Environmental Risk Premiums And Price Effects In Commercial Real Estate Transactions

This article presents the results of a study of the effects of environmental contamination on the sale prices and overall capitalization rates of commercial real estate. Environmental risk for commercial real estate can be related to uncertainties concerning state-mandated cleanup requirements, potential off-site liabilities, and other factors. As risk increases, income is discounted or capitalized through higher required rates of return into lower prices and values. Using a series of regression models, this study estimates price discounts and environmental risk premiums for sales of retail centers in Southern California from 1994 through 2007. Significant price discounts are evident for contaminated properties sold prior to remediation but are shown to disappear after the properties are remediated. In addition, environmental risk premiums, as measured through overall capitalization rates, are found to decline over time, presumably as market participants become more knowledgeable about and experienced with contamination-related issues. In this study, both adverse pricing effects and elevated risk premiums are shown to diminish as the properties were remediated and as the market changed over the study period.