SAN FRANCISCO-Distressed real estate is about the only real estate game in town these days. And there’s lots of it. One of the keys to knowing whether to take it back or invest in it is assessing its value. And according to Howard Ellman, an attorney in the San Francisco office of Buchalter Nemer, when the real estate is a broken development project, the project’s value depends entirely on how it can be used. How it can be used, in turn, depends on what government agencies have permitted. And according to Ellman, those permits are not simple, static or free.
GlobeSt.com: What is the status of the entitlements? Are some at risk of expiring? What will it take to get an extension? Is one possible, legally and politically?
Ellman: The various entitlements necessary to build a project are never all issued at the same time. Particularly before construction commences, knowing which entitlements have been obtained, and which have not that could be show-stoppers, is critical. Many entitlements have an automatic expiration if some subsequent hurdle is not crossed. These include subdivision maps, use permits and building permits. Automatic expiration means the entitlement—and the real value that entitlement created—is lost. It is critical to understand when the entitlements expire and what it will take to prevent expiration. The government may or may not have the legal authority (or political will) to extend or reissue the entitlement. Extending or reissuing also may not be free; the government may want additional fees or exactions in return. Lastly, government extension or reissue of an entitlement triggers environmental review under the California Environmental Quality Act. That review may be perfunctory or extensive, short or long, cheap or costly. Review at all exposes the project to legal challenges by any lurking opponents of the project (neighborhood groups, environmentalists, etc.).
GlobeSt.com: What government-required conditions must be satisfied to complete the project? What will it cost to satisfy those conditions? How long will it take?
Ellman: Land use entitlements almost always come with strings attached. Those strings are called conditions of approval. Essentially, the government says, for example, “Here’s your right to subdivide. Before you can do so, however, you must satisfy these 100 conditions.” Many conditions are not difficult or costly to satisfy. Others are. Some can require the cooperation of other property owners (e.g., the need for an easement across some other person’s land) or the permission of some other government agency (e.g., a permit from the US Fish and Wildlife Service). These types of conditions can give others a significant degree of control over whether the project succeeds. Identifying those conditions and what risks they carry is critical.
Identifying which conditions have been satisfied and which have not is equally important. This is not always easy. A recorded final subdivision map, an issued building permit or even a completed project does not necessarily mean that a project has paid all its fees, or satisfied all its mitigation or exaction obligations. A careful review of the entitlements documents and the government’s file is necessary. Statements of government staff that a condition has been satisfied should be validated with some independent written evidence. Staff statements or comments do not bind the government.
GlobeSt.com: Is the government attempting to change the rules applicable to the project? Can they? If so, does the rule change impact the project timeline or cost? Are there any grandfathering protections?
Ellman: If a project is not completely finished, changes in law since a loan or equity investment was underwritten could trigger additional costs and/or obligations that must be satisfied to complete a project. For example, a school district may have increased its school mitigation fees, a city may have passed a green building ordinance that increases construction costs or a county could have adopted more stringent/costly requirements for storm water drainage. Even where laws have not changed, and change in underlying facts could trigger application of pre-existing law. As an example, a project built as condos but rented instead might be forced by the local city to go back through the local subdivision process before those condos can be sold because of legal protections for renters. Importantly, there may be defenses to all these types of attempts to change the rules and/or apply existing rules to changed facts.
GlobeSt.com: Who is best equipped to satisfy the remaining conditions, obtain remaining approvals and/or get extensions? Borrower/developer? Lender/investor? Some third party? What are the relative risks?
Ellman: The risk of leaving the property in the borrower/developer’s hands to satisfy the remaining conditions and/or complete the project work must be weighed against the risks attendant to the lender/investor becoming directly involved. Getting directly involved could risk construction defect or hazardous materials liability. On the other hand, the borrower/developer may no longer have sufficient staff and/or may have lost political credibility with the government agencies.
GlobeSt.com: Is it possible to reposition or re-entitle the project?
Ellman: A project as entitled may be unmarketable or would have greater value with different entitlements. If so, it is critical first to understand the existing entitlements. There may be an opportunity to refocus the project within the scope of the existing entitlements with a minimum of government approval hassle. For example, if the approvals were for an age-restricted condominium project, perhaps converting to an apartment project (either age-restricted or un-restricted) is possible. Even if the existing entitlements are too specific to allow very simple repositioning, the government still may be willing to issue new/modified entitlements. If so, it is important to assess the likelihood of getting the entitlements and the associated time, cost and risk (including litigation risk from third party challenges such as neighborhood and environmental groups).
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Natalie Dolce
Natalie Dolce, editor-in-chief of GlobeSt.com and GlobeSt. Real Estate Forum, is responsible for working with editorial staff, freelancers and senior management to help plan the overarching vision that encompasses GlobeSt.com, including short-term and long-term goals for the website, how content integrates through the company’s other product lines and the overall quality of content. Previously she served as national executive editor and editor of the West Coast region for GlobeSt.com and Real Estate Forum, and was responsible for coverage of news and information pertaining to that vital real estate region. Prior to moving out to the Southern California office, she was Northeast bureau chief, covering New York City for GlobeSt.com. Her background includes a stint at InStyle Magazine, and as managing editor with New York Press, an alternative weekly New York City paper. In her career, she has also covered a variety of beats for M magazine, Arthur Frommer's Budget Travel, FashionLedge.com, and Co-Ed magazine. Dolce has also freelanced for a number of publications, including MSNBC.com and Museums New York magazine.
