinancing — and even during term of a loan. These risks can put financial strain on borrowers, and in the event of default, pose a significant risk to lenders.
Despite the exposures, there are several solutions that can protect your organization, its lenders, and other stakeholders.
The webcast will cover risks that borrowers and lenders face during real estate financing and insurance and other solutions that are available to mitigate them and enable financing and associated real estate transactions and development.
During the webcast, our panel of experts will discuss:
-Changing dynamics in today’s commercial real estate lending sector
-Environmental risks faced by lenders and borrowers
-Specialty solutions to manage environmental risks
Stakeholders who will benefit include:
-Risk managers at financial institutions
-Borrowers who purchase commercial real estate
-Real estate companies and developers
-Law firms
Maha Mauka Squarefeet Brochure |Maha Mauka Squarefeet PDF Brochure|
Real Estate Financing and Refinancing: Environmental Risks for Borrowers and Lenders
1. REAL ESTATE FINANCING AND REFINANCING:
ENVIRONMENTAL RISKS FOR BORROWERS AND LENDERS
MAY 13, 2015
2. MARSH 1
Primary Information
Secondary Information
• Bulleted text in Arial left aligned
• Paragraph spacing 0.6 lines before bullets
– Second level copy with 0.2 lines before
- Third level
- Fourth Level
- Fifth level
ED MORALES
SENIOR VICE PRESIDENT
GLOBAL ENVIRONMENTAL PRACTICE
6. 5
• COMMERCIAL REAL ESTATE IN 2015
• THE STORY IN PROPERTY LENDING
• NEAR-TERM FORECAST
1Q15 MARKET UPDATE
7. 6
ALL THE KEY DRIVERS FOR PROPERTY DEMAND ARE TRENDING IN
THE RIGHT DIRECTION:
• HOUSING MARKETS RECOVERING NICELY.
• JOBS ARE BACK PAST PRIOR PEAK LEVELS.
• INTEREST RATES STILL EXTREMELY LOW.
• PROPERTY INVESTMENT CONTINUES ITS SLOW CLIMB.
• MORE NEW CONSTRUCTION/DEVELOPMENT.
• NEW ACTIVITY IN A NUMBER OF SECONDARY MARKETS.
THOUGHTS ON REAL ESTATE IN 2015
8. 7
Small cap property sales:
+22% in 2014: 7-year high
Large property sales:
+45% in 1Q2015 (YonY)
PROPERTY TRANSACTIONS GROWTH
9. 8
EXPANDING UNIVERSE OF U.S. BUYERS
• THREE TIMES AS MANY BUYERS IN ‘14 VS ‘09 IN THE DEPTHS OF
THE CRISIS.
10. 9
• SMALLER SECONDARY MARKETS WITH STRONG GROWTH
PROFILES ARE SEEING INVESTOR INTEREST.
• COMMON DENOMINATORS:
• Strong job growth
• Growing technology sectors, healthcare and financial services
industries…
BEYOND NYC AND SF: MIGRATION TO SMALLER
METROS
11. 10
MIGRATION TO SECONDARY METROS
TOP 10 HIGH-GROWTH METROS
FOR PHASE I ESA GROWTH:
1Q2015 (YonY)
Las Vegas, NV 52%
Columbia, SC 42%
San Antonio, TX 38%
Charleston, SC 26%
Milwaukee, WI 22%
San Francisco, CA 19%
Sacramento, CA 19%
Stamford, CT 16%
Portland, OR 14%
Raleigh, NC 13%
13. 12
• 2015 FINANCING MARKET IS INCREASINGLY
COMPETITIVE.
• REGIONAL/LOCAL BANKS ARE GAINING MARKET
SHARE.
• LENDING STANDARDS HAVE NOT CHANGED MUCH IN
THE LAST YEAR.
• UPTICKS IN LENDING VOLUMES SUPPORT POSITIVE
INVESTMENT TRENDS…
LENDING TRENDS THIS YEAR
14. 13
• A POSITIVE TRAJECTORY IN LENDING.
• 6.5% GROWTH IN 2014 (FDIC)
• ORIGINATIONS IN 2014 ABOUT 25% PERCENT BELOW
2007 PEAK.
• Multifamily 25% higher than those 2007 volumes.
• Absolute levels of multifamily lending should remain
strong.
LENDING: SLOW PACE OF GROWTH IN
ORIGINATIONS
15. 14
• WIDE VARIATION IN LENDING BY BANK SIZE.
• STRONGEST GROWTH AT THE LARGEST REGIONAL BANKS AND
MID-SIZED BANKS.
• SIGNIFICANT PULLBACK BY COMMUNITY BANKS.
• GROWTH ESPECIALLY STRONG IN CONSTRUCTION/DEVELOPMENT
AND MULTIFAMILY CATEGORIES.
LENDING BY BANK SIZE
Growth in CRE
Loan Portfolios
(2014 vs. 2013)
All banks 6.5%
Assets >$50B 4.1%
$10B-$50B 16.8%
$1B-$10B 10.5%
<$1B -1%
16. 15
• HEADING INTO NEW ROUND OF REFINANCING, PEAKING IN 2017
• LENDERS VIEW THIS WAVE OF MATURITIES AS OPPORTUNITY TO
INCREASE VOLUMES.
• EXCESS CAPITAL LOOKING TO FINANCE SOLID REAL ESTATE
DEALS.
• EXPECTED TO FUEL A SURGE IN REFINANCING ACTIVITY FROM
NOW THROUGH 2017.
NEW ROUND OF REFI’S
17. 16
• VYING FOR A PIECE OF THE REFI MARKET:
• Traditional lenders
• Life companies
• Conduits
• Private equity (non-bank lenders, new this refi cycle)
NEW REFI PLAYERS
18. 17
• CONSTRUCTION AND DEVELOPMENT
LENDING WAS THE FASTEST GROWING
CATEGORY OF CRE LOANS ACROSS
BANKS OF ALL ASSET SIZES.
• TOTAL CONSTRUCTION SPENDING IN
2014 HIGHEST SINCE DOWNTURN.
• BEYOND KEY METROS (NY, SAN FRAN,
BOSTON):
2015: THE YEAR FOR CONSTRUCTION LENDING
HOT SPOTS:
CONSTRUCTION AND
DEVELOPMENT
Denver
Raleigh-Durham
Suburban VA
Oakland
Las Vegas
Austin
San Jose
Miami
Seattle
Portland
20. 19
• STILL A LOT OF ROAD TO RUN IN THIS RECOVERY.
• RETURN TO HEALTHY 2005/6 LEVELS.
• MODERATE GROWTH IN NEW ORIGINATIONS.
• CONTINUED MIGRATION TO SECONDARY AND TERTIARY
MARKETS.
“2015 WILL BE ONE OF THE STRONGEST YEARS WE’VE SEEN IN
COMMERCIAL REAL ESTATE SINCE THE CREDIT CRISIS AND IT’S FOR
ALL THE RIGHT REASONS.” KEN RIGGS, RERC
“OPTIMISM IS HIGHEST IT’S BEEN SINCE THE DOWNTURN.” RYAN
SEVERINO, REIS
THE MARKET FORECAST
21. 20
• MUCH GREATER AWARENESS OF ENVIRONMENTAL DUE DILIGENCE.
• RISK MANAGEMENT IS NOW EVERYONE’S BUSINESS.
• PAST “DEAL KILLERS” ARE NOW BEING MANAGED.
• PROPERTIES AND PROJECTS THAT FAILED ARE COMING BACK INTO
THE MARKET.
• MORE DEFERRED MAINTENANCE ISSUES ARISING ON REFIS OR
NEGLECTED PROPERTIES.
• PROPERTY CONDITION ASSESSMENTS GROWING IN IMPORTANCE.
THE FORECAST FOR RISK MANAGEMENT
22. MARSH 21
ENVIRONMENTAL RISKS ON PORT &
TERMINAL FACILITIES
JARED DUBROWSKY
VICE PRESIDENT
GLOBAL ENVIRONMENTAL PRACTICE
24. MARSH 23
Common Environmental Exposures and Losses
– From an Individual Pollution Condition
Third Party
Offsite cleanup
Property Damage
Bodily Injury
Loss of value
Regulatory
and Legal
Natural Resource
Damage
Toxic Tort Claims
Legal Defense
Costs *
Off-site Disposal
Legacy
Fines and Penalties
Governmental re-
openers
Divested Properties
Business
Risks
Borrow Default
Business
interruption
Loss of Rents
Increased
development costs
Defense can be important defending against frivolous and non-meritorious actions.
1st Party
Cleanup
Known
Conditions: cost
overruns for pre-
existing conditions
Discovery of
unknown pre-
existing conditions
New Conditions
from operations
Re-opener of
“closed” issues
25. MARSH 24
• Spills
(Sudden)
• Leaks
(Gradual)
• Contractor
Tasks
• Expansion/
Mods/Maint.
• Legal
Req’ments
• Business
Interruption
• Lease terms
• Acquisitions
• Construction
• Spills
(Sudden)
• Leaks
(Gradual)
• Legal
Req’ments
• Contract
Req’ments
Material
Arrival
On-Site
Material
Handling
On-site
• On-site Mgmt
• Spills (Sudden)
• Leaks
(Gradual)
• Air/Water
• Legal
Req’ments
• 3d Party BI/PD
Wastes
• Spills (Sudden)
• Leaks
(Gradual)
• Legal
Req’ments
• 3d Party BI/PD
• Chemical
Content
• Emerging
Issues
Product
• Waste Disposal
Liability
• Natural
Resource
Damages
• 3d Party BI/PD
• Legal Defense
• Emerging Issues
• Off-site
contractors
Off-Site
Exposures
Process/
Site
Pollution Conditions Driven by Site Use
What goes on now? What went on in the past?
26. MARSH 25
Risks Profile Vary Significantly based on Industry
Agriculture Healthcare
Automotive Industry
Aviation Manufacturing
Chemical Marine
Education Tech & Telecom
Forestry Products Transportation
General Industry
27. MARSH 26
Environmental Issues in Real Estate Transactions
Storage Tanks
• Aboveground and underground
Asbestos
• Asbestos is a mineral fiber that was commonly
used in many building materials prior to being
banned in the early 1980’s.
Lead Paint
• Lead was a common ingredient in paint prior to
it being banned in 1978.
Mold
• Cleanup and health impacts
28. MARSH 27
Environmental Due Diligence
• Has evolved for risk identification and to facilitate some protections to
“innocent landowners”
• All Appropriate Inquiries (AAI)
• Transaction Screen Reports
• Phase I Environmental Site Assessment
• Phase II limited subsurface investigation report.
– “To do or not to do. That is the question”
• Baseline for insurance solutions
29. MARSH 28
Regulation
• Various governmental agencies either require that banks conduct
environmental due diligence or have a procedure in place for addressing
environmental issues.
• Office of the Comptroller of the Currency (OCC)
• Federal Deposit Insurance Corporation (FDIC)
• United States Small Business Association (SBA)
30. MARSH 29
Borrower Objectives
• Unnecessary discovery, action and costs
• Governmental reporting
Minimize due diligence particularly Phase II investigations
• Minimize environmental costs to operating financials
• Eliminate risks that could be enterprise threatening
Operating portfolio risks
• Initial financing
• Refinancing
• Securitization impacts
Secure favorable financing
• Costs and Uncertainties
• Indemnities
Address environmental obstacles to enable successful acquisitions and divestitures
31. MARSH 30
Lender Objectives
Dealing with Outstanding Bad Loans
Minimize Loan Credit Risk
• Environmental costs to borrower could result in default.
• In the event of default, Lender can be responsible for the cleanup .Exercised
significant management control
• The cost to remediate the contaminated property can exceed the principal amount of
the underlying loan.
• Business Impacts:
̶ Corporate Lending Standards. May pass on otherwise manageable &
profitable loans.
̶ Drives due diligence requirements onto Borrower which can be in conflict with
Borrower’s goals.
• Facilitating Sale of assets
• Dispose of liability at favorable terms
• Control Environmental Risks
̶ Unknown pre-existing conditions
̶ Known cleanups
32. MARSH 31
Common Objectives
• Address Costs and Enterprise threating risks from:
– Unknown pollutions conditions
– Known cleanups
• Complete All Appropriate Inquiry but minimize-eliminate unnecessary
Phase II work
• Explore cost-effective alternatives to address environmental risks
around objectives
33. MARSH 32
ENVIRONMENTAL RISKS ON PORT &
TERMINAL FACILITIES
SAMANTHA RUNYON
SENIOR VICE PRESIDENT
GLOBAL ENVIRONMENTAL PRACTICE
34. MARSH 33
Environmental Insurance
Environmental Insurance Tools
• Pollution Legal Liability / Environmental Impairment Liability
• Lender Liability / Secured Creditor
A Strategic Risk Management Tool
• Can provide coverage for claims related to both historical and operational
pollution conditions.
• Can provide coverage for “unknown” environmental conditions and regulatory
re-openers/changes in regulations.
̶ Cleanup costs
̶ 3rd party liability (bodily injury and property damage)
̶ Legal defense
• Available on both individual transaction and on a portfolio basis.
• Can protect either or both the lender and/or borrower.
35. MARSH 34
Environmental Insurance Tools
Pollution Legal Liability vs. Lender Liability
Feature Pollution Legal Liability Lender Liability
Overview Designed to provide protection for
unforeseen / unknown contamination
Designed to provide protection from financial
loss due to a pollution event
First Named Insured Typically borrower however can be
lender.
Lender can be added via a additional
insured mortgagee
Lender
Cleanup Costs Yes, for new releases or unknown pre-
existing conditions
Yes, for new releases and unknown pre-
existing conditions. Can also include
coverage for known conditions.
3rd Party Bodily Injury /
Property Damage
Yes Yes
Trigger 1st party discovery or 3rd
party/governmental claim
Dual Trigger: Default on loan and pollution
event. 1st party discovery is provided only
after lender has foreclosed on property
Claim Payment Cleanup costs and/or 3rd party liability
claim(s)
Lessor of outstanding loan balance or
estimated cleanup costs
Maximum Term 10 years Can be provided up to maturity of loan
Underwriting Environmental reports Underwrite to financials (collateral, equity,
etc.) as well as environmental reports
available
36. MARSH 35
Environmental Insurance Tools
Pollution Legal Liability vs. Lender Liability
Feature Pollution Legal Liability Lender Liability
Markets 20+ XL and Zurich
Limits Over $250M+, carriers willing to sit
excess of each other
$50M
Known Conditions Excluded Can be covered based on financial risk
Individual Transaction Yes, benefits are:
• Addresses environmental concern
• Can be used in lieu of financial
guaranty or escrow
• Can be placed quickly
• Dedicated limits for property
Yes, benefits are:
• Addresses environmental concern
• Can be used in lieu of financial guaranty or
escrow
• Can be placed quickly
• Dedicated limits for property
Portfolio Transaction Yes Yes, benefits are:
• True risk transfer mechanism
• Streamlines the loan process
• Cost of insurance is typically less than a
Phase I
• Can provide lender a competitive
advantage
• Can add sites as necessary
37. MARSH 36
Environmental Insurance – Known Conditions
Cost Cap / Remediation Stop Loss
Insures cost overruns and controls price uncertainty on Remediation – Cleanup Projects
• Actual extent of contamination is greater than estimated.
• Actual degree of contamination if greater than anticipated.
• Previously unidentified contaminants have been discovered.
• Increased time for remediation (capital implementation and O&M).
• Offsite cleanup of contamination adjacent to the covered site is assumed.
• Changes in Cleanup Standards.
• Governmental change in cleanup requirements.
Coverage available through AXIS and BEAZLEY
• Limits up to $10M - $15M per project.
• Terms up to 10 years.
• Upfront cost is premium and associated taxes.
• Pricing: Rate on line 15-17%, Buffer 30 to 45%, Co-insurance 10%.
38. MARSH 37
Environmental Insurance – Known Conditions
Environmental Liability Buyout or Guaranteed Fixed Price Remediation
Environmental Liability Buyout
• Is the contractual transfer of cleanup obligation and other liabilities to a third
party contractor.
• Contractor also assumes liability with agencies.
• Environmental insurance covers the third party and client.
• Requires full funding of remedial costs and associated risk transfer
elements at the time of the transaction.
Guaranteed Fixed Price Remediation
• Client retains environmental liability.
• Third party contractor provides fixed costs bid to achieve end-point for
cleanup.
• Insurance covers client and the third party.
• Initial out of pocket costs is the insurance and associated taxes.
40. MARSH
Panelist Contact Information
DIANNE CROCKER
EDR Insight
Principal Analyst
+1 203 783 8156
DCrocker@edrnet.com
SAMANTHA RUNYON
Senior Vice President
Marsh’s Global Environmental
Practice
+1 213 346 5759
samantha.j.runyon@marsh.com
JARED DUBROWSKY
Vice President
Marsh’s Global Environmental
Practice
+1 212 345 4641
jared.dubrowsky@marsh.com
ED MORALES
Senior Vice President
Marsh’s Global Environmental
Practice
+1 415 743 8023
ed.r.morales@marsh.com
41. This document and any recommendations, analysis, or advice provided by Marsh (collectively, the “Marsh Analysis”) are not intended to be taken as advice
regarding any individual situation and should not be relied upon as such. This document contains proprietary, confidential information of Marsh and may not be
shared with any third party, including other insurance producers, without Marsh’s prior written consent. Any statements concerning actuarial, tax, accounting, or
legal matters are based solely on our experience as insurance brokers and risk consultants and are not to be relied upon as actuarial, accounting, tax, or legal
advice, for which you should consult your own professional advisors. Any modeling, analytics, or projections are subject to inherent uncertainty, and the Marsh
Analysis could be materially affected if any underlying assumptions, conditions, information, or factors are inaccurate or incomplete or should change. The
information contained herein is based on sources we believe reliable, but we make no representation or warranty as to its accuracy. Except as may be set forth in
an agreement between you and Marsh, Marsh shall have no obligation to update the Marsh Analysis and shall have no liability to you or any other party with
regard to the Marsh Analysis or to any services provided by a third party to you or Marsh. Marsh makes no representation or warranty concerning the application
of policy wordings or the financial condition or solvency of insurers or reinsurers. Marsh makes no assurances regarding the availability, cost, or terms of
insurance coverage.
Marsh is one of the Marsh & McLennan Companies, together with Guy Carpenter, Mercer, and Oliver Wyman.
Copyright 2015 Marsh LLC.
All rights reserved.