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Nov. 6, 2012

Limiting Liability in Brownfield Redevelopment

By Michael Russo, Contributing Editor

Multi-housing development is fraught with risk. It’s the potential gains that make the business so rewarding. Brownfields almost always raise those stakes and require a higher degree of due diligence to protect the developer from future liabilities.

The depth of environmental investigation, regulatory requirements and financial approvals at the federal level alone are significant. That’s why few experienced brownfield developers ever find themselves in court. They understand that brownfield is a niche that is neither kind nor conducive to a blow-and-go construction mentality.

“Particularly in urban infill, our clients are not surprised by the extra time and money required to develop these brownfield sites,” says Fernando Villa, a partner with Pircher, Nichols & Meeks—a national real estate law firm. “However, the uninitiated can be seriously taken back by the regulatory and legal issues involved.”

Despite the extra work, there are plenty of market-driven reasons to pursue brownfield redevelopment. In Villa’s experience, brownfield opportunities continued to arise during the height of the recession. Much like the adaptive reuse of historic structures, brownfields are now helping lead the resurgence in the multifamily rental market.

The availability of land close to urban transit centers is diminishing, and the existing sites near these hubs are often perceived as being environmentally contaminated. For this reason, brownfields are becoming more of a necessity for developers. These urban areas are often centrally located in premium rental settings, hence the success of recent urban infill projects in major cities across the U.S. and in the fast-growing rental market in Toronto, Ontario, Canada.

Brownfield sites sometimes have—or are suspected of having—environmental legacy issues. These concerns drive the value of the land down, making the properties even more practical for redevelopment.

“If you can cost efficiently address environmental concerns and protect yourself against liability, you can create extraordinary value when developing these sites,” says Villa.

Keeping track of federal financing alternatives—loans, grants, equity capital and loan guarantees, tax incentives and tax-exempt financing—is a part-time job. There are undoubtedly many public tools to complement state and local programs and increase the financial attractiveness of brownfield investments.

As many developers know, however, there are caveats to earning these credits, and approvals are time consuming and complex.

“The good news is that state and local governments have become much more willing to accommodate developers and their concerns than before the recession hit,” says Villa. “It should be much easier now to get local authorities to cooperate.”

Meanwhile, the National Brownfields Practice Group (NBPG) continues to pursue a vigorous advocacy campaign that includes public outreach to stakeholders and walking the halls of Congress.

“At this time, the non-revenue program enhancements are being more favorably received on Capitol Hill,” says NBPG chairman Michael Goldstein with the law firm Akerman Senterfitt in Miami. “The financial incentives are obviously a much harder sell.”

NBPG’s goal is to see the EPA Brownfields Program funded at $330 million, rising to $361 million by 2016.

“We are not being unrealistic and harbor no illusions that [increased] funding will be authorized and appropriated [soon], but we have to lay the groundwork,” says Goldstein. “We think that over the next couple of years, Congress will respond because it’s a good investment.”

The Brownfields Tax Incentive shows the most promise for timely legislative support. It remains the only federal program to incentivize private site owners by allowing approved environmental cleanup costs to be fully tax deductible in the year incurred, rather than capitalized and spread over a period of years.

Initially enacted in 1997, the temporary incentive ordinarily is piggybacked onto another tax bill and extended every year. However, the continuing uncertainty about the incentive’s annual expirations and extensions makes project planning more difficult for brownfield developers.

“We may see possible increases in appropriations in future years,” sums up Jason Marmon, a former staffer for U.S. Rep. Joe Sestak (D-Penn). “I just don’t think we will see it in the next couple of years.”

Let the law work for you

Part of the due diligence work on brownfield sites includes environmental investigations before properties are acquired. What’s important is that these environmental site assessments comply with U.S. Environmental Protection Agency (EPA) standards.

“Under federal Superfund laws, complying with these EPA standards can give developers a high degree of protection from liability,” says Villa. “However, this does not mean full protection if the property experiences environmental problems in the future.”

The first step toward regulatory compliance typically involves the hiring of an environmental engineer or consultant to perform a “Phase I” and, if necessary, a “Phase II” site assessment. It is also important to acquire proof that the consultant or engineer is certified to perform the assessments.

A Phase I assessment is usually not time-consuming or expensive for developers to undertake. It typically involves a review of available building records; titles and survey reviews; photos of the site or flyovers; and interviews with managers regarding current and past use of the property. The Phase I process does not involve invasive testing and can be accomplished within two to four weeks at the same time that zoning reviews and other due diligence tasks are being completed. Legal costs related to a Phase I review commonly range from $3,000 to $8,000 on the West Coast.

“The idea is to get a sense of whether, based on past or current uses and a visual survey of the property, an environmental problem exists today or in the past,” says Villa.

If the answer is “yes,” then the consultant may recommend the initiation of Phase II testing procedures. This work typically involves soil sampling, groundwater testing and other investigative procedures.

“At this stage, it is essential to work closely with regulatory agencies like EPA to achieve the clean-up level required for the site, says Kristine MacWilliams, PE. “In brownfields, EPA allows a ‘redeveloped’ approach. This means everything on the site is not going to be cleaned up to pristine conditions—ever. It’s simply not feasible.”

MacWilliams has spent 15 years evaluating properties in connection with real estate transactions and development and serves as regional director of site mitigation for Partner Engineering and Science Inc. in Torrance, Calif.

“When necessary, a Phase II assessment is valuable from a legal and financial perspective,” says MacWilliams, who is based in Charlotte, N.C. “In March [2012], EPA awarded $69 million in grants to several cities that qualified for brownfield development assistance.”

The results of Phase II testing may require a clean-up, further investigation or simply a monitoring of the site. Again, Villa emphasizes that undertaking these steps provides for “significant” legal protection under both federal and state laws.

The attorney also recommends that builders or developers consider taking out environmental insurance if there are concerns about the property.

“Satisfying EPA standards meets the underwriting criteria for major insurance carriers, so acquiring coverage is rarely a problem,” says Villa. “Insurance is strongly advisable to protect against third-party claims from tenants, construction contractors or adjacent property owners.”

Federal regulations require that neighboring properties are notified when an environmental clean-up takes place. However, MacWilliams urges developers to take a more proactive approach and educate neighbors on the efficacy of the clean-up, especially if the site was perceived as being highly contaminated.

A number of states are also following California’s lead and adopting legislation that allows for “immunity agreements.” Essentially, the developer enters into an agreement with certain designated agencies to certify that it has complied with all appropriate environmental inquiry standards and is addressing any remaining problems on the property.

“The moment you sign that agreement with the designated agency, you as the developer become protected against liability under a number of different state laws in California and elsewhere,” says Villa.

Pre-development planning

The level of environmental clean-up required by the EPA and other agencies is directly related to a project’s end-use. Low-rise residential housing will require a higher level of clean-up than a commercial or industrial application. Adding a park-like setting to a commercial property at a later stage of development is never a good idea, as it may invalidate all of the building team’s up-front regulatory work.

As the EPA’s Superfund records show, there are few sites that are beyond clean-up. Consultants like Partner Engineering and Science Inc. are often able to negotiate with regulatory agencies on the level of clean-up required for the project. A site that includes a new asphalt parking lot with a photo kiosk as the retail base will be much more affordable to clean up than a mixed-use development.

“It’s rare to see a developer blindsided, but some may walk away,” says MacWilliams. “If a dry cleaner previously operated on the site, there’s a 95 percent chance an environmental clean-up will be required.”

While abandoned dry cleaners are infamous for tetrachloroethylene (PERC) contamination, and corner gas stations for petroleum leaks, in an up-and-coming urban area these sites can be boons for developers.

In cases where the site has already been cleaned up by the seller, Villa recommends that developers require “warranties and representations” on the condition of the property to be sold. Should these “warranties” turn out to be false, the seller of the property is required to make good on any losses incurred from future environmental problems.

The developer can also ask that the seller or prior owner of the property provide “environmental indemnity” on the transaction. Of course, these indemnities are only as good as the financial strength of the party issuing them, so Villa again recommends environmental insurance as an additional layer of protection.

The next bad thing

Substances like polychlorinated biphenyls (PCBs), asbestos, hexavalent chromium, trichloroethylene and arsenic all suggest toxicity and health concerns and are commonly associated with significant tort and environmental liability.

Fortunately, none of these substances are in what some legal experts are calling the next area of massive toxic tort litigation and liability. It is mold that has generated nationwide media attention and involved architects, construction companies, commercial and residential landlords, property managers, and contractors in multi-million-dollar lawsuits.

“The major environmental issue in our industry continues to be vapor intrusion,” says MacWilliams. “This plays into brownfield development, because more often than not, you are likely to leave some level of contamination in place.”

Years ago, researchers found that certain contaminants can volatize and move through concrete foundations and into occupied spaces. The specification of a vapor barrier solves these potential problems without being prohibitively expensive.

Injection chemicals are also used to help neutralize chemicals instead of pumping the contaminated water out of the ground. However, the removal of all contaminated soil is not a practical option. These limitations make the use of vapor barriers that much more attractive.

“You cannot continue to use natural resources to clean up other natural resources,” says MacWilliams. “From a sustainability standpoint, you will reach a point of diminishing returns.”

Financing Brownfield Redevelopment

The financing incentives listed below were active through FY 2011, according to Charlie Bartsch, senior program advisor for economic development at the EPA. However, it’s been tough to follow recent changes amid budget cuts in an election year.

■ The EPA Clean Water Act provides more than $3 billion of construction capital, including brownfield mitigation, to correct or prevent water quality problems and groundwater contamination.

■ The Brownfield Clean-up Cost Expensing Incentive allows new owners to recover clean-up costs in the year incurred. Unfortunately, the incentive has received little use, according to Bartsch, due to “on-again, off-again availability, lack of information and poor structuring as a deal-making incentive.”

■ HUD/Community Development Block Grants are funded individually by state and include demolition and removal, rehabilitation of public and private buildings, and more.

■ USDA Rural Development Programs meet broadly defined objectives by offering business loans, intermediary re-lending and rural development grants. Eligible activities can include site clearance and prep work, rehab, and the construction of real estate improvements and amenities.

■ Rehabilitation Tax Credits offer 20 percent credit for historic structures (certified by the state) and 10 percent for non-historic developments, with no certification required.

■ Energy Tax Incentives offer developers a $1.80/sq. ft. deduction for commercial building construction that saves 50 percent of energy costs, as well as $0.60 for 20 percent energy savings.

■ New Market Tax Credits at 39 percent over seven years for equity investments in low-income communities. More than $24 billion was awarded to 463 Community Development Entities since 2001.

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