CONFIDENTIAL
Surplus Property Roundtable
Year 5, Meeting 4
Chicago
November 1-2, 2017
The Surplus Property Roundtable convened in Chicago (IL) on November 1, 2017 for its fourth meeting of the year. Bob Parker, President and Jay Gardner, Executive Director presided.
This memorandum seeks to chronicle the central aspects of the proceedings, synthesizing those agenda items where substantive discussion among the membership transpired. The memorandum is not a transcript of the discussions and does not serve as a statement of position of the Surplus Property Roundtable or its member companies.
Contents
I.Wall Street Backed Private Equity – A Conversation on How Private Equity is Repurposing Surplus Property
II.Great Ecology and Tellurium Partners
III.Benchmarking Committee – Stakeholder Management
IV.Real Estate and Environmental Panel – Insurance and Financial Assurance
V.Sustainable Environmental Program Management
VI.The Future of Remediation Selection and Site Prioritization
VII.Center for Creative Land Recycling
VIII.Deed Modification Requests
IX.Education and Outreach Committee Action Plan
- Wall Street Backed Private Equity – A Conversation on How Private Equity is Repurposing Surplus Property
Art Frye (Spaulding & Slye Investments/JLL) and David Kirshenbaum (Hilco) offered their perspectives on investing in surplus property, with Frye bringing a fund manager viewpoint and Kirshenbaum looking at sites as a brownfield developer.
In general, a manger of private equity funds is not in it for the long run, perhaps 3-5 years. A brownfield site in a corporate surplus property portfolio, with a possible timeline of up to 10 years of remediation and entitlement work, could prompt them to pass. On the other side of the spectrum is the typical brownfield developer, who can be described as having “low equity and big dreams”. This thinly capitalized individual is “trying to grab the tiger by the tail” and needs financing (usually 90%) in order to close on sites.
Frye and Kirshenbaum, in response to SPR inquiry, discussed how a hybrid private equity-brownfields approach can be successful at surplus property sites. In today’s market, there are few opportunities that offer risk-based double digit returns, perhaps with IRRs in the high 20s. Should an investor (such as JLL) be able to mitigate brownfield risks within a 3-5 year period and earn those returns, they would be willing to invest in that“first tier” of the redevelopment and then take the property to institutional investors and together (possibly) take the site to its highest and best use through further investment and repositioning. Fund managers like this do not need to pass the hat looking for equity; however, they will take their time to perfect the highest and best redevelopment scenario, as their investors will expect that no stone goes unturned.
Alternatively, amaturebrownfield developer (such as Hilco) with ready access to private equity capital can close on deals quickly and takesites from the “awful stage to a saleable stage”. This brownfield developer can offers its partners – such as Cerberus and Goldman Sachs – returns in the 20s. With its private equity partners investing at the entity level rather than project level, a brownfield developer like this has the cash to take down sites with their balance sheet and thus does not need financing.
Following this overview, membership discussion looked at several aspects of these approaches.
Managing environmental and entitlement risks
In general, the developer entity will need to handle the environmental and entitlement work. Private equity will want to “shove it down” to the developer, as they want “no unknowns” when they invest. In response, the developer will layer in environmental insurance and negotiate indemnification provisionssince it is the party that will have to “stand up” if something goes wrong. Private equity – notwithstanding it mantra of “how much can I get out in 3-5 years” – is showing some flexibility as hotel and retail is down and they are looking for opportunities. As a result, some dedicated funds will take on more risk and, naturally, will expect greater returns. The developer, in turn, will work to make the environmental and entitlement risks more “digestible”, outlining the path ahead and showing how it can get private equity comfortable – typically involving the heavy use of consultants.
The discussion further indicated that environmental risks today are easier to manage than entitlement/market risks. The parties can quantify environmental risks and identify a path to get to an end point. In contrast, there is no ready protection against entitlement risks. Moreover, who can predict what the market will look like after a 3-5 year entitlement process? The presenters advised that sellers can help plan it out and be ready to work with fund managers. For example, the seller generally will know the local community in which it has operated and can engage local representatives to ascertain what they would support at the site.
Portfolio Strategy
SPR members inquired as to private equity/brownfield developer interest in less obvious sites, particularly those where there may not be a lot of value in the real estate once it is cleaned up. The consensus appears to be that packaging assets - by class or by region - may be helpful. An example was offered of a power plant company that packages one “cherry” with one“crabapple”. To the private equity/brownfield developer, it’s a portfolio deal to evaluate. To the SPR member, it’s a means to move two sites off the books.
Value/Certainty/Speed
SPR members engaged in an open-ended discussion in response to a hypothetical involving a known corporate buyer with a lower offer versus a marketing approach that may bring in a brownfield developer at a higher price. On the one hand, taking the corporate offer may be beneficial as the end user is known and there should be positive community reaction to the jobs to be created by the new user. This approach may also obviate the unknowns typically associated with a speculative developer, who may walk on the last day of diligence period. Conversely, the corporate buyer approach may require the seller to take the site off the market while the corporation engages in its longer-term planning and entitlement evaluations (perhaps as long as 12-24 months). Will seller be willing to carry the site for that period?
The brownfields developer may be able to close more quickly and take on more of the environmental risks. Under this approach, the seller could“pull back on reserves”more promptly as it gets the site off the books. The approach also may be consistent with the seller’s greater focus on managing environmental risks and less concern about entitlement/market issues. While the Seller may be willing to give up value to get out of environmental risks, it will need to scrutinize buyer’s experience in dealing with the issues. Ultimately, what is going to keep you out of the news?
- Great Ecology and Tellurium Partners
Mark Laska (Great Ecology) focuses on the natural resource components of surplus properties. His firm seeks to create economic value from these resources after remediation. A core component of their work is a market assessment – if they do an ecological uplift at a property, have they created any value that is of interest to the market or the company? Additionally, the firm will evaluate the regulatory climate – can their work create valid credits and thus get permitted?
Eric Williams (Tellurium Partners) overlays surplus property portfolios with mitigation bank locations. By looking at sources such as the US Army Corps of Engineers mitigation bank database, they seek to ascertain whether a reasonable amount of credits can be obtained for the undertaking.
SPR member discussion indicates that the Corps generally takes too long to review and approve these projects. One approach is to donate land to a trust for long term management, in essence creating an endowment and letting the trust address issues.
Credit values vary widely. A credit sells for $25,000 to $1,000,000 (roughly one credit per one acre, depending on the value of the natural resources). In New Jersey, a credit can be worth $850,000, while in Los Angeles, a credit may be valued at $25,000.
- Benchmarking Committee – Stakeholder Management
SPR members discussed various approaches to stakeholder management, focusing on when/how to engage regulators. While notice to agencies is typically done by environmental/remediationmanagers, such notice is distinct from engaging regulators proactively with regard to the cleanup of surplus properties. The use of a defined regulatory engagement plan typically is done on an ad hoc basis, left to project manager discretion when there is a known concern. Conversely, where property divestment is the goal, members proactively engage regulators always or, at least, regularly. The level of engagement can be mapped out as part of the redevelopment strategy, taking into consideration the anticipated reuse and who the project partners are. In certain circumstances, however, a developer is the better face for regulatory engagement, without direct seller engagement.
- Real Estate and Environmental Panel – Insurance and Financial Assurance
This multi-presenter panel led the group’s discussion on insurance and financial assurance. PLL remains common today, insuring against both known and unknown environmental conditions. PLL aligns the interests of the parties to a transaction, particularly in getting the seller comfortable and by putting the seller on the policy. Members generally recognized that real value in the transaction is achieved by protecting against the “knowns”, where the seller and buyer may have a difference of opinion about the impact, cost and approaches for dealing with site conditions.
Insurance brokers advise that the price of PLL can be lowered through the diligence process and by more fully developing the contemplated remedy. Cost – roughly ½%to 1% of deal or property value. For example, a 10 acre site with $10,000,000policy limit could have a premium in the range of $100,000 - $300,000. Duration – up to 10 years; renewable.
Members noted PLL helps to get senior management (as Seller) comfortable with proposed transactions. Note, however, that a company may be reluctant to bring insurance into a transaction, where defense of claims is turned over to a 3rd party and its lawyers. Such a seller can self-insurance and need not lose control over decisions as to what is discoverable and what documents should be produced.
Developers want it on all deals, as it protects against a catastrophic loss to the “low capital, big dreams” developer. Private equity, even where it is successful in getting sellers to keep liabilities, likes PLL as it covers defense costs should they be sued as a site’s current owner.
Financial assurance – in contrast to environmental insurance – is the contractual means to ensure the performance of agreed upon actions. FA can take many forms, such as escrow, trust, holdback, letter of credit and corporate guarantee (of Buyer’s LLC). It creates a five-legged stool, giving seller as much protection as possible. One seller has even taken a lien on other property owned by a developer, releasing it as work is performed on the subject site.
Members noted that some FA mechanisms “compete” with each other – why escrow if insurance will cover it? If robust diligence on Buyer is performed, what FA is really needed?
A member additionally noted that its expectations are different at operating sites, where it is more of “show me the money” scenario as the Buyer would be acquiring a site as part of an ongoing operation and concerns regarding site cleanup are not as prevalent. In contrast, for the sale of a legacy property with cleanup work to be performed, the seller will want to have reserves set asideto fund the cleanup, supported by the various FA mechanisms.
There is some question as to the survivability of guarantees if Buyer subsequently sells the site, thereby requiring additional contractual provisions relating to notice to original owner and approval rights. The buyer nonetheless may flip the property anyway. A PLL policy, which runs with land, can be helpful in such a circumstance.
There are mixed opinions about guaranteed fixed price contracts offered by environmental consulting/engineering firms. Some wonder is it credible. Are the firms just gambling? While there are stories of problems from the 2000s, the current approach features a fixed priced to secure an NFA, with the consultant puttingmoney into escrow. Members opined that this approach is useful forproperties like gas stations, but not at complex sites like former refineries. At gas sites with generally common issues, the firms have done it for years, and companies see very few change orders.
- Sustainable Environmental Program Management
LeeAnn Tomas-Foster (Arcadis) presented a case study on the City of Chicago and its use of brownfield sites to deliver public benefits to impacted communities. The presentation is available on the SPR web page.
- The Future of Remediation Selection and Site Prioritization
Arcadis presented on advanced analytical and presentation technologies. Discussion among SPR Members indicated that graphics-oriented data presentations – as opposed to traditional tables and lengthy appendices – has gone over well with stakeholder groups and regulators, as it is easier to demonstrate data and communicate site assessment results. Additional comments suggested that these approaches enhance regulators’ understanding of and comfort level with the work performed. As a result, they also may help reduce the need to do additional sampling and allow sites to progress to remediation more quickly.
Questions were raised about how such technologies are used at the consultant level. Arcadis advised that they are iterative in their use, helping teams in the field make decisions in real time as to where to go next. The traditional method of collecting one round of data, evaluating it, and then sending a crew out to more work is streamlined when using the advanced technologies. On a project management level, data is cloud-stored and can be accessed by multiple consultants, with client authorization. One challenge for Members is that consultants typically integrate the data sets into their own analytical systems, which can hinder collaboration or be problematic in the event that a Member makes a change in consulting firm.
- Center for Creative Land Recycling
The Center for Creative Land Recycling (CCLR; Sarah Sieloff)) describes itself as the “Grease and Glue” working in the space between the private and public sectors. In the presentation and the resulting discussion, CCLR and SPR Members discussed how they might work together at challenging sites. Traditionally, CCLR has been engaged through corporate communications offices, rather than EHS, Legal, or Real Estate. CCLR is currently working with one Member to prepare a brochure that communicates the company’s success in remediating its surplus properties. More generally, CCLR can serve as the “front” to the public, local government and other stakeholders in connection with the cleanup and reuse of a site. This approach can be helpful where the prospects for successful reuse of the site could be impaired should stakeholders remain focused on the site’s prior history (“labeled” as the xxx “company site”). Rather, CCLR could become engaged with those stakeholder to assist in presenting a forward-looking vision and help “move the property along”.
- Deed Modification Requests
Jon Bloom (Exxon) and Jonathan Elton (Shell) developed this presentation in response to sidebar discussions at the Detroit meeting.
In many cases, the successful divestiture of surplus property relies on deed restrictions limiting future use of sites. While these legal instruments help companies “get as much a clean break as possible in the deal”, they can work to impede site revitalization in later years. With urban areas continuing to experience increased economic activity and related demand for retail, residential and mixed-use development, SPR Members are fielding an increasing number of requests for deed modifications.
If a “clean break” was the initial goal and largely has been achieved through a deed restriction, why entertain a modification? The group discussion suggests that the removal of additional sources or contaminated media could be beneficial (even if not initially required) and that there is some concern that land use restrictions could be successfully challenged in court. Reaching agreement with a subsequent property owner to lift a restriction would avoid having to defend it at the courthouse.
SPR Members generally factor in several considerations and go through certain steps before agreeing to lift restrictions. Technical reviews would examine the remedial requirements necessary to take the site to residential standards, for example, including additional removal or capping that might be appropriate. Regulatory review of the plan and approval must be secured. Additionally, the current property owner must take the lead on zoning and have secured the requisite rezoning before the company will reach an agreement to modify the restriction.