A brownfield is a real estate deal that appears, before redevelopment, to entail a complicated and expensive site preparation phase and above-average risk. After redevelopment, the project should appear to be a near-normal real estate deal that may have manageable and quantifiable additional risks.
Brownfield financing has benefited recently from improvements in remediation technology that reduce remediation costs and from advancements in the allocation of risk. The availability of environmental insurance gives both developers and banks another way to protect themselves from brownfield liabilities. Many states have also developed innovative tax incentives and subsidies to aid in brownfield remediation and redevelopment.
A brownfield should be considered a real estate deal with adequate market potential and likely manageable environmental problems. Using this approach, logical and conventional analytical tools long accepted in real estate development practice can be plied for successful redevelopment outcomes. Caution flags should rise if a brownfield is characterized as a contaminated site first, which, if cleaned up, may have real estate redevelopment potential. Cleanup should be viewed in the context of the development, not development in the context of cleanup.
A brownfield development can be viewed as merely a construction project with potential for excess site preparation costs (to cover cleanup of any contamination), potentially significant excess transaction costs (due diligence, legal fees, community run into the future. Since successful brownfield deals are essentially real estate deals at the core, their ability to compete for financing and tenants or buyers should be determined by basic real estate development fundamentals. If the excess brownfield costs can be controlled or additional funding can be obtained to cover such costs, then there is no reason why brownfield issues should preclude an otherwise sensible real estate development from being undertaken.
At the end of the lending process, brownfields should be treated as real estate deals, not credit deals. This means that the property itself would act as sole collateral for a permanent mortgage with a "normal" loan-to-value ratio. This approach would exclude having a large corporate guarantee (credit deal). Ideally, brownfield deals would also exclude recourse financing to the borrower. Risk-related issues such as insurance and liability to borrower and lender are important but of secondary emphasis.
The potential for excess site development costs means that many brownfield sites have a financing gap because development costs to the redeveloper exceed market value as determined by the lender and other market forces. This financing gap requires creative financing. How a developer can creatively obtain funds (primarily from government subsidies) to investigate and remediate a site that at the time may have uncertain or negative market value, is the challenge at hand.
After remediation, the site may have existing remediation loans that need to be subordinated to permanent first mortgages, so the developer/borrower can then structure a deal that meets normal real estate lending standards acceptable to mainstream lenders. Using creative financing is important because it reduces developer risk during the project's early development and permits use of external funds rather than the developer's own investment capital.
Characterizing Investment Opportunities
Properties have variable brownfield severity, which is primarily a function of the level of the excess costs. While many different schemes for characterizing severity are possible, the following illustrates instances when creative "gap financing" may be applicable. There are five types of potential brownfield sites:
• Viable sites: These sites feature good economic development potential and low levels of contamination. The private sector developer can develop such a site without government financial assistance.
• Threshold sites: These sites have satisfactory economic development potential and moderate contamination, the extent of which may be difficult to determine without substantial investigation. This type of site needs government assistance to develop. The focus of this chapter is on these threshold sites.
• Potential future sites: The economics of these sites are unknown. In these cases, the real estate is worth more than the existing operating business and there may be redevelopment pressure. These sites will generally evolve into one of the other types of brownfield sites.
* Non viable sites. Regardless of contamination, this site has little or no economic use in the foreseeable future. The best strategy is to stabilize the site and wait until future conditions warrant development.
* Super-polluted sites. Despite possible economic development potential, these site are perceived to present a public health issue.
Many brownfield problems are otherwise worthy real estate projects with excess site preparation costs due to the property's contamination. The degree to which a developer can obtain sufficient financing to address conventional development in addition to the cleanup of contamination can make or break the deal. We identified a financing gap where brownfield issues cause project development costs to exceed market value. There are some conventional, as well as innovative, ways to address this gap.
A developer can approach local, state, or federal governments to obtain subsidies to help the project meet its hurdle rate of return. However, these subsidies are viewed quite differently by developers, who generally want funds right away, and the government, which favors non-project fiscal benefits like tax revenues and has a longer-term perspective.
The dynamics of short-term and long-term money may have to be reconciled to make a project successful. Creative mechanisms include subsidies that have characteristics of subordinated debt, grants that do not require repayment because of long-term public benefits, and tax breaks that enhance operating cash flows.
Creative financing from relevant government entities and other brownfield programs can plug the gap and turn an otherwise impossible deal into one that meets the hurdle rate. Development costs can be held down and cash flows improved so a larger loan can be obtained and less equity is needed, both of which drive up the rate return.
Finally, the timing of creative financing early in the development process can help developers keep their cash needs down and move the project forward.