The Million-Dollar Environmental Problems You Won’t Find in a Phase I

Most industrial property acquisitions include a Phase I Environmental Site Assessment. Many also include a Phase II. But what if some of the biggest environmental liabilities aren't covered by either? 

In this episode of Tank Talk, Shannon and Haley explore the environmental compliance risks that often go unnoticed during due diligence and why those risks can impact valuation, profitability, financing, insurance, and future operations long after a deal closes. 

From missing permits and poor recordkeeping to overdue inspections, infrastructure documentation gaps, and compliance history, the team discusses the operational environmental issues that buyers, sellers, lenders, and investors should evaluate before acquiring industrial assets. 

Whether you're involved in mergers and acquisitions, private equity, commercial lending, or industrial facility operations, this episode provides practical insight into the environmental risks that may not appear in a traditional Phase I or Phase II assessment. 

Because when it comes to industrial acquisitions, contamination isn't the only environmental liability worth investigating. 

Transcript

Welcome And Why Compliance Matters

Haley Hall 0:09

Welcome to Tang Talk with Integrity Environmental. Join us as we sit down with founder, principal consultant, and bulk fuel storage expert Shannon Olbers to explore regulations, safety, and essential tips for navigating the bulk fuel storage industry. Join us as we explore the unique joys of work and life in Alaska with industry experts, including our team, vendors we work with, and the companies we support.

Industrial Sales Shift To Private Equity

SPEAKER_02 0:37

Shannon, we have seen a huge increase in industrial property sales since 2020.

SPEAKER_03 0:43

Oh, yeah. We're definitely seeing that trend across many of the industries we serve. We're also seeing a shift in ownership. Like 10 or 15 years ago, Haley, I think all the industrial facility acquisitions we were part of were strategic buyers rolling up competitors or expanding their footprint in communities. Now we're seeing a lot more private equity-backed ownership, and those groups tend to evaluate risk a little differently. Sort of changing the landscape. Fun fact, also at the same time, we're seeing environmental and operational compliance requirements that are a lot more extensive than they were a decade ago. And in the olden days, when I first started this business, environmental compliance issues were viewed as something that could kind of be cleaned up after a transaction closed. The cost was usually small enough that it didn't really affect the deal. Shannon, why is this becoming more important now? Well, private equity ownership has increased, like I said, and holding periods are shorter. They don't hold on to facilities forever. They have a window. And those environmental compliance issues can directly impact things like EBITDA, valuation, financing, and exit timing, which is words I never used in a facility trade or a facility purchase 10 years ago, but they are really important to these private equity buyers.

SPEAKER_02 2:02

So are you saying costs are higher now and that they will impact the deal significantly?

SPEAKER_03 2:08

Yeah, that's exactly what I'm throwing down, Haley. We routinely see deferred environmental compliance, aging infrastructure, poor record keeping, permit deficiencies, operational gaps, all these things translate into enforceable corrective actions or violations. And those costs can range from hundreds of thousands to millions of dollars to resolve. So environmental compliance is not really a minor line item in a sale anymore. In some cases, it can really impact evaluation, financing, insurance, and whether you even proceed with the deal at all. We've kind of moved beyond the let's straighten it out on the back end era. The cost of straightening it out is just too big to ignore anymore. And yeah, buyers and lenders should be really paying a lot closer attention to these types of risks before they sign.

SPEAKER_02 2:53

Wow. Well, I'd really like to dive deeper on this topic. We had a recent podcast suggestion from an MA specialist. The request was for can you talk about environmental compliance beyond phase one and two ESAs? What should buyers be paying attention to when buying

Phase I And II Are Limited

SPEAKER_02 3:12

bulk fuel farms?

SPEAKER_03 3:13

Oh, that is a great question. And that explains why you asked me about sales. Phase one and phase two are just the very tip of the environmental iceberg.

SPEAKER_02 3:24

So why do you think he mentioned phase one and two ESAs? Are they a first step in an acquisition?

SPEAKER_03 3:30

They're not the first step, but they are part of the due diligence process. Phase one reports are required for most bank loans. They focus on the potential for pollution or contamination to be present at the site. I would say most industrial property sales involve a phase one ESA report. Phase two ESAs, they go a little further by performing analytical or a physical investigation of potential or recognized environmental conditions. But, and this is a pretty big but, phase one and phase two ESAs do not cover environmental compliance related to operations. It's just looking at the contamination potential. I do think there's a common misunderstanding for people outside of our industry. They kind of assume a phase one covers all environmental liability because it this sounds silly, but it just has the word environmental in it. And so they're like, I have the environmental report. Everything must be good to go. I think it's important to understand that there is a whole world of liability on the operations side that savvy acquirers need to pay pretty close attention to.

SPEAKER_02 4:29

Well, what can a buyer do to address environmental compliance?

SPEAKER_03 4:34

Well, during regular due diligence, you can perform an in-depth audit of environmental compliance related to operations, environmental due diligence, if you will. And our firm does that very frequently.

SPEAKER_02 4:46

What should a good environmental compliance audit cover?

SPEAKER_03 4:50

Well, I want to keep this podcast within an hour so that I cover the basics that our firm follows. But listeners, keep in mind that a true audit should go deeper on each of these basics. And depending on what industry you're looking at, there will be other critical audit items that we don't cover in this more general podcast episode. The difference between purchasing a seafood processing facility and a bulk fuel farm, for example, there's a lot of different audit pieces that are different for those two different industries.

SPEAKER_02 5:20

I'm assuming this is where I interject with our reminder that we are not lawyers, and this podcast is for informational purposes only and is not a substitute for professional legal or regulatory advising. Yes.

SPEAKER_03 5:34

Yes.

SPEAKER_02 5:35

Wave that legal disclaimer wand, Haley, please. Okay, well, wand has been waived for informational purposes only.

Permits And Records Buyers Must Verify

SPEAKER_02 5:43

Let's just start with permits.

SPEAKER_03 5:44

Okay. If you are investing in a particular industrial sector, you should really be aware of or have a knowledgeable consultant working with you that knows what permits are typically required and when they were last updated or renewed or due for that. And then just a reminder: there are federal, state, and sometimes local levels of permitting, and you need to check all three. All three could apply and have pretty significant impacts if you're crosswise with them. If there's any common permit that is missing, there should be documentation of why it's not in place. You should never take a seller's word for it that a permit just isn't needed or doesn't apply. We do hear that quite a bit. Remember from previous podcasts that most federal permitting always applies, and you have to either have a permit or have a documented exemption. If there is nothing in place, just a blank space for something like air or water permitting, that's a pretty big red flag for us.

SPEAKER_02 6:37

What about all of the record keeping reporting that goes along with these permits?

SPEAKER_03 6:42

Well, that's a good question. Much like accounting records, environmental record keeping can also be manipulated to show a very rosy picture. And then you walk the yard and realize it is complete and utter fabrication. Environmental compliance records should be treated like audited financial statements. And what our firm does is we typically request the last couple years of annual reports and we look at what's being reported and the attention to detail, how much pencil whooping is going on. And then we also typically, you know, standard auditing practice will ask for every record from a random month two years ago just to see what they've got on hand for that. And then what we typically see is most sellers have some, but not all of these things. If they've got absolutely nothing to provide, though, that's a big red flag for us. And then I do want to point out that for a record keeping audit to be truly successful, it does need to have some kind of site visit component. You got to go and look at the facility, the yard, the infrastructure, the housekeeping, like all those things can be really beautifully portrayed on an inspection checklist, but maybe completely false in real life. And you gotta match the two up.

SPEAKER_02 7:50

So we covered permits and reporting and record keeping, which takes care of the now. But does an acquire need to look back in time too, Shannon?

SPEAKER_03 7:59

Yeah, yeah,

Compliance History And Major Inspections

SPEAKER_03 8:00

they do. Compliance history is very important part of environmental due diligence. You want to ask the seller to disclose any ongoing compliance cases or notices of violation, and then you're gonna do your own records research and sort of see if they've left anything out or misrepresented things. You know, true it up, trust but verify. That's what I like to say. What we look for is a chronic history of violations, spills, or poor inspection performance. For example, we we recently did this for a seafood processing facility. And online they had a permit. It was current, but when we went into the reporting database, there was a three-year history of zero submittals. No annuals, no monthlies, no nothing. Big old zero. That clued us in that we needed to dig a little deeper.

SPEAKER_02 8:49

So, how about required third-party inspections? Those can be pretty spendy. Should acquires be aware of inspection schedules?

SPEAKER_03 8:58

Absolutely. Especially if a facility involves pipelines or tank assets. Mini inspections such as STI SP001 and API 653 internals, they're due every 10 or 20 years. They can be incredibly expensive, not only in the cost of the inspection, but for API 653 internals, you have to take the tank down and clean it and not use it during the inspection time. So you're kind of losing your throughput for that tank for that time period. You're gonna want to be very aware of when those inspections last occurred and when they will next occur. And if they're all due in a couple years, you could be acquiring a large costly future liability. A special note for our listeners on tank assets: if the tanks are older than 10 years in age, it may be smart to get an inspection done prior to completing the sale to ensure you're getting a usable asset. This can also be a pretty smart strategic move to shift inspection costs to the seller because all these inspection intervals reset when you do these inspections, and that gives you a fresh 10 or 20 year window, assuming all these tanks pass the inspections, before this cost is due again. I do want to make sure to include a caveat here though, Haley. There are different qualities of inspections and there are limitations to what an inspection report can tell you. So make sure you understand the scope of the inspection and what it specifically can or cannot tell you about the asset. Just because the tank has a current tank inspection does not necessarily mean that you have a tank ready to perform well for the next 20 years. This topic could honestly be its own entire podcast subject, and maybe we'll do that in the future. But for now, if you are looking at acquiring a facility that has some kind of tank assets, keep the things I just talked about in mind.

MSGP Benchmark Monitoring Course Message

Commercial 10:41

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Inspection Files And Facility Schematics

SPEAKER_02 11:36

We do know from past podcast episodes that engineering standards require certain inspection records to be kept for the life of the tank or equipment. But what happens during the sale? Do those records just start over with a new owner? No.

SPEAKER_03 11:53

No, no, they do not start over at all. This is a real common problem that we run into. It is critically important to receive from the seller any past inspection records, strapping charts, construction schematics for all your major infrastructure. This includes tanks, piping, containment structures, drainage pathways. This is very commonly overlooked and it creates huge problems for compliance in the future. Like we get brought in to write an SPCC, and if I don't have any of the schematics, I don't know how big the containment area is, I don't know how old the tanks are, I don't know when they got last inspected. Those all become compliance issues for your spill prevention plan. And then it also really hinders capital expenditure projects in the future because you're going to have to pay whatever engineering firm you hire to come in and map your facility because you have nothing existing to give them. So something as simple as a pipe jump addition to, you know, move fuel from one tank to another can end up being several magnitudes higher cost because you got to go in and map everything and figure out where all the stuff is first. So I just, yeah, they don't start over. You need to request them and they need to be a part of your checklist. You can't just let that slide. I would say 99% of the issue with getting these records in real life is that they're on somebody's computer or in someone's email, and they're the seller doesn't have them organized and ready to go. And the due diligence window is only 90 days or 120 days, and they just can't get it all together along with all the other things you need to do for a sale on the financial side. And so they just don't get conveyed. They kind of get lost in the shuffle. But this one thing can be a pretty significant expense all on its own, and that's not even related to environmental compliance. That's just operating the tank farm.

SPEAKER_02 13:35

Oh, well, I'm so glad I brought that up. It sounds like such a critical thing to make sure not to miss. So far, we looked at this from the acquirer's perspective, but do you have any advice for the sellers?

Seller Prep That Protects Valuation

SPEAKER_02 13:47

Oh yeah.

SPEAKER_03 13:47

Oh yeah, I sure do. Everything we just discussed, we also perform for our clients preparing to sell a facility or asset. Performing the environmental compliance audit like this can be a way for you to improve the value of your facility ahead of the sale. It also removes a lever that an acquirer might use to drive down the price. Sometimes, even if you are compliant, like I just mentioned, if your records aren't organized or complete, you're not going to be able to prove compliance to the acquirer within that time frame of due diligence, and they will use that as a lever to drive down price. So having your environmental records organized and ready act just like having audited financial records. It shows an acquirer, your low risk, high value, and it reduces the workload on your team during due diligence. So this can often be a good first step towards getting your property ready for sale before you even enter the due diligence. It also gives you an idea of where your gaps are and where you need to strengthen.

SPEAKER_02 14:38

Great. Well, we've talked about buyers and sellers, Shannon, but this podcast idea originally came from the banking side of this equation.

Lenders And Insurers Price The Risk

SPEAKER_02 14:47

So what should lenders be worried about when it comes to environmental compliance liability? Literally the bottom line, Haley.

SPEAKER_03 14:57

That's so fun to say that. Environmental liabilities don't come out of revenue, they come directly out of cash flow and profitability. So if a facility suddenly requires a million-dollar corrective action project, that can really impact things like debt service and financial performance in the future. And like we said before, these corrective actions and settlements can take years to process. So that liability can linger and impact profitability for a long time.

SPEAKER_02 15:24

Is that it though? Are there any other stakeholders that are potentially impacted by these environmental liabilities during an industrial property sale? Almost.

SPEAKER_03 15:33

We can't forget to talk about insurance and shout out to all my friends in the insurance biz. I see you. Environmental compliance does affect insurability. When we're auditing an acquisition, we're not just looking for potential regulatory problems. We're looking for things that could increase premiums, create coverage exclusions, PFAS, I am looking at you, or make the asset difficult to insure altogether. In many cases, insurers and lenders are evaluating the same things we are: asset condition, inspection history, spill history, maintenance practices, and operational controls. It's just risk evaluation through different lenses. The key takeaway here, though, is that if there's a lot of environmental compliance issues with the property, it can be very expensive to insure or may not be insurable at all. And what we typically see in real life is that if a facility has a strong history, especially of like spill history, it may bump you out of one class of insurance and bump you into a much higher level of insurance and rarely make it uninsurable. And it's a huge impact to the value of the property and profitability. And so I back to the whole theme of this podcast. You need to know these things before you purchase because it can really affect all of your calculations. If this is gonna bump you into a higher insurance bracket, you need to know right away before you have a sale price offered.

Do Permits Start Over Yes And No

SPEAKER_02 16:55

Shannon, before we had this conversation, I was under the impression that when you buy a facility, all of the permits and environmental compliance just starts over. Is that true?

SPEAKER_03 17:08

I'm gonna give you my favorite answer, which is yes and no.

SPEAKER_02 17:12

Great.

SPEAKER_03 17:14

If you are transferring past permits from the old owner into the new entity's name, the seller may not have compliant permits to start with or good record keeping systems in place. And if you continue operating what's in place, you will be inheriting any problems the old system had. For private equity or family offices, this can be an especially bad blind side because they aren't operators. They don't, they don't know what's right or what's wrong. And if all the same staff stay in place and they keep doing what they've always done a couple years into that acquisition, you're gonna get an audit or an inspection from an agency and it's gonna be a complete bam blind side that all these things were wrong and had been wrong and should have been fixed years ago. So, yes, they do start over, but no, you still need to do some due diligence and understand how compliant what you're inheriting is.

SPEAKER_02 18:03

Can past compliance issues transfer? I just always thought that if the previous owner got a violation, that it would be their problem, not the new owner's.

SPEAKER_03 18:11

You know, Haley, for mini permit violations, that is true. If the past owner didn't do monthly inspections, for example, the new owner won't be on the hook for that. But for things that the permit requires, like testing, monitoring, inspections, those tests need to be completed to maintain the permit. And if the seller hasn't done it, the new owner will be responsible for getting those required samples or inspections completed. A good example of this is the API 653 internal inspection on a tank. In the permit, it will show that the last internal 653 inspection was due, let's say, three years ago. Once you buy the property and you amend the permit, the state or federal agency will require that overdue inspection to be performed immediately. Now, most agencies are willing to work with an acquirer to get a reasonable schedule in place and get caught up, but you don't want to be caught unaware or go into ownership not even knowing you're behind on it. It just adds more expenses to that first year of operation.

SPEAKER_02 19:06

How big of a red flag is it if a seller is not showing up as compliant or not being very transparent about their environmental compliance?

Haley Hall 19:16

Hmm.

SPEAKER_03 19:16

I think that depends on the kind of seller you're working with, Haley. We work with all kinds. And, you know, the small mom and pop shop that's selling after 40 years in business, they're not as sophisticated. They haven't kept up with permitting very well. And I'll be honest, it's probably a big part of why they're selling, like, you know, the good old days. They don't like all the new permit requirements and all the stuff they got to keep up with it. In my mind, that is less of a liability than a larger multi-facility company that's showing blatant disregard for permitting requirements and they're sort of artfully dodging compliance costs. I feel like they bring that same energy to the sales table and to their finances. And to me, that's just a bigger red flag as an auditor.

Red Flags And Limits Of Deal Clauses

SPEAKER_02 19:56

Could the buyer just tie environmental compliance in as a condition of the sale?

SPEAKER_03 20:02

Hmm, I'm not a lawyer, but yes, I'm I'm sure you could. Lawyers can do anything. But, and this is another really big but how much of the sale price do you tie into the potential for compliance issues? I have seen violations settled for $8,000. I have seen violations settle for $3.4 million. Same kind of violation. Just depends on where you're at, what kind of facility it is. It's such a huge range, it's very difficult to predict what that final cost of any particular compliance resolution will be. So I think listeners should walk away from this podcast, just aware that there is so much more beyond phase one and two reports. There's a whole world of environmental permitting compliance that should be part of your due diligence process, and it cannot be easily controlled by just including a full compliance clause as a condition of sale. I don't know that you could claw back a $3.4 million settlement issue out of a sale. It's hard. So just like accounting records can be manipulated to show that beautiful picture, I just want to reiterate that environmental compliance records can do the same thing. It's better to ask your questions up front and make that purchasing decision with all the information.

SPEAKER_02 21:08

So do different kinds of acquirers need to pay attention to different

Buyer Types And Different Risk Windows

SPEAKER_02 21:12

things?

SPEAKER_03 21:13

Absolutely. So private equity groups, which is what kicked off this whole conversation, when they acquire an industrial business, they're looking to create this attractive investment package, right? They want controlled, predictable profitability profiles. They typically have a five or seven year window to get their operational system savings in place and show a good, strong profitability history. Hidden environmental compliance issues throws a huge wrench into that timeline. And it's really hard to sell a turnkey business package with significant state or federal violations in progress at one of the facilities. And then remember, most environmental compliance issues take years to solve. And that resolution costs a lot just for the violation itself, but also you're going to have legal and consulting fees to help you navigate all of this resolution. It blows up all the financial modeling because all of this stuff comes directly out of a profit. It's not built into the model of the business. So for that kind of acquirer, this stuff is critically important because the window's so short. For longer-term acquirers like strategics or family offices, the cost to resolve environmental issues can still be important, but it's less impactful than for our shorter-term acquirers. And then for these longer-term buyers, poor permitting coverage could actually be an opportunity to buy at a lower price and then increase the value of the property over time and reduce the risk profile of that asset. And it's sort of like protecting your future profitability or increasing your future profitability. But it could also be a landmine that impacts the performance of that asset portfolio for years. So in the end, I think all kinds of buyers need to better understand the risks they're potentially bringing aboard with a purchase so they can predict success better.

Compliance Versus Contamination Final Takeaways

SPEAKER_02 22:51

Well, as we wrap up this episode, I just want to emphasize that environmental contamination and environmental compliance are not the same thing. Most acquisitions evaluate contamination risk through phase one and phase two environmental site assessments. Far fewer evaluate operational environmental compliance risk. Even through operational compliance issues, they can have an equal or greater impact on valuation and the future profitability.

SPEAKER_03 23:20

Yeah, if you're involved in this type of sales, it's pretty critical to understand these type of risks and how to mitigate them. I want to thank our MA listener for the suggestion. This was a really fun podcast topic and uh shameless plug. We're really good at these kind of audits. We do them all the time. We help buyers understand the full cost of the acquisition before the deal closes, and we can help sellers get their highest potential outcomes. Thank you everyone for listening today. Hi there, this is Shannon Olkers. And as the owner of Integrity Environmental, I wanted to take a minute here at the end of the podcast to make sure that you knew the following. This podcast is for informational purposes only and should not be considered legal or regulatory advice. We are not responsible for any losses, damages, or liabilities that may arise from the use of this podcast. This podcast is not intended to replace professional, regulatory, or legal advice. And the views expressed in this podcast may not be those of the host, that would be me for Integrity Environmental. Thank you very much for listening. And if you do need professional regulatory advice, we'd be happy to help you as part of our consulting services.