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.

Recently, several environmental consultants have told me that their companies plan to change their Phase I ESA strategy this year to begin emphasizing their firms' value throughout the entire property ownership lifecycle.

The idea is to begin offering clients a hybrid service that combines pre-acquisition due diligence assessments with life-of-ownership environmental monitoring and the sales pitch goes something like this: "For $2,000 I can conduct a Phase I ESA now or for $2,000 and then $1,000 per year I can deliver the ESA and provide ongoing property monitoring for as long as you own the property."

So the question is "is it possible for an environmental professional to deliver $1,000 in value during the years in which a commerical property is not transacting?" These clients thinks it is very possible and I would agree with them.

Each of these firms has a slightly different idea of how they would monitor properties after the initial Phase I had been completed but they all share similar characteristics.

First, the data, findings and opinions from the original ESA would need to be archived and used going forward as a baseline. Second, periodic updates would need to occur looking for material changes such as the up-gradient adjoining property that just appeared in the state's leaking tank database. Finally, an automatic alerting mechanism would need to be developed to notify stakeholders of material changes that were identified and to suggest the appropriate actions.

Some "back of the envelope" math makes it pretty clear why these firms are excited about the opportunity. Right now, the average commercial property transacts every 7 years. If you assume an ESA averages $2,000, then the total revenue opportunity from a property is $2,000 every 7 years. But if the same property is then monitored for $1,000 per year, the total revenue opportunity from that property increases by 400% to $8,000. In addition, because the monitoring firm has attached itself to the property, the chances of winning the next Phase I project have probably been increased. After all, who knows that property better than the firm that has been monitoring it?

Given the continuing obligations language under AAI combined with the FDIC's recently updated environmental policy which emphasises monitoring portfolio loans, it seems that this may be an idea whose time has come.