A Boon for Brownfields

This article, written by ALR executive(s), originally appeared in Environmental Protection magazine, July 1998 issue, p. 12.This column is geared towards service professionals who work on brownfield projects, but may also be useful for other business sectors. 

A Boon for Brownfields
Imagine two different environmental consulting firms competing for a remediation project.  Both firms are qualified to do the job.  One firm merely puts in a proposal for the cleanup work.  The other firm finds at least part of the funds needed to finance its work.  Which firm do you think is going to get the job?  In many cases today, there will not be a cleanup unless the owner gets back significantly more than it puts in, and the sooner the better. 

In January 1998, the United States Conference of Mayors published a report titled Recycling, America's Land.  According to the report, cities ranked the lack of cleanup funds as the number one impediment to brownfield redevelopment. 

The threat of enforcement is not nearly as potent as it once was.  Property owners and lenders need an economic incentive to clean up contaminated properties.  There are many firms that can competently clean up a site.  The future belongs to those firms that combine technical expertise with financial savvy.  Remediation firms must show their clients how to pay for part or all of their services.  These funds can come from a variety of sources.  This article discusses one of those sources. 


Obtaining remediation loans under the CRA program

1.  Work with banks who serve the area near the site you plan to redevelop.  Lenders must try and serve low and moderate income neighborhoods in the communities they are located.  Therefore, a local bank or branch will have to provide the funding if CRA credit is to be involved. 

2.  Educate the banker about the various mechanisms which are available to help reduce risks to lenders.  These include the lender liability provisions included in many state Voluntary Cleanup Programs. 

3.  Find out which banks serve the area surrounding the brownfield you plan to rehabilitate.  Call their community development office and get a copy of their CRA program and compliance profile.  Between records available from regulators and banks you will be able to determine whether they need some assistance in meeting their CRA requirements.  Lenders who are having a difficult time meeting their CRA requirements may be particularly receptive to brownfield loans. 
























Brownfield finance
Underwriting a clean site is easier than financing a brownfield.  At a typical commercial development, mortgage financing is based on cash flow.  The cash flow from the collateral must cover interest payments as well as all other expenses.  Lenders also leave a cushion to cover the temporary loss of tenants, cost overruns and other contingencies.  Still, credit-worthy developers can usually borrow heavily.  In fact, lenders provide funds up to the point where the cash flow of the project is only 110 percent of its expenses. 

Brownfield sites, however, present a level of risk and complexity that does not exist at most commercial developments.  The projected cash flow at a brownfield is not necessarily indicative of the risk it poses to lenders.  The discovery of additional environmental problems can reduce, postpone or eliminate the income from a site.  It can also wipe out the owner's equity as well as a sizable portion of the lender's investment. 

Many lenders are also concerned about having to clean up contaminated sites.  The possibility of a lender being required to pay for cleaning up a site is remote, but it still exists.  In this case, the lender can lose much more than it has invested in the property.  At the very least, lenders can be forced to invest substantial funds in expert reports, legal fees and other transaction costs. 

Origins of the brownfield problem
The brownfield problem first arose when manufacturing companies left outmoded facilities and decaying urban areas.  This migration began because of economic and not environmental reasons.  Facilities in urban areas could not compete with new buildings in the suburbs. Buildings that were previously state-of-the-art became obsolete.  The shift from a manufacturing to a service economy doomed other facilities.  The flight to cheaper labor within the United States, south of the border and overseas exacerbated the problem.  For all these reasons, the number of underused sites increased steadily. 

Even though most brownfields were never serious candidates for Superfund liability, the mere threat of strict, joint and several liability effectively blocked the redevelopment of marginal sites.  Even when environmental problems exist, economic reality is the ultimate reason why a site remains idle.  Brownfields do not get developed for one simple reason:  the potential rewards do not justify the risks.

Traditional sources of financing are not enough
Generally, brownfield projects require more complex financing than a traditional commercial project.  Financing must often be layered with funds coming from a variety of sources.  The need for layered financing begins with the investigation of the site and continues through the remediation process, and even beyond.  Financing is often cobbled together with a combination of private and public sources.  Even the private sources of brownfield finance often become involved as a direct result of various programs. 

The important number is not the cost to clean up the property, but the ratio of the cost of remediation to the post-remediation value.  Developers often break both of these figures down to per acre or per square foot costs.  Many brownfield sites are not that valuable; their reuse will not generate enough money to pay for the cleanup. Other brownfields are not badly contaminated, but are not very valuable and therefore [the] mere threat of Superfund liability is enough to keep developers and lenders away. 

One real estate adage holds that the three most important things about a property are location, location and location.  If the location is right a property can overcome high levels of contamination.  Ultimately, a developer buys the future revenue stream that a property produces.  The per-square-foot revenue must be high enough to offset the per-square-foot cleanup costs.  The gap between these two figures helps determine how much, if any, private sector financing is available. 

At many brownfields, the gap between cleanup costs and revenue is not enough.  Public sector or regulatory incentives are needed to rehabilitate thousands of marginal brownfield properties.  Once revitalized, these properties will contribute to local employment, property taxes and the economy.  These and other dividends more than justify the taxpayers' investment. 

Commercial real estate is fueled with financing.  People with successful properties leverage their investments and obtain rates of return that are unheard of in many other fields.  For example, a developer puts in 10 percent of the money needed for a project.  The rest of the money is obtained from various lenders.  The property goes up 10 percent per year; therefore, the owner's equity doubles each year.  In the meantime, this portion of the developer's profits are sheltered from income taxes.  Many developers proceed to borrow against this equity.  The ensuing interest payments are deductible, and therefore shelter rental income from taxes.  Lenders have made this type of investment possible.  In fact, lenders really decide which brownfield sites are revitalized. 

Thousands of mid-range brownfield properties exist.  A substantial number of these will not be redeveloped with traditional forms of financing.  Without various government programs, others will languish for years before sufficient funds are invested to evaluate their environmental condition.  Easier loans are often made on greenfields, which is why between 1982 and 1992 more than 13,823,000 acres of land were lost mostly to greenfield development.  About 4,266,000 of these acres were prime or unique farmland.  The 13.8 million acres is roughly equal to the combined acreage of the states of Connecticut, Rhode Island, New Jersey, Delaware and a quarter of Maryland. 

What has changed?
There have been a variety of financing mechanisms put into place to help encourage the revitalization of brownfield properties.  Some of these incentives relate solely to brownfields.  Others, including the Community Reinvestment Act (CRA), are programs that are designed to revitalize downtrodden areas, and apply to brownfields in addition to other sites that need assistance.  Without these incentives, many neighborhoods will continue to decline.  Federal, state and municipal governments have decided that this trend cannot continue.

The CRA requires a broad array of lending institutions to help satisfy the credit needs of their communities.  This includes low and moderate income neighborhoods.  The CRA was designed to encourage financial institutions to help satisfy the credit needs of their entire communities.

Brownfield lending and the CRA requirements
In 1995, the CRA was amended to include brownfield lending.  The change providing CRA credit for brownfield loans was included in a footnote.  The footnote states that "loans to finance environmental clean-up or redevelopment of an industrial site as part of an effort to revitalize the low- or moderate-income community in which the property is located."

Many brownfield loans can satisfy both the standards outlined for sound banking practices and the requirements of the CRA criteria.  The brownfield loans help create jobs in moderate and lower income communities.  They also provide many indirect benefits. 

Community benefits
Without local jobs, neighborhoods often deteriorate.  Workers leave depressed communities to go where the jobs are, which tends to further depress the community and hastens further deterioration. Using CRA-induced funding to revive brownfields can help break this cycle. 

CRA's scope and strength
Enormous sums of money are being invested in CRA programs.  This type of financing has the potential to help spur the cleanup of many sites. 

Not only is the program large, it may be an ideal place for financial institutions to satisfy their CRA requirements.  One reason is that examiners take qualitative criteria into consideration.  For example, examiners may consider the degree to which banking activities, " . . . serve as a catalyst for other community development activities."  Brownfield loans may be uniquely suited to play the role of catalyst for other community development activities.  This is an attempt to provide some type of qualitative element to the evaluation of institutions' performance.  It should help lenders leverage their brownfield loans. 

Other qualified activities include the rehabilitation of housing in low and moderate income communities.  This is certainly an important part of getting a community back on its feet.  However, brownfield redevelopment provides leverage that simply does not exist in many other qualified activities.  There are several reasons for this.  One is that it brings jobs back into the communities.  This draws people back into the community and gives them a reason to fix up houses near the brownfield site.  After all, without jobs many of the neighborhoods will continue to deteriorate despite the renovation of some houses.  In addition, the rehabilitation of brownfield sites provides some momentum for a community, something to build on. 

Why hasn't CRA been used for more brownfield loans? 
Many banks still shy away from brownfield loans.  Bankers and regulators believe that this is because the perception among lenders has not changed.  In the last few years, federal and state initiatives have been enacted that offer a great deal more protection than lenders prevoiusly had.  It will take time for the perception of some lenders to catch up with the reality. 

Some lenders do not know the difference between Superfund and brownfield sites.  Others explained that after looking at brownfields in a certain light for many years, it will take patience and education to change perceptions.  Many bankers still look at these properties as problems and not as possibilities.

This attitude will change as bankers realize that brownfields can be a source of profits, not only a reservoir of problems.  Environmental officers must find a way to make a loan work.  At the same time, they have to make sure that the environmental risks undertaken are prudent. 

Another reason is that the CRA's brownfield amendment was only enacted recently.  Furthermore, it is contained in a small footnote to a much larger program.  Believe it or not, many lenders are still not familiar with the availability of CRA credit for brownfield loans. 

In May 1997, Vice President Gore announced the Brownfields National Partnership Action Agenda.  Part of the agenda includes a commitment by the Treasury Department to provide information to the lending community about brownfields.  More specifically [the] Treasury will be providing information to the financial community about lender liability and CRA topics. 

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