It has now been nearly five full months since this blog's inception and during this time I have made fourteen entries. Three of these entries included my comments and thoughts regarding the state of the ESA industry; an industry that has clearly been directly impacted by the credit crunch. Now that the calendar fourth quarter has concluded and the numbers are in, I thought I would share what EDR is seeing in the U.S. due diligence market.

First and foremost, transactions are down. After showing strong year-on-year growth for most of 2007, ESA projects contracted in the fourth quarter by 7.4%. During the same time frame however, the number of environmental consulting firms ordering from EDR moderately increased. So at the end of the day it appears that a larger number of environmental consultants are competing for work in a transactional market that has gotten smaller.

This decline in transactions started off in the CMBS arena and for a while the only environmental consultants being directly impacted were those who focused on portfolio securitization projects. As evidence of this, only $6.2 billion in securities were issued in October as compared to over $34 billion in August. However, the situation quickly spilled over into other due diligence sectors including small balance lending, M&A and corporate real estate development. McGraw-Hill Construction is forecasting a 6% decline in commercial construction in 2008.

Today the type of commercial real estate buyer or investor is changing as well. Gone are the highly leveraged buyers and replacing them are the all-cash and low-leverage buyers. As a result, many environmental consulting firms are redirecting their sales and marketing efforts towards the foreign investor, REIT and institutional markets. This seems to be playing out most notable in the retail and hospitality asset classes.

Nearly everything I am reading is forecasting more of the same for 2008. The U.S. economy has certainly slowed with some predicting a 50/50 chance of recession this year. But whether we go into a recession or not almost doesn't matter. Even if we avoid a technical recession, the business and lending environments have changed and the ESA market this year will not look like it did last year.

These cycles are inevitable and seem to occur roughly every 7 years. During these times a few things tend to occur. First, there will likely be some consolidation in the environmental consulting industry. Second, as already mentioned, consultants will redeploy their sales teams to target markets that are relatively active. And third, firms will closely analyze their business processes to identify work areas that could be further automated.

My guess is that the companies who execute the best in these areas will come out of this cycle stronger and better positioned for the next phase of expansion.

Much has been written lately, including here, about the recent disruption in the commercial real estate credit markets. Things have most certainly changed since August as CMBS issuances have declined dramatically (securities issued in Augusted totaled $34.4 billion but reached only $6.2 billion in October). However, as the market continues to be viewed as a global market by investors, deal flow is moving forward outside of the United States.

At EDR we have traditionally been a company that serves the U.S. market only. However in just the past 6 months, we have suddenly found ourselves participating in due diligence projects all over the globe. In fact, the total number of countries where EDR has provided some service has now reached 20. These countries include Canada, Mexico, Germany, Russia, Spain, Bahrain and South Korea. In each case the reason EDR became involved in a cross border project was because the environmental consultant used the Parcel application to author their due diligence reports.

Anecdotally we are also hearing more often that our clients are being pulled overseas to investigate properties. In most cases these clients are serving a corporation or global real estate investment operation that is expanding or diversifying overseas holdings. This activity is not limited only to the largest environmental professional firms with offices in other countries. Rather, U.S. based firms who only have offices in America are also being asked by their clients to jump onto airplanes and travel abroad to conduct Phase 1 work. The opportunity for global expansion therefore appears to apply to a large cross section of the U.S. environmental professional marketplace.

As further evidence of these changing times, one client recently asked EDR to attend an international due diligence workshop in Europe. At this event the client flew in their practice leaders from the U.S and three European counties. The main purpose of the meeting was to discuss how they were going to coordinate future portfolio projects with properties in multiple countries. The expectation here is that on these projects the quality of work and turn around times are equal to those expected on U.S. based work. Clearly quite a challenge given the availability of information and other dynamics involved with working several time zones away from home.

During an age of global capital flows this only makes sense and was to be expected at some point. What many other industries have been experiencing for years is now reaching our industry. Some environmental professionals are clearly embracing this opportunity and are already seeing the payoff.

Last month I made a blog entry titled "State of the ESA Industry". In it I described what EDR has been seeing since the much-discussed credit crunch began over the summer. Long story short, there's fewer Phase 1 projects being conducted right now as compared to last year while at the same time the number of environmental consulting firms in the market continues to increase (e.g. less work being shared by more people).

We estimate the decline to be in the 10% range right now. Nearly all of this decline in transactional volume (so far) has been isolated to a specific sector of the commercial real estate market: CMBS. The result is that firms with clientele heavily concentrated here are bearing much of the burden. The flip side of the coin is that firms focused more on portfolio lenders, law firms, government and corporations are actually seeing year-on-year increases in transactions. We think this is where the growth will be for the next year.

It has been well documented that the small balance loan market is expanding rapidly. While definitions vary, I would broadly describe this market as having two general characteristics. First, mortgage originations are sub $2 million. Second, the lender retains the loan (and relationship with the borrower) rather than selling it.

Many environmental consultants have also recognized this as a growth area and are aggressively marketing services to it. These services are not full Phase 1 assessments but are more limited in scope and often involve no site visit. Instead, the service is more of a desktop review. The end result for the consultant is a service that, while less expensive than the full Phase 1, is often more profitable. As a side benefit, a certain percentage of these desktop reviews will uncover a condition that leads to a more detailed assessment. Based on recent changes in ordering behavior from the industry, this segment of the market appears to be expanding between 10-20% compared to last year. Further, but somewhat anecdotal, evidence of this growth is being heard within EDR's Solutions Group. Here, requests for desktop review templates has increased sharply over the past several months indicating an interest to automate these reviews as much as possible.

While on vacation for the past two weeks I received a number of emails from clients asking for EDR's view into the state of the industry. Here is what we are seeing.

On a year-on-year basis, ESA transactions had been up by 3% through August. Then starting in September and running through October, things slowed down. For the past 6 weeks, the volume of ESA activity has declined by 14% compared to last year despite the fact that the total number of environmental consultants ordering from EDR has increased. So basically we're seeing fewer projects being performed by more firms. However, this is slightly deceptive and does not tell the entire story.

Nearly all of the transactional decline is coming from the CMBS sector of the market. Firms who specialize in portfolio securitization work for Wall Street are taking the entire hit right now and the situation is very similar to what we saw in 1998; the last time the CMBS market contracted. By contrast, the onesie-twosie balance sheet mortgage market continues to perform quite well and continues to show annual growth.

In 1998, the drivers for the CMBS decline were the Russian ruble crisis and overdevelopment in the commercial real estate market. Back then it took about one year for things to play out before volumes began to increase again. This time around, we don't have the problem with overdevelopment. Instead, the only driver seems to be the credit crunch which began in late summer. Based on conversations with firms who specialize in this area as well as with Wall Street firms, the general consensus is that the current slow down in portfolio work will not last as long. Many clients are reporting that they are already beginning bid on portfolio work again and expect to see some large projects come through in November and December.

As I mentioned in an earlier blog post, the current situation is being described not as a "real estate event" but instead as a "capital markets event". This comment is reflecting the fact that underlying commercial real estate fundamentals remain good so any decline in lending is the result of capital availability, upgraded underwriting standards and the ability for mortgages to be securitized.

Most of EDR's 6,000-plus clients do not work for Wall Street so they should not be seeing much of an impact in work volume. However, those few that do are clearly weathering a bit of a storm right now. Hopefully this period will pass relatively quickly.

This post marks the beginning of what I hope will be a long and productive multi-way conversation between EDR, our customers, our employees and really anyone who cares about real estate. I hope that in the coming weeks and months this site will develop into a great place for the exchange of ideas and information to anyone who comes across it.

As I sit here writing this, CNBC is on my split-screen showing the DJIA down another 213 points today which leads directly to the question a lot of our clients have been calling us about over the past few weeks: What will the impact of the current credit crunch be on the CMBS and general commerical real estate market? Well, the quick and easy answer is "I don't know". But I will offer up the following points I heard yesterday during a conference call with EDR's sister company; Trepp.

For starters, what is happening now is not a "real estate event" but is a "capital markets event". The point being that CRE fundamentals remain good and money continues to flow into CRE. This is not to say that things aren't changing, though. Clearly, there is less silly money out there, underwriting has become more conservative and refi activity has dried up.

All of this will certainly reduce CMBS issuances over the next few months but we're already seeing some of this business simply transfered to balance sheet lenders (who say they're swamped right now).

For most Phase I professionals I don't think there will be a huge impact on your business just because of the current re-pricing of risk in the capital markets. However, I would (and do) keep a close eye on the US consumer, consumer spending and consumer confidence. If things change for the worse here then I think we're looking at a different story.

When the CEO of Wal-Mart says "customers are running out of money", I worry a little.