FEATURE ARTICLE, OCTOBER 2008

FINDING GREEN FOR A BROWNFIELD
Financing brownfields in today’s capital markets.
Craig Carbrey

In an uncertain development climate, the emphasis on well-located infill properties is more important than ever.  In many established markets with a lack of developable land, brownfield sites provide a means for savvy developers to acquire infill sites with outstanding development potential. The foundation of brownfield development is taking underused properties and grooming them toward economic growth to generate income for the developers, and generate property and sales tax revenue for the community. Despite having a significant upside, a number of key challenges abound, particularly with regard to financing these contaminated properties. With conventional lenders continuing to exercise extreme caution and tightening their lending standards, acquiring higher-risk properties, such as brownfields, requires the right mix of expertise and vision for both the developer and lender.

So, how can developers successfully complete these transactions?  There are several scenarios, to find these great deals, flex their equity and achieve return on investment. 

During the real estate boom of the early 2000s, prices for contaminated sites were not adjusted for the added risk and, in some cases, the cost of remediation.  At the time, there was a lot of cash chasing but few development opportunities, creating an imbalance in market supply versus demand. With the tightening of the credit markets, there have been fewer buyers. Sellers are adjusting their price expectation to reflect the risk of a brownfield development. 

Additionally, current market conditions have had a measurable effect on environmental insurance and environmental engineering consultants, a key component of all brownfield developments. With demand across the market dipping, insurance carriers and consultants are now more willing to negotiate terms, providing an outstanding opportunity for developers to both contain their risk and lower their development cost.

Specialization Reduces Risk

Unlike financing a greenfield property, brownfields bring a number of added environmental risk factors for both the developer and lender. The developments require an extra level of due diligence to satisfy various environmental rules and regulations.  For example, regulatory approval for risk-based cleanups is based upon the level of exposure and risk to the public.  As a result, development risk is more significant for residential projects than commercial, office and industrial uses. Successfully evaluating and hedging risk involves a highly sophisticated approach to environmental risk analysis and management, which conventional lenders are often hesitant to take on.  Some of the most significant environmental challenges associated with brownfield financing include the structuring of appropriate insurance coverage, environmental liability, regulatory process and protection from cost overruns.  When encountering an environmental issue, many conventional lenders would rather pass on the deal than assess the situation to make the deal a reality.   

This need for specialization, combined with the climate of uncertainty in the capital markets, has enabled private equity and specialized lenders to become much more significant players in brownfield finance.  Specialized brownfield lenders such as EnviroFinance Group provide a specialized expertise in how to identify and manage risks, a skill that the majority of traditional lenders do not possess.

Guidelines for Successful Development

As with any real estate transaction, developers must be highly strategic when seeking out the right financing partner.  In addition to the fundamental characteristics of the financing process, lenders favor borrowers who possess the following criteria when evaluating a potential brownfield project:

• A talented team of professionals with brownfield experience.  Evaluation includes ensuring that the environmental consultant, the insurance broker and the engineer will work well with the regulators to assess risk and get remedial plans approved.

• Extensive due diligence. Favored applicants must have completed significant due diligence on the environmental investigation.  A Phase I and Phase II assessment is insufficient. 

• A well defined exit strategy upon completing the remediation.

• Favored debtors with previous experience in dealing with brownfield transactions and knowledge of the environmental issues involved to manage the risk.  

This type of underwriting will help developers mitigate the numerous risks associated with brownfield development and tap into the vast potential associated with a well-located land parcel primed for long-term growth.

Location Yields Opportunity in the Southeast

Modern development projects are placing an increasingly high importance on Smart Growth, which uses existing transportation centers, proximity to employment, infrastructure and a reasonable cost of housing to maximize the utility of the property and its benefit to the community.  When properly implemented, Smart Growth is a win-win scenario for all parties involved; the municipality gains revenue from property and sales taxes, while the quality of life is improved for the city’s residents. 

Perhaps the greatest opportunity to implement a Smart Growth Strategy is on infill locations with environmental challenges.  Does such challenged development exist in the Southeast?  The Southeast, unlike the strong brownfield development market of the Northeast, with states such as New York and New Jersey attracting the interest of developers to build on urban infills, continues to be regionally and product sensitive.  The over development of the residential market has been a detriment on its economy. As there is little sign of the residential crisis leveling off, it will likely take most of the following year for the Southeast region to muster through the over supply in the residential sector.  On the flip side, if well situated commercial, industrial and office properties are strategically located in urban areas with an existing population base, such projects can still be financially viable. 

With a growing number of cities realizing the financial benefits from putting dormant properties back into productive use, it is expected that brownfield development opportunities will continue to represent a significant portion of America’s urban revitalization efforts, even after residential and commercial markets recover from the credit crisis. 

In all regions, a clear path to the end is paramount and remains the ultimate measure for success. The philosophy of “if you build it, they will come” is long gone from lenders’ lists of financing criteria. 

Opportunity in an Uncertain Environment

The significant growth in remediation innovations and technologies and increased bargaining power for developers in today’s market has given rise to a number of previously unavailable opportunities for brownfield development.  Amidst this new development climate, it is the responsibility of the leaders in brownfield lending to offer programs that are financially feasible. These lenders must also take into consideration the variety of inherent risks in brownfield development. It is this combination of knowledge and understanding that will help to further solidify the importance of brownfield development in the real estate industry and continue to bring communities positive development projects that improve quality of life.

Craig Carbrey is president of Sacramento, California-based EnviroFinance Group.

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