Suffice to say it’s been a wild ride for the automotive industry over the past two years. McKinsey had once forecasted that 2020 would be highly profitable for automotive manufacturers and services with emerging markets driving the majority of gains. It seems that none of their consultants predicted a global pandemic in their crystal ball. COVID-19 devastated the auto industry. Car sales plummeted, factories shut down, and car parts took ages to ship thanks to the supply chain crisis. Yet the future may not be so bleak. Economic strategists like those at ING Group are confident about the sector’s recovery, giving new hopes to those invested in property that lease to automotive businesses. But, the steep costs of the environmental due diligence that comes with having cars as a tenant could muddy the optimism that automotive properties are solid investments.
Grime and tide wait for no man
Automotive properties are notorious for being dirty thanks to the array of hazardous chemicals that fuel, tune, and polish cars. Because of that, any pending sale, acquisition, financing, or refinancing of an automotive property should be subjected to environmental due diligence. That due diligence is no laughing matter as both federal and state laws are phrased in such a way that any current or former property owner, operator, or lender can be held liable for the cost of regulatory agency-mandated site remediation. This applies even if the owner didn’t cause the contamination, wasn’t aware of it, didn’t own or operate the property at the time of the contamination, or the contamination wasn’t deemed to be illegal at the time.
One of the reasons that the liability clauses in these laws are so stringent is because older properties typically didn’t have the best waste management systems in place. “A lot of older automotive properties are severely contaminated because it wasn’t out of the ordinary for people to pour oil and toxic fluid down the drain or dump chemicals directly into the ground,” says Paul Bongiorni, a commercial real estate specialist in Springfield, Massachusetts. Those nasty norms that he described were more recent than you may think, because the Solid Waste Disposal Act, which was considered “the first federal effort to improve waste disposal technology,” only passed in 1965. Most automotive properties are environmental hazards: most were built before that act was ever written, hence why automotive properties have so many problems when it comes to cleanliness.
The first, and hopefully the last step a property owner would need to deal with for the environmental due diligence comes in the form of a Phase 1 Environmental Site Assessment (ESA). A Phase 1 ESA is a visual inspection performed by a registered environmental assessor, where the assessor will walk through the property, comb through historical records to check out past uses of the property, and check the surrounding area for any possibility of outside contamination. If the assessor deems that the property could be contaminated, then they will order a Phase 2. Depending on the size of the property and the extent of the contamination, a Phase 2 can be anywhere from $8,000 to a six-figure number, and that’s not including the cost of cleanup. That price tag alone is why a lot of automotive property purchases fall through. When it comes to an automotive property, that assessor will pay special attention to how the property management handles wastewater.
“The absolute best-case scenario for an automotive property is to get one that directly pours wastewater into the sewer,” says Zach La Motta, a CRE professional who recently graduated with his Master’s in Real Estate Finance & Investment from NYU.
Direct drainage is a good sign that a property is “clean,” but many automotive properties are older and therefore aren’t directly linked to a sewage line. Many older properties have septic tanks that get dumped out by a third party instead. But, according to La Motta, the worst-case scenario isn’t a septic tank, it’s a cesspool. “Cesspools are way more common in older industrial buildings, they’re essentially a catch basin type enclosure, but what makes them so terrible is that they’re perforated, so the waste will seep right back into the soil.”
Most of these cesspools, which the Environmental Protection Agency dubs “motor vehicle waste disposal wells,” were banned nationwide in 2000. Though some states may waive the ban and allow the property owner to continue using the cesspool if they apply for a permit, this is where it gets prohibitively expensive. Cleaning out the property’s cesspool is an additional operating expense. According to the EPA, waste fluids that go into a cesspool need to meet drinking water standards. If the wastewater doesn’t meet those standards, then the property owner must install “pretreatment equipment” that decontaminates the water before it goes into the cesspool. Periodically, the owner is required to send off a sample of the wastewater for laboratory testing depending on the permit requirements. If that’s too much of a chore to deal with, then don’t worry, all you have to do is permanently plug the well, but only after you’ve written to your permitting authority with a minimum of 30 days before you do so. This is all on top of spending an exorbitant amount of time and money constructing a new sewer system for your property that’s in-line with building codes. Easy peasy.
Another point of interest that the assessor will look at are the type of vehicle lifts, which are a must-have for automotive properties, are present. These lifts typically come in one of two forms: electric or hydraulic.
Mechanics can debate the merits of either: electric lifts can carry heavier loads than hydraulic lifts, while hydraulic lifts can fit in narrower places and can offer lifting capabilities without putting the operator in danger. But as far as anyone who wants to buy or sell the property is concerned, the clear winner is the electric lift because the presence of a hydraulic lift almost automatically warrants a pricey Phase 2 assessment.
Thanks to the follies of its design, a hydraulic lift has the potential to leak oil into the environment. The soil around the in-ground pistons of a lift system is a common source of pollution from hydraulic oil leaks. Individual buried fluid tanks at each lift can be found in older underground vault systems, as can a series of lifts connected to remote reservoir tanks via pipes or hoses that can also leak. Another issue with subterranean hydraulic systems is their capacity to collect waste liquids during vehicle maintenance, such as floor wash. Modern vehicle repair shops may employ above-ground lifts with above-ground hydraulic tanks that are easier to check, but that’s still generally considered an environmental red flag.
Hydraulic fluids are used under high pressure to push pistons that lift heavy objects, their composition differs from that of other petroleum products. The special uses of hydraulic fluids require additives to improve hydraulic fluid properties. These additives improve viscosity, fire-resistance, and anti-foaming, which is why hydraulic oils can contain other chemicals such as sulfur, phosphorus and chlorine compounds. Even though the composition of hydraulic oil is different from petroleum contaminants that are recognized as environmental hazards in the ESA guidelines, the medley of toxic substances found in hydraulic fluids are a serious area of concern.
In fact, hydraulic lifts are such an environmental point-of-contention that their mere presence warrants a Phase 2 assessment, even if the hydraulic lift has never sprung a leak. “Because most hydraulic tanks are embedded into the ground, it’s physically impossible to determine if there has ever been a fluid leak by visual inspection alone,” says La Motta. If you have any on the property, you can expect to have to deal with a Phase 2 Assessment.
Because of the environmental hassle that automotive properties pose, if you have a multi-tenant building and one of those units is an automotive property, then expect the whole building to be deemed an environmental property. La Motta knows this to be true as he is in the process of buying his own automotive property. “Once you have a certificate of occupancy for an automotive unit, which is usually classified as a moderate environmental hazard, you’re not going to be able to put a daycare in that same unit,” he said. “Because of all the restrictions and hoops you have to jump through, it’s just so much easier to put other hazard uses in the same building.”
But during this surge of industrial warehouse developments, limiting your development may not be such a bad thing. Industrial properties are also deemed hazardous by the EPA, but the same circumstances brought on by the pandemic which led to the temporary decline of the auto industry have driven rapid growth in the logistics sector. As people were trapped in their homes during the lockdown, e-commerce sales exploded so developers flocked to make more warehouses wherever possible. In fact, logistical real estate has become so popular that many developers are buying automotive properties just to convert into industrial warehouses. Bongiorni, the real estate specialist, has seen a flurry of industrial developers looking for contaminated properties to build their warehouses on since there’s such a huge crunch on the industrial market. “These developers aren’t looking for a steal, they’re looking for a yield,” he said. “They’re willing to take on this kind of environmental liability and potentially spend millions of dollars to remediate just to get their hands on something.”
Automotive real estate comes with a list of unique complications. Low interest rates allowed people to borrow money cheaply, which have made the sticker shock of ESA assessments and cleanup less scary. Even still, this asset type is not for the faint of heart. Investors who purchased automotive properties often welcome the complications of a dirty property, hoping to take advantage of the instant price increase after the site is cleaned up. The automotive sector may have a bumpy road to recovery, but thanks to the new interest in industrial real estate automotive properties may have more value to offer now, in spite of their dirty reputation.