Residential Real Estate

We've all seen it. That perfect corner location, vacant industrial building or urban site that just seems to sits empty year after year. "Environmental problem", we hear. "Costs too much to cleanup." "They can't give that site away."

Perhaps.

What if the site were clean? Would it be a good development site then? What if, instead of environmental cleanup costs coming out of your pocket, you could get the government to pay them? What if, additionally, you could get income tax deductions or, better yet, transferable income tax credits for cleaning up the site?

Government funds may not be available in every case but, when government funds are available, commercial real estate projects not otherwise feasible can be made profitable. For developers, profitable is good.

Revitalization of brownfields is an urgent concern in many communities. When the local community benefits, public money may be available. In fact, in many cases public money is available. You just have to know how to ask for it.

When it comes right down to it, all commercial real estate development involves four primary areas of concern: (i) market demand; (ii) access; (iii) use and (iv) finances. These four aspects are the primary focus of every development project.

The issue of brownfield site development implicates the “use” and “finances” aspects of commercial real estate development.

The presence of certain hazardous substances, pollutants, or contaminants may impair the ability of a site to be used as intended by a developer absent remediation to remove environmentally offensive substances or, where applicable, installation of suitable institutional controls to limit their exposure.

Developers often don't know the difference between a polychlorinated byfenyl and a polynuclear aromatic hydrocarbon or any other regulated substance that may contaminate a potential development site.

What they do know is that the presence of these substances in quantities requiring cleanup or installation of institutional controls adds costs to real estate projects that would not be incurred if these substances were not present. From a developer’s standpoint, these costs are “extras”. Environmental cleanup and installation of institutional controls add to the cost of site development but do not add to its value.

Real estate development is driven by economics. The science and regulatory scheme for dealing with environmental contamination is left to environmental attorneys, engineers and others. Developers need to know how much it will cost, how long it will take and how the developer is going to recover the added expense.

In many cases, a viable source for recovering brownfield cleanup costs is government money.

The sources of government funds for brownfield redevelopment are varied. They fall into the broad category of what commercial real estate developers refer to as “entitlements”. While there are a few actual “entitlements” available to brownfield site developers, such as favorable tax treatment for brownfield site clean up costs, the greatest opportunities to obtain government funds for brownfield site development are through use of government “incentive” programs.

The main point to understand about government development incentives is that they are designed and intended primarily to benefit local government, not developers. This is not to say that they don't benefit developers. It is just to point out that benefiting developers is not their primary aim.

Understanding this distinction is critical when searching for government money to benefit private development. The way to obtain government money for private development is for the private developer to align its development plans with the needs of the public, as determined by local government.

I am not suggesting that all development decisions should be turned over to local public officials, but a developer seeking public money should certainly try to design the project to give them what they want. Presumably, local public officials are in touch with the needs of local citizens. If they are willing to pay to fulfill those needs, why not accommodate them?

If there is no public objective sought to be achieved by local government through development of a particular project, there will be no public money available for the project. Once again, availability of government funds for private development is an “incentive”, not a right. Developers are “entitled” to seek “incentives” and, if the developer fulfills the incentive’s objective, it will be "entitled" to receive the benefits of the incentive program, but when it comes to receiving public money, use of the term “entitlement” is often overoptimistic.

Use of public funds must primarily benefit the public. It is up to the developer to make sure its development plans coincide with the public good so that what benefits the public can benefit the developer as well.

Fortunately, it is possible for municipalities to offer development incentives in a way that can benefit the public, the project and the developer while not really costing local government a dime. In some cases State and Federal cleanup grants are available that may used to benefit the project. In other cases, user taxes in the form of business district sales tax rebates or sales tax and real estate tax increment financing can be used. If the right set of circumstances is present, transferable income tax credits may be available to the developer to market and sell to raise private development capital.

In smaller communities, it may be necessary to educate local officials as to the programs available to help them provide economic incentives for needed development.

Once public officials become convinced their public constituency will benefit from a project, and can be shown how to receive those benefits with little or no out-of-pocket costs to local government, the stage is set. At this point, a development financing scenario that uses public funds for private development can be structured to the mutual benefit of the community at large and the private developer. Thus is born the so-called “public-private partnership”. It is not so much a partnership in fact, as it is a mutual benefit compact. It is a relationship that sets up the proverbial “win-win” scenario where both the public sector and private sector benefit from private development through use of public funds.

Brownfield development incentives, like all government development incentives, are designed and intended to induce developers to build the type of development within a community that local government believes is needed. Development incentives are bargaining chips, so to speak. They are the currency in trade to “purchase” the kinds of development local government seeks.

This concept is the foundation for obtaining public money for private development.

To receive public funds for a private project, a developer will need to demonstrate that (i) the project benefits the public good (the "Public Purpose Test") and, (ii) “but for” the commitment of public funds, the project will not go forward – at least not in a way that achieves the maximum benefit to the public sought by local public officials (the "But For Test").

As fundamental as the Public Purpose Test and the But For Test are as predicates to receiving public money for private development, they are not as difficult to satisfy as one might imagine.

The benefits to local government obtained by offering incentives to developers to clean up and redevelop brownfield sites are numerous. They are recognized to include revitalization of blighted and decaying areas, decreased pollution, increased jobs, expanded retail choices for local residents, relief of the tax burden on local residents, increased value in the tax base enabling increased spending on city services and education, improving the quality of life for all residents through creation of public amenities such as parks and open space and creating a more satisfying living environment.

Courts have widely accepted that use of public funds to promote economic development is a legitimate public purpose, even if the public funds inure to the benefit of private developers.

Real estate development is an intensely local undertaking. Competition exists within and between local communities to attract development. Commercial real estate development, particularly retail development, can be a great benefit to local governments because it enhances the real estate tax base and increases sales tax revenue. Real estate tax revenue and sales tax revenue are the two primary sources of revenue available to local governments to pay for governmental services.

For real estate development to go forward, however, the project must make economic sense to the developer. Environmental clean up costs and other excess costs of developing brownfields can adversely impact the economics of any commercial project.

If $1,000,000 in extra cost is incurred to investigate, clean up and prepare a brownfield site to build a 200,000 square foot shopping center, but the same 200,000 square foot project could be built across the street on a “clean” site without these costs, the brownfield developer will be at a competitive disadvantage to another developer who develops the clean site. If the going rental rate for retail space is $40 per square foot in the geographic area in which the two sites are located, it is not likely that prospective tenants will be willing to pay more rental per square foot simply because the brownfield site developer paid more to develop its project. As a consequence, the brownfield site developer’s return on investment will be less, because – all else being equal – it has $1,000,000 more invested in the project than the developer of the clean site across the street.

This fundamental financial reality becomes particularly significant when the street separating the two sites is a city or village boundary, with one site in one municipality and the other in another municipality. This is especially true if, in fact, market demand will support development of only one of the two sites with the hypothetical 200,000 square foot shopping center, so that competition exists between the two municipalities to get the project built within its municipal boundaries.

Why would a municipality care if the site is built within its boundaries instead of the one next door? Because municipalities rely primarily upon real estate tax revenue and sales tax revenue to pay the costs of running the municipality and to pay for vital municipal services like police protection, fire protection, street maintenance, snow removal, and the like. If the project is built within the municipality it will enjoy the benefit of increased real estate taxes and increased sales taxes the project brings with it. If it is built across the street in another municipality, it will not.

Even when inter-municipal competition for tax dollars is not at stake, development of brownfield sites is desirable to municipalities because it can change the character of the property from a blighted, unhealthy eyesore to a productive tax generating enterprise. This can increase the taxable value of not only the brownfield site but surrounding properties as well, and create jobs and serve as a catalyst for urban renewal.

The key point here is that there is a recognized public interest in returning brownfield sites to productive use. Understanding this can open the door to receiving public money for private development. Public money can make the difference between going ahead with a project or giving it a pass.

When considering a brownfield project, know what sources of public funds are available and how to make the case to receive them.


Thanks for listening.

Kymn