As part of the underwriting process lenders look at all aspects of risk in their analysis.

One way to mitigate their underwriting risk is to obtain independent third party reports on the property. Not only is this a way to mitigate risk, it also acts as a way to justify any underwriting assumptions that the lender has made in their analysis. The third party reports can include a property appraisal, building condition assessment (BCA) and environmental site assessment (ESA).

It can be difficult for the borrower to understand the requirement by the lender for the need for third party reports, especially if it is not articulated properly. While different types of financing dictate what reports are required, it is always safer to err on the side of caution and assume for simplicity sake that all three are generally required. Each report covers a different area of risk for a lender and helps mitigate and even support the different areas of underwriting of the property.

The appraisal

An appraisal report establishes the underlying market value of the property today. This helps to provide the lender with the information on whether their underwriting is too aggressive, too conservative or at market. It also helps establish market rents for the property that the lender can compare, as well as information on the expenses for the property and market capitalization rates. While the lender may complete this on their own, it can also help provide additional information to either support their conclusions or to challenge them.

As a borrower, if you are purchasing a property, an appraisal report should be one that you automatically complete to help you determine whether you are below, at par or above the market as a general guideline.

The building condition assessment (BCA)

The BCA is another report that is essential for the lender and should be for a borrower. This report outlines the general condition and state of the property. It will focus on the major components of the property, i.e. the roof, building envelope, windows, mechanical systems etc. and identify their age and condition. It can also look for any deferred maintenance at a property as well as any potential safety items that may require immediate attention.

A buyer of a property should always look to complete one of these reports since it will also outline over the next seven to ten years the major underlying costs required to keep the property in good working order and provide comfort to the lender that the property does not have any major areas of work required over the term of the mortgage.

The lender can review this report and then determine whether there are items that require immediate attention and will have to be replaced or repaired in order to protect the integrity of the property.

The environmental assessment (ESA)

The last report that is absolutely and always required by the lender is the ESA report. In many cases borrowers and property owners inquire as to the absolute requirement for the report. This report outlines any major areas of environmental concern in and around the property itself, but also identifies potential areas of environmental concern from properties within a specified radius surrounding the property.

This report provides comfort to the lender on whether there are no concerns with the property or if they should be concerned with the area or the property. A “clean” ESA report indicates that there are no environmental concerns with the site itself or around the site. The lender can be satisfied that potential sources of contamination are not present and cannot be detrimental to the value of the property.

On the other hand, a report that identifies an area of concern might have identified a potential source of contamination which could be related to hydrocarbons or some other naturally occurring contaminant or manmade contaminants that might be present on the property. Potential sources of contaminants off site around the property might relate to dry cleaning facilities or gas stations as examples but there can be many different possibilities.  The report itself will determine if any are in operation or have been in operation over a specified time period.  

The presence of any onsite or off site sources does not always mean that there is a problem it simply requires extra care be exercised and further investigation undertaken. If a potential source of contamination is identified, then the lender can be satisfied that the environmental engineer will investigate this source further and then determine an appropriate course of action.  

Keep in mind that at a time when environmental concern and being proactive dominates our social and economic well-being, it is only prudent to obtain an ESA report. However, it is also prudent to obtain the other two reports as well and while it may be an upfront cost that seems like it could be avoided, in reality it could save you a lot of time and money in the long term.