How I Bought a Retail Property and Entered the Hell of Regulatory Interpretation

To quote Ringo Starr, “I’m certain that it happens all the time.”

By John E. McNellis, Principal at McNellis Partners, for The Registry:

One truth that bears learning is this: News is very seldom as good—or as bad—as it first appears. Even when it comes out of Washington, D.C. If you exult over making a fistful of money, you will soon recall that half goes to the government; when you lose your shirt, your accountant will remind you of its deductibility and the government’s share in your folly.

Two months ago, we bought a Rite Aid drugstore in northern California. Now, we’re replacing our acquisition financing with long-term debt. As with every real estate loan in America, our lender is requiring a Phase I environmental report to verify the property is free of hazardous materials. Because shopping centers are typically constructed on raw fields or farmland, only two types of underground contaminants usually bedevil them: gasoline and dry-cleaning solvents. That is to say, contamination of retail centers almost invariably comes from within, from their own leaking gas stations and dry cleaners.

From this common knowledge, veteran retail buyers work off a rough syllogism along these lines: Almost all old dry cleaners leak; my center has an old dry cleaner; I sure as hell better have mine tested. And, conversely, even the most prudent buyer will be unconcerned with contaminants if her property went from farm to drug store, if neither it nor its neighboring properties ever housed a gas station or dry cleaners and if no toxic spill or environmental clean-up has ever been reported in the surrounding neighborhood.

This was the precise situation with our Rite Aid, causing us to be less worried about contamination issues than ballistic missile strikes. But we still needed a Phase I environmental report. As you know, a Phase I is simply a research paper that sets forth a given site’s historical uses, and whether any contaminants are known or suspected to be affecting it. If a site has no history of uses giving rise to the possibility of contamination, if nothing in the public record suggests contamination from a nearby source, the Phase I concludes that no further action is required.

Given our site’s history, the environmental consultants should have given it a clean bill of health. Instead, they found that the presence of a dry cleaner (one with no known history of spills or contamination) two parcels away from ours was enough to warrant drilling our property. This irresponsibly cautious conclusion could have blown the loan and caused us a small world of grief. Fortunately, our lenders are the best in the business and they concluded that, rather than drilling our property, we should boot the consultant.

Why was this consulting firm overly cautious? Was it trying to get more business for itself or was it reacting to the relentless march to the sea of environmental regulations?

It’s fair to say the goal of most governmental regulations is well-intended, even high-minded. For the sake of argument, you might even concede that the majority of regulations—e.g. requiring hard hats on construction sites—are good rules. But it only takes one burr under the saddle to make a horse buck.

Protecting the public from known cancer risks is a noble aspiration. It is in the implementation of this goal, deep down in the bureaucratic trenches, where needless economic tragedy occurs. If the devil is in the regulation, hell is in its interpretation, especially where bureaucrats have little understanding of the business they’re regulating. Is the public truly at risk from trace amounts of undisturbed contaminants thirty feet below an asphalt-sealed surface?

Until last year, environmental regulations over hazardous waste were becoming increasingly stringent, the actionable levels of dry cleaning solvents, tetrachloroethylene, trichloroethylene and their kin (collectively, “perc”) approaching damn near zero parts per billion. Do deals blow over environmental reports? Every day. Can a shopping center be cast into economic purgatory by requiring a horizon-less remediation of a spill that everyone save the regulators considers inconsequential? To quote Ringo Starr, I’m certain that it happens all the time.

A couple of months ago, I attended a gathering of a couple hundred real estate entrepreneurs. One speaker, a Texan whose name you would recognize, addressed the group with a rosy outlook for the next several years. He said, “With this president, you can be sure of at least two things: Taxes sure as hell aren’t going up, and we’re not getting any new regulations.” Despite the preponderance of liberals in the assembly, a couple hundred heads nodded in agreement.

In fact, the whole business world has been nodding in agreement, the stock market is on a tear based in no small part upon this knowledge, the economy is roaring, real wages are rising and unemployment is inching ever lower. The news out of Washington is not all bad. Give the devil his due; the economic news is good, and it’s not all a serendipitous coincidence. And if the administration would somehow pick out the ridiculously-implemented burrs while leaving the hard hats in place (yes, given its scorched-earth approach, that’s highly unlikely), the news would be that much better. By John E. McNellis, author of Making It in Real Estate: Starting Out as a Developer. The article was first published on The Registry.

The lowest hanging fruit of them all: Airbnb and its ilk. Read…  How to Face the Housing Crisis in Expensive Cities

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  35 comments for “How I Bought a Retail Property and Entered the Hell of Regulatory Interpretation

  1. Andrew says:

    We had a similar experience with a Vancouver City Building Inspector, who twice refused to pass a house I was helping to build. The owner/foreman finally asked for another inspector, and it passed.
    I don’t want to quibble, but With a Little Help from my Friends was written by Lennon-McCartney, and thus not attributable to Ringo.

    • Joan of Arc says:

      Andrew, the last thing we needed was for you to quibble over the Ringo thing. We’re discussing a business neighbor 5 doors down accidently spilling a little cleaning fluid and the next day the government shows up with a drilling rig and a permit to bore an 8″ diameter hole through your roof and floor down into the ground 600 ft. below the surface looking for any chemical traces. They are going to find something even if it’s only a subterranean termite mound. The tab? Only $8 million for a $2 million building and business that was purchased for $30,000 down. Needless to say the owner walked and the place is still vacant.

    • alex in san jose AKA digital Detroit says:

      “If you come up with a really pithy saying or song, but someone associated with you is more flamboyant, sure as shootin’ it’ll be attributed to them” – Mark Twain.

      (Not really by M.T. as far as I know, but he’s much more memorable than “Alex in San Jose AKA Digital Detroit”.)

  2. Paulo says:

    Or, in nearby Campbell River all building inspections are now simply signed off by an engineer, requiring an additional few thousand dollars to guarantee an over-build. Likewise, septic systems have to be installed by a ‘certified’ (engineered) contractor, electrical requires a $1,000 + ‘permit’ which in my case on a recent build was not even inspected, and wells now have to be registered. I still had to pull the permits.

    This is one reason why my current home, although built to code, is in an unorganized and non-inspection location.

    In town, WCB drives by and informs home builders they must be harnessed up or face a fine when roofing, insurance companies now require WETT woodstove inspections on top of measurements and photographs of the installation, and by-law inspectors might tell you to move a garden shed if it is too close to a property line. And if you sell, a bank requires an additional and so-called ‘home inspection’ done by someone with a certified home inspection ‘ticket’, despite not knowing anything about construction or building practices. (They take a course and work under another non-informed inspector.)

    As a long-time carpenter (40 years), I used to inspect my friends homes and they would gift me a thanks, (Crown Royal, usually). Nowadays, that won’t work. When I sold my last house the buyer was forced to use an inspection service recommended by their bank and the so-called inspector did not even go into the crawl space. When I sold my Mom’s place, ditto….and the inspector missed her flooded crawl space despite the home being located in a notorious and well known wet zone and we were selling in the middle of winter.

    A thousand or two here, or there, a few permits and stipulations and pretty soon real dinero is tacked onto to the financing charges. Add in some curbs, gutters, and storm drain connections and…..

    Crazy. Buyers, who are not in the trades, are at the mercy of those who pass the buck, and it is very very expensive.

  3. Javert Chip says:

    I know, stupid question, but if “…only two types of underground contaminants usually bedevil [shopping centers]: gasoline and dry-cleaning solvents….”, why isn’t that class of business subject to periodic inspection? Why let the contamination continue for years?

    Almost every town has abandoned gas station real estate that is almost unsalable due to clean-up expense. Why wait until the contamination spreads to other real estate before it is detected?

    • RepubAnon says:

      The thing about solvents is that they don’t stay put – being liquids, they flow along with the ground water, forming a “plume.” It’s therefore entirely reasonable to want to check on this stuff.

      One would, however, think someone would have looked at this site before, and set up monitoring wells.

      • Night-Train says:

        Gasoline and some solvents, like perchloroethlyne, can be further divided into “floaters” and “sinkers”, respectively. The components of gasoline are lighter than water so they float on the groundwater surface. The sinkers sink through the aquifer and collect on the top of the bedrock and may stay put or flow along the dip of the strata. And depending on the complexity of the geology, to determine the full rate and extent of contamination, the usual regulatory standard, may be fairly simple, or a lengthly, difficult and costly process.

        Most of the contamination from service stations and dry cleaners, predate current regulations to a time there were no regulations. All gasoline tanks leaked and dry cleaners either disposed of their solvents through a drain in the floor, which wasn’t connected to anything, or just threw it out the back door. Obviously, today’s regulations have stringent requirements on these industries to prevent soil and groundwater contamination experienced historically.

        If one is in real estate, particularly, industrial or commercial sites, they should do due diligence in selecting an environmental consultant. And develop a relationship with a reputable one.

        • Kent says:

          Correct. The issue is that we expect the next property owner to pay for the sins of the previous owner. That is blatantly unfair. If you can’t get the previous owner to pay, then the government should do it itself.

        • rvette454 says:

          Night Train,exactly and well stated. As far as further comments,”the government should pick up those costs” associated with the protection and cleanup , that would be very contrary to many as the profits are privatized and the liabilities are socialized. In this case regulations are worthless unless they are enforced equally.

    • Enrique says:

      A rule of thumb per close relative who is a developer: if a site has had a petrol station it can pretty well only ever be used as a petrol station.

      Note how many old abandoned gas stations you see in the US. Station closes and no one can ever use the property for any other purposes due to potential environmental liability issues.

      BTW I appreciate McNellis’ contributions to this site. Very insightful stuff always.

    • kam says:

      I had a lawyer that was a little light-fingered, who eventually got out of the business, only to find a far better business. He would purchase real estate adjacent to known old gas station properties, drill his property (knowing exactly what he would find), then sue everyone who was ever on title on the gas station property.

  4. Otto Maddox says:

    Ringo also said “Everything the government touches turns to crap.”

  5. Mike R. says:

    As a society, we’ve lost any proper sense of perspective on risk. The driver for this loss of perspective is money and greed, NOT anything noble or caring.

  6. Bookdoc says:

    Saw similar thing in Columbus-I worked at a dealership in downtown. Paid well but the place was falling apart-I left after a year. They had a long term heavy truck service contract that required them to service these rigs 24/7. The plan was to sell the place when the contract was up. A hospital next door wanted to buy the property for a parking garage. By the time the contract was up, the regulations for contaminant cleanup had hit and the hospital landed up moving to a suburb. The dealership still sits there, abandoned and empty 7 years later near downtown and no one has any interest due to the cost of cleanup.

  7. mean chicken says:

    So true! It’s gotten so you can’t even spray for eagles anymore.

  8. Memento mori says:

    Government actions should never judged by their intentions but by their results. The way to hell is paved with good intentions.
    Case in point, I had a rental property in San Diego and the city asked that we change all shower heads to low flow type to save water.
    I paid for the water consumption so I new exactly how much water I was using all the time. After I changed all the units to low flow shower heads, I noticed about 10 to 15 increase in water consumption.
    I was intrigued as this was contrary expectations, water consumptions was supposed to go down not up.
    After installing such a shower head in my home, I realised that you had to stay way longer under the shower because of the low flow. Not only that but after talking to the tenants, I found out that more of them were taking baths instead of showers because of the low flow shower head frustrating expereince.
    So there you have it, good intentions , bad results.

  9. Night-Train says:

    Nothing like seeing a river catch on fire.

  10. MC says:

    To quote Arnold Schwarzenegger in Last Action Hero: “No… this is California!”.

  11. Nicko2 says:

    Just another reminder why I avoid American sourced produce and food products, lack of environmental standards. I’ll take EU sourced food every time – pesticide free, and no worries of contamination. The US is quickly falling behind the shifting global economy – ie. carbon tax

    • fajensen says:

      Just getting food from the EU is not enough; It has to be “ecological” also.

      The conventional agriculture business in the EU in general are using lots of pesticides, Spain and Netherlands being some of the worst because of the very industrialised approach they take to growing vegetables.

      Then we have Monsanto, father of Agent Orange and PCB, lobbying the EU for more and getting it.

      Industrially produced pork products can be infested with MRSA CC398;

      This is a real stinker of a scandal: The Danish meat industry, which is very industrialised and therefore has a high rate of infection apparently has decided it was the more effective strategy to simply infest everything top-down via their breeding and export programmes, thus making the cleanup an EU-problem and so expensive that the Danish government will never force them to do it.

      We may have standards and principles in the EU – but we are very rapidly eroding them in the name of “competitiveness” and in order to “reduce trade barriers”. TTIP, CETA and so on are not dead, just slowed down!

  12. Petunia says:

    When I first moved to FL, I was at the bank while the exterminator was working outside. They literally had a fire hose connected to a tanker truck, hosing the grounds with insecticide. Arial spraying was also done regularly by the town. I can vouch for the town not having a bug problem, but it may be a superfund site.

    • Petunia says:

      Also, with all the major floods, especially in oil country, contamination can no longer be assumed to be contained to any single area. The regulations may no longer make sense because they can’t be enforced.

      • Derek says:

        In oil country, post-fracking, you can be sure that all water is contaminated, and will only get worse. There’s a reason there’s such good cancer treatment in Houston.

  13. Bet says:

    If Texas wasn’t so huge the whole state would be a superfund clean up site. My once beautiful 600 acre farm now a fracking farm is unlivable due to the chem fumes but am thinking my farm (married into and out) was also a chemical dump from all the herbicides and insecticides dumped to grow feed corn. Go Monsanto!! America’s SITH lord
    I moved those living there can’t
    I 10 from Galveston to Baton Rouge has been called cancer alley for like forever.
    Environmental Regs maybe a pain but are
    Difficult to put into place as lobbyists and industry fight tooth and nail to stop
    Them. I have been to Southeast Asia and China with no regs. Always happy by the grace of fate I live here Be glad some one cares
    That you can have hopeful clean water (sorry flint). Clean air. Food. Ect
    As for the EU. When putting in laminate flooring I would never buy US Always buy EU. The formaldehyde off gassing is stricter
    The US companies buy from China who dumps the chem crap on us but abides by EU standards to sell there
    Us equals love of money above all else

  14. raxadian says:

    Shopping centers have been a bad business since at least one or two decades ago. When people can buy the same stuff, but cheaper, near their homes or order online? Yeah why bother to drive away the city?

    Gas stations? Well if you put a car wash were a gas station used to be is way easier that selling it as a home. Is basically the same kind of chemicals being used after all. In fact car washing used to be a service gas stations offered to get extra bucks.

    The fuel tanks get filled with sand I think? Then they pour some concrete over it. Then they do the car wash, either by hand wirh beautiful women or with those machines.

    Two former gas stations in my city are now car wash stations.

    Others in a city close by have been abandoned by decades.

    I mean if they were in a privileged place they could have been repurposed as parking space I think? But that’s not the case.

    • Night-Train says:

      Sometimes the tanks are pulled and disposed of in an approved facility.

      • raxadian says:

        That almost never happens because is too expensive. Not to mention that if the tanks are decades old they are likely to find them damaged and then is just more trouble.

        • Brian M says:

          This is a pretty broad generalization.

          Remediation is possible and occurs more frequently than some here claim.

  15. Simple solution switch your business plan to a dry cleaner. Problem solved

  16. zoomev says:

    Lives and communities are still being destroyed by pollution and it is that that justifies the regulations — see ‘Life In The Plume: IBM’s Pollution Haunts a Village’ @ syracusecom.

    Also you should know not everyone’s salary is going up. Some of us at real blue chip companies are still having ours cut by inflation.

    • raxadian says:

      The real salary, aka buying power, is actually down due to inflation and the consequences of the last tax cut. You could have a 5% raise this year and Trump-conomics will eat it in less than six months.

  17. Nala says:

    The problem you faced had nothing to do with regulations, per se, but the environmental company conducting the phase 1 report was covering its bases so not to be sued later. Most lenders will allow environmental insurance to be issued in the name of both the lender and owner (paid for by owner upfront for the term of the loan) for any future environmental issue as noted in the phase 1 report. I have seen deals blow up before because of the recommendation of a phase 2 (core sampling). Never allow a phase 2 to be done on your property for the simple reason that if any contaminants are discovered, a monitoring system will be installed at your costs and results reported to some environmental government employee forever, and any future owner as well.

  18. FDR Liberal says:

    If I was to buy a piece of land and knew I would need or would prefer have a loan down the loan, I would contact the bank, etc., and ask them what soil engineer firms do they recommend to review the property.

    At the same time any reputable lessee also demads a soil sample be done before moving into any property so if he ever planned on selling this property, etc., or leasing it out

    IMHO the author didn’t perform due dilegence before buying the property.

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