Today’s Market Feels Yesterday’s Mistakes
Weeks after the government takeovers of Fannie Mae and Freddie Mac, the impact of the subprime mortgage crisis continues. While the financial downturn affects every avenue of the United States economy, those alleys closest to the real estate market are feeling it the most, even in the relatively removed brownfield market. Scott Beckerman, vice president and manager of Comerica Banks’ Environmental Risk Management Group, said he’s seen banks shy away from brownfield projects they previously would have helped fund.

“We’re in different and strange economic times, and some banks that in the past would have lent on these types of projects are now hesitant to do so,” Beckerman said.

Jonathan Philips, senior director and general partner at the industry’s leading brownfield investment company, Cherokee, said the situation is much the same on the equity side. “When the market was very strong, I think there were a lot of people who were willing to take a risk on a one-off brownfield project,” Philips said.

Funding Types and Sources
None of that is to say debt and equity players have left the stadium of brownfield funding, but many are watching from the sidelines to see how the market reacts. Moreover, each player holds different expectations for the projects they green light. Equity players—the investment firms and venture capitalists—typically seek out projects that will generate a high return from their investment. They’ll usually fund large dollar projects, which when rehabilitated and redeveloped, will gain a higher value, at which point the investors will collect their profit either from a percentage of the land once sold, or through a percentage of the lease paid by its eventual tenants.

Debt players—banks and other lending agencies—tend to provide funding at the other end of the spectrum. While brownfield loans operate the same as typical loans with the interested party filling out the proper forms and passing the requisite credit checks, the fees and rates are higher than normal loans due to the risks inherent in brownfield sites.

Kevin Noell, managing director of Terra Vita Development, summed up the differences between the two. “Equity investors look for higher risk transactions, which tend to have a higher rate of return. And brownfield development is considered at the top of the risk,” Noell said. “Lenders don’t take a lot of risk, and rightfully so, because they don’t get paid to take a lot of risks.”

Brownfield sites can be segmented into three different levels and each level carries its own risk.

Level I: The site, improved or unimproved, has been studied and surveyed; environmental contamination levels are generally known, although no plans for remediation are in place.

Level II: The developer has a work plan in place with entitlements and possibly a guaranteed fixed price remediation contract. Little work has been done to clean up the contamination, and unforeseen variables still exist.

Level III: The site has been cleaned to the predetermined standard for its zoned use, and a closure letter has been issued.

There are many variables involved in closing a deal on the funding for brownfield remediation and redevelopment. Due to the diversity of projects, lenders and investors, different funding opportunities exist. We will take a closer look at some of the major players and what they are looking for in prospective projects. The table on pages 12–13 provides a synopsis of these players.

Comerica Bank
“We probably did brownfield lending before it was called brownfield lending. We come from a long history of strong commercial banking in the midwest, which has a heavy manufacturing presence,” said Scott Beckerman. “It started in the late ‘80s when we first started seeing banks taking losses and foreclosures, and having to swallow the cleanup costs on properties. That knowledge has lead Comerica to be willing to provide funding for brownfield projects at each stage of development, and on either improved or unimproved land.

Regarding developers, Beckerman said, “We want to know we’re working with someone who takes brownfield redevelopment seriously, even if it’s their first project. We want to know they have a plan for the property that they have either investigated or prepared for the environmental concerns, or are eager and prepared to do so. The projects that most often go wrong are projects where the developer cuts corners and then down the line runs into unforeseen environmental problems that cost time and money.”

Beckerman added that experience and flexibility push applicants ahead of the pack.

“I think, in brownfield redevelopment, experience is imperative, and the team they’ve assembled behind them—those are two very important things,” he said. “An important element to a project right now is flexibility. By the time you get done with the investigation, the assessment, the regulatory process, and the municipal approval—the markets are moving so fast right now the demand may have changed; so to the extent that you have a flexible project, that’s a big plus.”

Remediation Capital Funding
New York’s Remediation Capital Funding is a relative newcomer to the field. Formed just over a year ago, and restructured in April, the agency mixes a hands-on approach with a willingness to fund risky projects.

“We absolutely look at Level I sites,” Joel Arberman, senior vice president of RCF, said. “If the developer has a good amount of cash invested in the project, and it’s in need of environmental cleanup, and that’s why they can’t get a loan, then they should certainly come see us.”

“It doesn’t bother us that the borrower doesn’t know the extent of it [the contamination], we’ll work with them to get through that, and then if we’re comfortably with it, make a deal,” he said.

And while Arberman said applying for a loan with RCF is little different from applying for a loan from a conventional bank, the criteria is broadened. “We’d be looking for all the things any other lender would want, plus any environmental study that has been done, and then from a top-level perspective we’ll look at our risk-reward, and if it passes that then we’ll have our environmental engineers talk to the developer’s environmental engineer, and if they pass then we’ll move ahead.”

“If they have lease agreements for whatever would be built there, we would certainly push them ahead. Anything that mitigates the risks that we’re taking or helps enhance the value of the property at the end, will help,” he said.

As a private fund, Arberman said RCF also likes to see developers financially invested in the property. “We’re looking for the developer or the borrower to have something in the deal. We want to make sure they have more than time at stake. We want to see that they have some capital involved.”

EnviroFinance Group
California often leads the way in terms of environmental reform, so it’s no surprise that EnviroFinance Group’s originator, California CERF, formed there in 1997 as a development fund. After nine years and several name changes, the group was capitalized as EFG in 2006. Since then, Craig Carbrey, president and chief credit officer for EFG, said the firm’s gone on to fund a wide swatch of Level II projects.

“We’ve closed a $42 million loan, and we’ve closed a $4 million loan, but our sweet spot is $10 million,” he said.

Carbrey said that any developer or borrower seeking funding from EFG would need to show, at a basic level, they were serious about going in, and getting out. “In today’s market, today’s world, there needs to be real money involved; the borrower needs to come in and be willing to share some of that risk,” he said. “Also, the deals we’re working on right now—they have lease agreements or pre-sale agreements, and we can grant them financing. You don’t have to have it in hand necessarily, but you have to be in a strong enough market to prove that it will work.”

Beyond that, experience, either inherent or included, gives a developer the edge.

“Now, some guys can be new to a brownfield [project] and they have the right lawyer, and the right engineers, and it gets done. You don’t necessarily have to have experience, but you have to have the right team in place,” said Carbrey.

Bayberry Asset-Backed Lending
Most lenders willing to negotiate brownfield funds formulate the loans based on the value of the property, either inherent or projected. New York’s Bayberry Asset-Backed Lending steps in and offers loans based on grants, tax rebates, tax refunds, awards and tax credits offered to developers by governmental agencies.

“Where we can add value [and] where others maybe can’t is, while we don’t lend on real estate, we’ll lend on the brownfield and any state or local grants, tax rebates and the like. Each state is different, and sometimes we have knowledge of programs in the state the developer might not be aware of,” said Mike Hansen, managing director of the fund. “We’ll step in and say, ‘Hey, we recognize that you’ll have this money later, so we’ll lend you money now, and once you get those refunds or tax rebates, then you can pay us back.’”

Like many others, Bayberry wants to see a developer with a plan, and some experience.

“I think probably most important is a viable remediation plan, even if it’s not approved by the EPA or local government yet. And we would prefer some past experience, but it’s not a pre-requisite,” Hansen said. “What would really push them to the top is if they already started, and were just looking to [provide] bridge [financing to get them] to the finish.”

Cherokee Fund
In 1998, Cherokee formed its first private equity fund, which holds $250 million in capital and assets. Ten years later, the company’s available funds have grown to include roughly $2 billion. Jonathan Philips, senior director and general partner of Cherokee, said most of it is set aside to invest in brownfield redevelopment at all development levels, particularly the first.

“That’s what Cherokee was founded and formed to do—invest in environmentally distressed properties,” he said. “We can invest along the lifecycle of a project, but our bread and butter has been property acquisition, although we’ll certainly look at other brownfield sites that are further along in their development, but need funding,” said Philips.

On a basic level, Philips said Cherokee wants to see that a developer has experience with large-ticket real estate deals, even those outside of brownfield development. “We’d like to see that they have significant experience and are taking on the type of project we’ll consider, and that they have the staff required to see it through to the end,” he said. “We’re not going to turn someone away because they’ve never done a brownfield [site] before. But if they’ve never done a big real estate deal before, that’s going to make us ask a lot more questions.”

It’s developers with projects in line with Cherokee’s mission that get pushed ahead.

“We’d like to see that they share our values about the environment, about community, about sustainability, about leaving things better than we found them,” Philips said. “Values are probably the most important, especially when you’re dealing with real estate. It’s an industry that has a definite reputation when it comes to integrity, and stewardship. And if that integrity isn’t there, it’s going to make it hard to form a partnership and build that trust.”

Your Local Bank
Typically banks don’t lend on brownfield projects, but some do. The bank nearest your office may not have the deep pockets of the major lenders, but it also might not be as shell shocked from the recent credit crunch, Comerica’s Beckerman said. “Due to the crazy nature of the market right now, some of the small banks may be open more to lending on a brownfield more than a big bank depending on how they’ve been touched by things like the subprime market.”

If that project you’re working on involves flipping an old gas station into a diner, or turning a pharmacy into office space, Noell said area banks are the place to look. “That’s a classic example of what a local bank would do,” he said. “If your transaction is put together [and demonstrates that it] mitigates the risk, and you have the right team put together—a developer, an environmental consultant, and the right lawyer—any community bank knowledgeable in real estate would be able to put that deal together.”

“Because the local banks may have a closer relationship with the government, they may have better insight into local regulations, better insight into local government operations, and better insight into community interests,” he said. However, local banks make lack environmental underwriting expertise, which could make them shy away from lending on a brownfield.

Canadian Market
It’s hard to think of the EPA as taken for granted. Say what you will, but the early incentives offered a reason to remediate, and federal laws provide a thread of consistency when navigating sites from state to state. By contrast, the brownfield market in Canada is still in its nascent stage. Without any federal guidelines, the onus fell on the provinces to draft individual legislation on standards and procedures.

“Five years ago I would say Canada didn’t have a very good regulatory closure process, and because of that we didn’t have very much of a brownfield market,” David Harper, managing partner of Kilmer Brownfield Equity Fund, said. What it did, and does have, is potential.

The lack of any consistent federal guidelines from province to province can make redevelopment in Canada difficult. Harper said that Kilmer, based in Toronto, uses different crews in different provinces.

“If you’re coming up from the United States, and you’re investing in Canadian property, then you should build a Canadian network. Brownfields are a very local business up here, and you’ll need to find people who understand the communities and regulations, or form a partnership with people who do know the locales and the methodologies,” says Harper.

As for funding, the relatively new nature of the brownfield market in Canada means funding sources in the country are scarce, especially at the remediation level, Michael Billowits, manager of Quantum Murray LP’s brownfield division, and Harper said. Quantum Murray LP and Kilmer have emerged as two of Canada’s funding sources.

Kilmer
“We’ll pay for all the environmental and up-front type activities. Developers throw in their land, and we step out once we get the closure letters and construction is ready to start,” Harper explained. United States developers should also have a Canadian location or a partnership with a Canadian firm, as well as a willingness to partner with Kilmer. “We’d have to have a partnership so we’d both have some skin in the game,” Harper said.

Past that, location and an understanding of the risks involved move developers to the forefront. “It would have to be a property in a good market—at the end of the day it’s real estate, right? Location, location, location,” Harper said. “And having their skill on the market side is really critical. The market risk is always the hardest risk to quantify.”

Quantum Murray, LP
When entering into a new situation, it’s always nice to have a partner, someone who’s been there before and knows what to expect. In Canada’s brownfield market, Quantum Murray LP’s cross-categorical experience in demolition, remediation, and hazardous material makes them a prime choice. And they’re willing to take on partners from south of their border.

“Oh yeah, definitely,” Michael Billowtis, manager of brownfields for Quantum, said. “We add value to the development in the design-build process for the decommission and remediation activities. In particular, we can combine the remediation plans with the future redevelopment plan to ensure the most cost-effective cleanup is completed. And in the design-build phase we commit to procuring regulatory closure.”

Quantum operates mostly in three of Canada’s largest provinces, and has experience navigating the municipal rules. “It’s very local in nature – the regulation situation,” Billowtis said. “The main areas we’ve operated in are Ontario, British Columbia and Alberta; and that’s mainly because those are the hottest markets, and those are the areas with some procedures for closures.”

State of the Market
“The market’s not completely dead, it’s just breathing hard.”

More appropriately, Carbrey added, “The market is catching its breath.”

“The profit margins are getting to the level—because property values are adjusting—where it’s becoming a little more advantageous,” he said. “The sellers are becoming more realistic on the price of the land, and sort of risk adjusting the price of land.”

For Philips, the real estate crunch cleaned out the wrong types of investors.

“From our perspective, there may be less people with capital looking at brownfields, which may be a bad thing from the environmental perspective, and from a community perspective, but it may have needed to happen to clear the field of people who didn’t know what they were doing, or were doing it for the wrong reasons,” he said.

In Noell’s mind, the brownfield market is strong compared to other real estate markets.

“I’d say it’s better, and I guess the reason is, when you’re dealing with property development you’re creating value,” he said. “In the brownfield work that task is bigger by quantum value because we’re taking something with a negative value and giving it a positive value.”

In the past, the time invested in redevelopment detracted from the appeal of brownfields. Now, what was once a hindrance may help ride out a property market on the downside of its cycle, Ann Davlin, general partner of the Bayberry Green Fund, said.

“In my mind, it’s the right time to break into the brownfield market,” Davlin said. “I think it’s probably a good opportunity to get into the brownfield market because you can get into a property that right now might not make sense, but in a few years, when the market changes, may be ideal.”

Hansen agreed.

“There’s an old Wall Street adage that when times are the worst is when it’s best to get in because all the major players have stepped back, and getting a piece of brownfield land and redeveloping it over the next several years could put you in the catbird seat when the market swings back around.”

Jonathan Robbins is a freelance journalist.