Turning Brownfields into Greenbacks

This article, written by ALR executive(s), originally appeared in Environmental Protection magazine, November 1996 issue, p. 28.  This column is geared towards service professionals who work on brownfield projects, but may also be useful for other business sectors. 

Turning Brownfields Into Greenbacks
Inactive industrial sites are transforming into productive facilities

Brownfields are industrial sites whose future use is restricted because of real or perceived contamination.  The number of brownfield sites has grown exponentially during the past 25 years.  The growth curve has reached epidemic proportions�as many as 650,000 brownfield sites exist in the United States today. 

Both the public and private sectors realize the problem cannot continue to grow unchecked. 

More of the impetus for redevelopment comes from state and local governments, which is not surprising since the brownfield epidemic directly affects thousands of U.S. communities.  Many of these impacts are so serious they threaten fiscal and social health of communities.  Brownfield sites frequently result in a decreased tax base, urban blight, loss of infrastructure, suburban sprawl, the depletion of farmland and a loss of employment opportunities.  State and local governments are more directly affected by these problems than their federal counterpart. 

Although the impact is felt most strongly at the state and local levels, federal legislation is largely responsible for the brownfield phenomenon.  In particular, the Comprehensive Environmental Response, Compensation, and Liability Act's (CERCLA) onerous provisions have induced thousands of property owners, lenders and prospective purchasers to shun industrial property. 

Theoretically, various provisions allow owners and lenders to avoid liability.  Unfortunately, two of the primary ways to avoid liability are fraught with difficulty.  Both the innocent landowner defense and the security interest exemption contain ambiguous language that is troubling to the members of the regulated community they were designed to protect. 

The ambiguity, coupled with CERCLA's draconian liability scheme, has created a vacuum.  Existing owners, prospective purchasers and lenders have become wary of industrial properties.  Hundreds of thousands of moderately troubled properties sit idle because of the threat of CERCLA liability.  These sites constitute the nation's approximately 650,000 brownfields.  Until recently, prospective purchasers, lenders and tenants have had no reason to risk CERCLA liability by becoming involved in brownfield sites�but things are beginning to change.  Federal and state governments have taken steps to encourage private parties to revitalize brownfields. An important plank in both federal and state programs are provisions that limit owner and lender liability.

Federal Initiatives
The federal government has revised its policy on prospective purchaser agreements�contracts between the EPA and buyers of contaminated sites.  The EPA originally published its Prospective Purchaser Guidance in 1989.  At that time its policy was to avoid entanglements in what it viewed as private real estate deals.  Since then, the number of inactive industrial sites has increased dramatically.  State and local governments across the country complained loudly about the impact the sites were having on the economic and social health of their communities.  The EPA now makes it easier for prospective purchasers to quantify their cleanup obligations by executing a prospective purchaser agreement. 

Other important initiatives included in EPA's Brownfield Action Agenda were the Underground Storage Tank Lender Liability Rule and Owners of Property Containing Contaminated Aquifers Guidance. 

State Initiatives
Many states have enacted Voluntary Cleanup Programs (VCPs), designed to encourage the reuse of dormant industrial sites.  Most VCPs offer mechanisms that limit owner liability for those not contributing to the sites' environmental problems. 

Some VCPs allow regulators to enter into covenants not to sue, which provides owners with the ability to quantify their environmental obligations to regulators. 

The state EPA agrees not to sue the owner/covenantee as long as it performs the cleanup to which it agrees to.  Without a cap on liability, investors steer clear of brownfield sites. 

Cleanup Financing
Legislators and regulators have provided a variety of mechanisms to limit the liability of those contemplating purchasing, leasing or lending money on brownfield properties.  The problem is that the parties remain wary of brownfield sites.  Their attitudes are based on sound logic. 

Greenfields are properties not previously used or despite previous use have no real or perceived contamination.  Prospective brownfield developers are aware that they can avoid the complications inherent in a brownfields acquisition by acquiring greenfields. 

Private industry typically will only consider brownfield deals that offer exceptional upside potential.

To date, the most important breakthroughs in brownfields have been the liability limitations. 

Unfortunately, these provisions merely put the owner or lender in the same position they would be in with a greenfield development.  These parties are also keenly aware that they will have to spend large amounts of money on legal, engineering and other professional help to get to the same place. 

Why should a developer or corporation spend time and money on a brownfields redevelopment?

In some instances, brownfield properties offer exceptional investment opportunities.  Many brownfields are available at a steep discount largely attributable to "stigma equity."  Stigma equity is created when the sale price and the cleanup cost are less that the uncontaminated value of the site. 

Finance is becoming more important in the environmental field, largely due to the decrease in enforcement actions.  Environmental agencies across the United States are under budgetary pressures.  Until recently, many remediation projects were undertaken solely because of the command and control system, meaning "you do or else."  The fines and penalties contained in various environmental statutes and regulations were sufficiently punitive to coerce action by a significant percentage of the regulated community.  Recently, legislators and regulators have been leaning away from the command and control model.  They recognize there is simply not enough manpower to rely exclusively on the paradigm. 

Incentives have been introduced to encourage companies to voluntarily take environmentally friendly actions.  In particular, brownfields are now the focus of legislative and regulatory initiatives designed to spur private industry to clean up the environment. 

Potential Market
Brownfield redevelopment constitutes one of the largest potential markets for environmental vendors.  Environmental vendors must help their clients pay for remediation costs.  Firms that help clients generate cash flow will be more successful than other technically competent organizations that choose to ignore the issue. 

Environmental vendors can ally themselves with organizations offering brownfield financing.  These relationships can work both ways�the financing firms frequently come across cleanup projects that require a broad array of expertise.  Consequently, they may be able to reciprocate. 

Property Tax Abatements
Real estate taxes levied by local authorities constitute one of the largest fixed expenses confronting property owners.  They are supposed to be based on the fair market value of each individual property. 

Unlike income taxes, which are based on actual receipt of money, property taxes are estimated on the property's market value.  This estimate is called an appraisal. 

Many private real estate transactions, such as loan applications, cannot be completed without an appraisal.  In private transactions, appraisers base their fee on the time and expertise required to evaluate the market value of a property. 

Property tax assessors are responsible for estimating the market value of properties for tax purposes.  They have thousand of properties to evaluate and do not have the luxury of charging more money for complex brownfield sites.  They are expected to complete their evaluations much quicker than an appraiser working for a private party.  In some instances, local governments contract out the evaluation of market value to "mass assessment firms."  Tight budgets mean that successful bidders evaluate properties in less time and for a smaller percentage of the cost than an appraiser.

In many cases the environmental problems plaguing a brownfield property are overlooked because the problems are costly to evaluate.  Beside doing an evaluation of environmental problems at a brownfield site, an economic analysis must be performed to quantify the economic impact of the problems. 

Many assessments are artificially high and the property owners suffer in at least two ways:  1) the property declines in value and 2) the property taxes are based on a value that no longer exists.

Fortunately, important precedents exist that recognize the adverse impact environmental problems have on the real property value. 

State constitutions require that property taxes be based on an ad valorem system, meaning "according to value."  Therefore, property owners may contest unrealistic tax assessments.

Assessments that fail to catalog environmental problems and ascertain their economic impact are disputable.  The savings from a successful challenge can often be substantial.  The owners of a New York office building that contained asbestos challenged the assessment and eventually obtained reductions of more than $20 million.  The funds saved on property taxes can be redirected towards remediation and rehabilitation of the site. 

Prospective Tax Abatements
Property taxes are based on fair market value�the central aspect of real estate taxes�enabling owners of environmentally challenged properties to appeal their tax levy.

This central tenant cuts both ways; as soon as a property increases in value, its assessment is likely to rise.  This is a disincentive to prospective brownfield developers.  In many instances, the intitiation and/or partial completion of cleanup causes the property value to increase.

This occurs despite the owner having yet to enjoy any tangible benefits.  Cleanup projects are frequently prolonged and costly.  Therefore, leasing efforts confront the same obstacles encountered before remediation.  Lenders are still wary of partially cleaned up sites. 

Cash flow will be negative because substantial remediation costs have not subsided, and tenants frequently cannot move in during the cleanup  phase.  Many owners will not market a property in the midst of an environmental project because they feel it places them in a weak negotiating position. 

Nevertheless, property assessors are required to tax any value increase attributable to cleanup efforts, meaning that a brownfield developer would see fixed costs rise at the same time cash flow remains static. 

The amount of the increase can be substantial�property taxes can jump from almost nothing to more than $1 million on partially cleaned up brownfields. 

Many states recognize the problem's severity and have tried to eliminate it through state laws that allows a tax holiday on value increases attributable to environmental cleanups. 

For example, New Jersey recently approved the Environmental Opportunity Zone Act, which state legislators believe will yield long-term benefits without any short-term detriment. 

Without this type of inducement, many brownfield developments would not occur.  Foregoing portions of the increases for a 10-year period is not costing local governments anything yet, but produces partial levies on the value increases for nine of the 10 years. 

Even more generous, Ohio's Voluntary Action Program alters the property tax structure for brownfield redevelopments by making available a 10-year tax abatement or holiday on value increases ascribed to remediation.

Voluntary Cleanup Programs
Many states have enacted voluntary cleanup programs with a wide array of provisions, including funds to investigate and remediate brownfields, and state money for prospective purchasers to investigate the environmental condition of a property with state money. 

This type of funding is important because it provides investors with strong motivation to investigate sites that were previously thought to harbor significant levels of pollution.

Once a prospective purchaser discovers that a site is relatively clean, the deal is much more likely to proceed.  Many salvageable sites would lay fallow without this state funding.

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