With a high demand for, but shortage of, well-positioned land to build on, investors and developers are increasingly focusing their efforts on infill projects. But many of these sites have long histories and, as a result, have a greater potential for having adverse environmental issues. A developer or investor with the skills to navigate the extra challenges associated with a brownfield development project enjoys a favorable competitive environment at the acquisition stage.
Brownfield projects can be rewarding, but you have to be able to execute on four important elements: 1) quantifying the problem before buying; 2) apportioning risk between seller, insurance, financiers and yourself; 3) accessing public money; 4) selecting the right options for remediation.
Quantifying the problem
An asset with an associated liability can transact easily, as long as the size of the liability is known. Environmental liabilities pose a unique risk because they have the potential to be far larger than expected. In order to adequately quantify the environmental risk, any brownfield project will need a Phase I, II and III Environmental Site Assessment (ESA).
First, the Phase I ESA should identify all potential environmental issues. A buyer may be tempted to skip this step if an environmental issue is already known; however, beware that a property with a known environmental release on the east side could have an unknown release on the west side! The Phase I ESA is an inexpensive first step that any would-be brownfield developer shouldn’t skimp on. It’s important to note that a standard-scope Phase I does not normally address issues like asbestos abatement, lead-based paint or polychlorinated biphenyls (PCBs) in electrical equipment. Because these formerly ubiquitous materials may be present, a buyer of a brownfield with an old building should request that a survey of these building materials is added to the Phase I ESA scope.
Following the Phase I ESA, Phase II Subsurface Testing is done to determine if the potential concerns identified have resulted in the contamination of soil, soil gas or groundwater. If so, the Phase III Subsurface Investigation is intended to characterize the nature and extent of the issues discovered in Phase II. Engineers and geologists can get pretty technical at this point in the process, but for a laymen the question is simple: can you draw a circle around the plume? If you don’t know where the contamination ends physically, then it is difficult to put a cap on the financial exposure.
Once the environmental issue is characterized, the final step is obtaining a quality Remedial Cost Estimate (RCE). The RCE differs from a proposal to remediate because it includes an estimation of all environmental costs that the owner or developer will experience due to the contamination (consulting costs, charges and taxes from the state, etc.). To calculate this, the consultant must make assumptions on the demands of the government regulators. At times, these demands may be ambiguous, which can make the estimation process tricky. Importantly, the RCE needs to be done in the context of the project. For example, a gas station may be able to be remediated to the point of a risk-based closure for $200,000. However, if the developer planned on excavating a subterranean parking garage and digging up polluted soil that could have remained in place, the environmental costs could triple.
An infill developer may want to place the costs and risks of a project into three buckets: predevelopment expense (characterization, work plans); development costs (excavation, soil disposal, vapor barriers); and post development expense (long term groundwater remediation/monitoring). Ideally, the buyer is able to offset all expected expenses through pricing discounts or indemnification from the seller. However, deals are often more complicated. If the contamination is well-characterized, the government regulators can be clear on their expectations, which means the RCE will be more accurate, and therefore the risks are low.
To the extent that there are some unknowns there will be risk. However, a skilled developer will be able to apportion this risk. The best entities to bear it are the seller or the polluting party, since they carry the risk by default. For example, in exchange for a discount purchase price a developer may agree to pay for the characterization, work plans and the disposal of contaminated soil; however, the seller would agree to keep the liability associated with the groundwater plume. Of course, in an arrangement like this it is critical to consult a quality environmental attorney.
Lenders and developers will naturally go down the path of contemplating “what-if” scenarios that would make a brownfields project forbidding. That’s when environmental insurance can save the deal. Insurance can be a great tool to mitigate unlikely, but expensive outcomes. However, a developer will struggle to obtain environmental insurance on the metaphorical “burning building.” What is more readily available are lender insurance policies that protect against two unlikely events: borrower defaults and the environmental costs being higher than expected. Having quality Phase I, II, and III environmental reports improves the prospect of getting environmental insurance.
Getting public money
Federal, state and local brownfield funds are available that can improve the economics of an infill project. At the federal level, many communities utilize grant programs offered by the EPA and other entities that offer a range of attractive economic incentives and financing tools that can be applied to offset the cost of assessing and remediating environmental issues. Although some of these federal programs are in jeopardy with the new administration’s proposed funding cuts, they are only some of the tools in the toolbox available for brownfield development. In many areas funding mechanisms such as tax increment financing, state and local grants and loans or housing and community development financing programs are available to support the clean-up of infill sites.
The cost of remediating a contaminated site can be high and it is important to leverage all available financing options, but in this competitive market the effort can be well worth it.
Selecting the right options for remediation
Regulations are mostly driven by state and local government, but it’s safe to say that regulators have generally become more forgiving on petroleum releases and more demanding on chlorinated solvent releases. Increasingly fuels are allowed to degrade overtime, which means that low risk closure has become less expensive to obtain than it was 10 years ago. Conversely, there is growing concern surrounding the human health risks associated with vapor intrusion of chlorinated solvents and other carcinogenic chemicals.
The good news for developers is that vapor intrusion can be mitigated more easily than other concerns through the use of a vapor barrier. While vapor barriers can be difficult to apply to existing buildings, the process is uncomplicated in new buildings and the installation expense can be easily and accurately calculated. Moreover, the application of a vapor barrier or the cost of excavating a well-defined quantity of soil are the types of remediation expenses that a brownfield developer and their lenders should be able to underwrite.
Remediation techniques like in-situ treatment of deep soil contamination and groundwater are a bit trickier and require an experienced environmental engineer to design an appropriate system.
Importantly, incorporating the remedial solution into the early design stages of the project can greatly improve ROI by not only addressing the issue, but also improving the aesthetic of the property and its perception within the community. For example, innovative landscape solutions such as ornamental fencing, clean fill and natural vegetative elements can be utilized in place of conventional capping. This way dollars spent on remediation can be leveraged to achieve additional value for the project.
For any developer who wants to take on a brownfield, my advice is to do your homework. Make sure you understand the risks and your options upfront, and build a great team of professionals to support you with engineering consulting and legal advice. With the right information and people in place, brownfield remediation can be a rewarding effort in today’s competitive environment.
Joseph P. Derhake serves as CEO of Partner Engineering and Science Inc., an engineering and environmental due diligence consulting firm. He has more than 25 years of experience in the industry.