Is Your Brownfield a Diamond in the Rough?

It's All About Managing the Risk

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George Vallone is president of the Hoboken Brownstone Company in Hoboken, N.J.

Mary Hashem is executive vice president of Envirofinance Group, LLC

Randall Jostes is CEO of Environmental Liability Transfer, Inc.

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Posted: Wednesday, July 17, 2013 7:46 pm

If your community is sick of watching more weeds grow on that unsightly brownfield, you first need a vision, then an environmental assessment, and then a willing tenant. Only then, will you be ready to attract a developer and court the financing partners you’ll need to turn that diamond in the rough into a gem the whole town will admire.

So said a trio of redevelopers at the recent Brownfield 2013 conference in Atlanta. The National Brownfields Conference is the largest event in the nation that focuses on environmental revitalization and economic redevelopment.

It is hosted every 18 months by the U.S. Environmental Protection Agency (EPA) and the International City/County Management Association (ICMA).

George Vallone, president of the Hoboken Brownstone Company in Hoboken, N.J., co-founded his real estate development company 30 years ago.

“Our business evolved into a brownfields redevelopment company because we couldn’t assemble large enough spaces,” Vallone said. “In these urban areas, you’re lucky if you can find two or three brownstones in a row, and we realized the aspirin factor: Every deal gives you headaches, so you might as well work on big deals,” he quipped.

“Real estate finance is really about risk management,” he said. The major types of risk associated with a redevelopment project include:

  • Environmental risk – liability related to the health hazards associated with the site;
  • Entitlement risk – the possibility that governing bodies regulating the site might not provide the necessary permits for redevelopment;
  • Market risk – the possibility that no one will want to buy or lease the site at the right price once the site has been cleaned; and
  • Construction risk – the uncertainty about how much construction and/or demolition will ultimately cost.

All these risks equate to financial risk, Vallone said, and that’s why mitigating these risks is the first step in a successful brownfield redevelopment project.

“Understanding the risk management process in the context of the capital stack is the key to understanding what you have to do to get the deal done,” he said.

Vallone explained that a “capital stack” is made up of three layers. The investment layer has the highest risk and the highest potential return. The middle layer is the mezzanine deck, containing some aspects of equity and some aspects of debt; and the lower layer is conventional bank debt, which usually accounts for 75 to 80 percent of the capitalization for a brownfield redevelopment.

Environmental Risks

Regardless of which layer the money is coming from, the key to finding willing investors and lenders is reducing the risk, said Mary Hashem, executive vice president of Envirofinance Group, LLC, a land development company that acquires, remediates and repositions environmentally impaired real estate throughout the United States.

Hashem said insurance plays a big part in risk management and the insurance landscape has changed a lot in the past 20 years.

“Initially, insurance products made brownfield redevelopment, as an industry, possible in many ways,” Hashem said, “by providing surety against environmental risks that banks and other sources of finance like to have to protect their investments. Insurance products have morphed; some have become much better; some have gone away and are re-emerging,” she said.

Another way to mitigate environmental risk is to transfer that risk to someone else.

Randall Jostes is CEO of Environmental Liability Transfer, Inc., (ELT) based in St. Louis, Mo. His firm is a member of the Commercial Development Company, Inc. (CDC) family of businesses. CDC is a real estate development firm specializing in the development, acquisition and redevelopment of major commercial and industrial sites and has acquired, indemnified and alleviated more than a billion dollars of environmental liabilities.

Entitlement Risks

Jostes said that, while his company takes the environmental risks away from developers, many brownfield projects depend on municipalities and government agencies to take away or reduce the entitlement risks. As an example, he cited a vacant 116,000-square-foot Viacom/Westinghouse facility in Atlanta that sat on 16.5 acres of contaminated land. If the site could be cleaned up enough to meet the environmental standards for a residential development, it would be worth three times as much as it would be if zoned industrial. But, there was no certainty that it would achieve even the industrial standard, so Viacom/Westinghouse was afraid to move forward, Jostes said.

To help facilitate the deal, the Georgia Environmental Protection Division agreed to work with ELT to bring the property into compliance with residential standards. Should they fail to do so, the site would be assured a restricted industrial permit at a minimum. That, said Jostes, calmed the fears of Viacom/Westinghouse and made the deal possible.

After ELT removed asbestos, demolished the building and remediated soil and groundwater contamination, the site was cleared for residential use and is now ready for a housing development, Jostes said.

“Brownfield opportunities are actually, in our opinion, more viable, more profitable and more productive than a greenfield opportunity, so it’s a misnomer to say it can’t be done,” Jostes said. “It can be done, and we’re doing it coast to coast,” he said.

Market Risks

Vallone said market risks are in a good place now that the recession has bottomed out and property values are primed for a long, slow recovery.

“So, I think this is a good time to convince property owners and municipalities that if we get to work quickly and we work smart, we can get it done in this cycle,” he said. “The lesson to be learned (from the recession) is to prepare and partner with people. Identify what you don’t know and then bring people in who know it, and get to work on the property.”

Vallone said developers should be given time to go through the risk management process before being asked to purchase a property.

“The idea of a public/private partnership is the way to go. There are a lot of developers that will bring a lot of expertise to the table if they know that once the property is teed up and you’re ready to transfer it over to them, you’ve allowed them to reduce the risk,” Vallone said. “You can’t finance the deal if it’s perceived to be too risky. While you’re in the risk-management process the cost of capital is astronomically high,” he said.

Jostes said the bottom of a market is the best time to invest in brownfields. A property that might be worth $15 million could hypothetically be purchased, because of the environmental uncertainties, for $5 million, he said. “If you do your due diligence and you can clean up that site for $3 million, you’re into a $15 million site for $8 million,” he said.

If you’re looking for investment capital, Hashem said it’s best to look locally unless you’re in one of the country’s top metro markets where national investors focus their attention. Local investors usually have close ties to the community and are more willing to take risks to make development happen.

Jostes said local banks usually charge a premium for financing brownfield projects. Interest rates are usually 15 percent or more. “But, so what? You could be looking at a 500 percent return on your total investment for a brownfield redevelopment,” he said.

Vallone and Jostes both said they use formula pricing in many of their brownfield deals. By starting with the value of the final development – depending on the land’s envisioned use – the costs of clean-up and financing can then be backed out to determine what the value of the undeveloped brownfield property should be. Then, formulas can be created to calculate the sale price based on whether certain milestones are reached or not.

“If you have a deal where there’s a buyer and a seller and they come together and transact in one instance of time, there’s a guaranteed loser,” Vallone said. “Either the seller sold too low and he lost, or the buyer paid too much and he lost. So formula pricing is the ultimate win-win strategy,” he said.

Construction Risks

Vallone said municipalities should issue a Request for Qualifications rather than a Request for Proposals when looking for a developer to take on a brownfield project. Proposals, hastily done, will rarely result in a successful project. Instead, municipalities should select a developer they trust and then give them time to understand and mitigate the risks and come up with a plan, and a price, for completing the project.

Jostes said municipalities in small markets have to take extra steps to attract developers. Bidding on projects is a big expense, so the more work that a municipality does up front, the more attention they’ll get from quality developers.

“You have to be able to reduce some of the risk. If a municipality comes to me and says, ‘Look, we’ve done most of that work. We’ve gone through the federal and state programs, we have done a risk characterization, we’ve done a market study, we are in great need of this end use and here’s why. We can demonstrate it. Are you willing to bid?’ Well, that goes straight to the front of our bid package,” Jostes said. “We’ll respond to that kind of request.”

Getting Your Ducks in a Row

Jostes said finding an end user for the property is more important than finding a developer, since developers will be attracted by a high-quality end user. He encouraged municipalities to look at their needs and find an end user who will satisfy those needs.

“If your goal is jobs, then you’re going to want to put incentives in place to attract a manufacturer, because if they come, then the developer will follow,” Jostes said.

“Everybody’s following the money, and the money really is with the end user. It does me no good to clean up and develop a site if nobody’s ever going to use it,” he said.

“So, if I were you, I would first characterize the site well to take the uncertainty out of the question. And, second, don’t chase the developer; chase the user. Because once you have the user, either the user will know a developer or the developers will come flocking to your door.”

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