The real estate industry has historically seemed immune from environmental risk. But the real estate lifecycle—whether for a single property or a portfolio of properties—encompasses many operations that include environmental risk components.

This edition of Marsh’s Environmental Risk Quarterly will focus on environmental risks in the real estate industry. It should be noted that many of the environmental risks examined here are universal—also affecting such industries as healthcare, retail, and communications, media, and technology.

Portions of the real estate lifecycle in which environmental risk plays a role include:

• property acquisition;
• property financing and investing;
• property development;
• property operation and management; and
• property divestiture.

Property Acquisition

The primary environmental risk to any entity during property acquisition is the failure to adequately screen one or more properties for environmental liabilities prior to acquisition. But environmental issues may also be discovered despite thorough environmental investigations. When environmental issues are discovered, the costs to clean up pollutants may often exceed the original estimated costs that were addressed in indemnification agreements.

Property Financing and Investing

Many real estate entities are looking for ways to improve opportunities to borrow from capital markets as a means to continue operations or for project financing. At the same time, lenders have pulled back on offering financing because of higher default rates. In the current economic climate, lenders and investors are now managing growing portfolios of foreclosed properties that may have environmental risk—which could create challenges in assessing exposures within a real estate portfolio and delay the appropriate “work out.” Environmental risk can limit the ability to monetize foreclosed properties at their maximum values.

Property Development

A chief exposure of real estate entities during property development is from contractors or professionals, who could be inadequately insured for environmental releases during construction activities on-site. Another significant environmental exposure during redevelopment projects is the potential to discover unknown pollutants or incur greater costs than originally anticipated to address known pollutants.

Property Operation and Management

Chemicals emitted from building operations can affect third parties, such as contracted management companies, dry cleaning establishments, and asbestos/lead abatement projects. Residual contamination from minor spills of maintenance products—including oils, fuels, and lubricants—could affected a property’s soil or groundwater. Indoor air quality exposure, such as mold or legionella can affect third party tenants or guests. Though it has not generated much publicity, claims are still being tendered to environmental insurers regularly for mold and legionella.

Property Divestiture

Buyers today are looking more closely at environmental risk issues and conditions at properties and have a much lower environmental risk tolerance. Problems, such as time limits or gaps in liability protection, with indemnification agreements, typically used to address environmental concerns during the purchase of real estate, can ensue. Sellers may be subject to counterparty credit risk if there is a “failure to perform” with respect to their indemnity obligations.

Recent Real Estate Claims Activity

The Marsh Environmental Practice monitors environmental claims activity on a regular basis. The following are a few significant recent claims affecting real estate entities:

• A federal court recently ruled that a property management company would not be covered under its general liability policy for claims against the company alleging that it hired a landscaping company at a golf course that contaminated the area with a toxic herbicide. The claim was denied because of a pollution exclusion in the management company’s general liability policy.
• A homebuilder was ordered by environmental regulators to pay a civil penalty of $625,000 to resolve alleged Clean Water Act violations at its construction sites. The company was also ordered to conduct inspections of its construction sites to minimize future runoff from those sites.
• A real estate client of an environmental insurer was involved in a mechanical failure of the controls of an elevator car which caused a capacitor to explode, dispersing oil containing polychlorinated biphenyls (PCBs) in the immediate vicinity. One commercial tenant was evacuated. The environmental insurer paid in excess of $100,000 to resolve the claim.

Environmental Insurance Solutions

Environmental insurers have products that can specifically address the environmental risks that stem from every phase of the real estate lifecycle. These products can be designed to provide coverage for one property or for a portfolio of properties. In some instances, portfolios can be categorized and priced according to their risk profiles and premium caps can be placed on future premiums for similar categorized sites. In addition, programs can be designed to offer premium relief for properties taken out of a portfolio of sites or to offer premium certainty for properties that will be rolled into an existing portfolio.

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