Commercial Investment Real Estate

This article, written by ALR executive(s) originally appeared in the Commercial Investment Real Estate Magazine, Commercial Investment Real Estate Institute, Volume XVIII, Number 6, November/December 1999, p. 35. 

TURNING BROWNFIELDS GREEN:  New Financial Tools Can Help Bring Environmentally Impaired Properties Back to Life

Despite the hefty cleanup price tag on the nation's myriad brownfield properties, these economically and environmentally challenged sites represent redevelopment opportunities for developers and other commercial real estate professionals. 

Clearly, brownfields present challenges for buyers and sellers, including potentially hesitant lenders, expensive investigations, and the threat of liability. However, understanding these types of properties, the challenges they present, and the available financing solutions can help facilitate brownfield deals. 

Brownfield Background
The U.S. Environmental Protection Agency defines brownfields as abandoned, idled, or underused industrial and commercial facilities where expansion or redevelopment is complicated by real or perceived environmental contamination.  An estimated 500,000 such sites exist in the United States alone with projected cleanup costs of $650 billion. 

Brownfields previously were unattractive for redevelopment for several reasons.  During the 1960's and 1970's, legislation imposed strict joint and several liability on owners, operators, and tenants of contaminated sites.  Sometimes, the mere threat of liability was enough to scare off investors. 

Cleanup costs ballooned to an average of $30 million per site.  The costs were high for various reasons, including expectations that sites would be cleaned up to background levels, which are the levels of contaminants that exist in the natural environment.  The Comprehensive Environmental Response, Compensation, and Liability Act of 1980 even raised concerns for properties with potential environmental problems.  However, in 1986, Congress amended CERCLA to include the innocent landowner defense.  Under this, if a prospective purchaser conducts an American Society of Testing and Materials phase I site assessment and does not discover contamination on the property, he or she is considered an "innocent purchaser" and may be entitled to protection against CERCLA liability for undiscovered contamination.  However, this defense does not offer complete protection. The gaps left by phase I investigations are being filled by various tools, including environmental insurance.  Another positive change is that regulators now take a more practical approach to remediation.  Now, risk-based cleanup standards often are used to protect human health and the environment without imposing unrealistic cleanup standards on responsible parties. 

Layered Financing
Today, traditional lenders are more willing to accept brownfield properties as collateral for several reasons, including the environmental insurance products that can reduce risk and regulatory actions that protect lenders against CERCLA liability under normal circumstances. 

Brownfield developers can take advantage of various layered financing tools to make redevelopment projects viable.  These customized financial solutions�not assembly-line financing�increasingly are being used for brownfields.  Decreasing the cost of money can lower both the purchase price and cleanup costs.  Layered financing involves the use of all available and appropriate sources of funding to revitalize problematic sites.  Layered financing strategies can be developed from various sources, depending on the client's [partner's] preference.  Several options are discussed below. 

Government Programs
The U.S. Department of Housing and Urban Development contributes funds toward brownfield redevelopment.  HUD financing can be used to leverage private capital.  These funds come through various programs including community development block grants, Section 108 loans, and the Brownfield Economic Development Initiative, which provided $50 million in grants this year. 

Tax Increment Financing
Various types of tax increment financing exist nationwide.  In one variety, the property tax TIF, property taxes are frozen at pre-revitalization levels.  Typically, when an area is redeveloped, property taxes rise to reflect the property's increased market value.  With TIF, the incremental property tax increase goes toward repaying debt taken on to redevelop the property. 

Old Insurance Policies
Billions of dollars in insurance coverage have not yet been claimed.  To locate or reconstruct lost insurance policies, companies must undergo a process called "insurance archaeology."  These funds can reduce the cost of financing brownfield redevelopment. 

Property Tax Abatements 
Property tax bills often are the biggest fixed expense confronting a commercial property owner.  Because property taxes are based on fair market value, environmental problems can reduce the fair market value of afflicted properties. 

Property taxes usually are not reduced to reflect the extent to which environmental problems have affected value.  Ensuring that each property is taxed based on its market value with all problems taken into account can make brownfield properties more marketable. 

Prospective Tax Abatements
After remediation, a property's value generally will increase to reflect its higher market value.  Various states have enacted provisions so that property values will not jump to their post-remediation value immediately after they have been cleaned up.  These laws vary by state, but owners can be taxed at preremediation rates for up to 10 years. 

Equity or Debt Swaps and Partnerships
Some remediation firms are prepared to trade their work on a project for equity in the property.  This provides the developer with equity capital that may be difficult to raise elsewhere and provides incentives to the remediation firm to complete the project as quickly as possible. 
        Other strategies may include:
            ~ loan origination depreciation;
            ~ income tax credits;
            ~ community reinvestment act fulfillment contributions;
            ~ lease audits for current and previous tenancies;
            ~ refinancing existing bank loans;
            ~ utility savings; and
            ~ waste reclamation savings.

Brownfield Possibilities
Today, owners are more willing to sell their brownfields.  Until now, many large companies have warehoused contaminated properties because such sales were surrounded by uncertainty.  But private and public initiatives now may be able to provide vendors with more certainty.  Recent innovations can help vendors profit from the sale of a contaminated property.  For example, once a property has been cleaned up, the appropriate insurance policy purchased, and assurances of no further action from regulators received, the vendor can be fairly confident that its involvement with a property has been severed permanently.  Owners also increasingly are willing to sell because retaining dominion over a brownfield is not free.  The ownership of contaminated properties must be disclosed in securities filings.  Ongoing obligations for security, insurance, and other necessities must be fulfilled.  The improving market for these properties is making more corporate owners consider cashing in. 

Urban sprawl also has made some brownfields more attractive to buyers.  Cities and states across the country are implementing smart-growth strategies that restrict the development of farmland and other open spaces.  This makes properties within developed areas, including inner city brownfields, more valuable. 

To take advantage of these opportunities, [real estate] brokers can align with appropriate partners or teams  Reviving brownfield sites can take a broad group of experts, including real estate and insurance brokers, appraisers, financiers, lawyers, and remediation professionals.  Becoming part of a brownfield team means broadening the relatively small pool of prospective purchasers of brownfields by educating conventional developers on the subject. 

Brownfield properties are not the only commercial properties with environmental problems.  Millions of sites nationwide have at least one environmental challenge. 

Knowledge of environmental issues and contacts with the appropriate financing solutions for these types of sites can help brokers and developers at non-brownfield sites such as gas stations or dry cleaning facilities as well.

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Modified:  03/15/03