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Distressed Property Due Diligence Tax Breaks, Incentives And Other Issues Impacting Value.Ngm.4 29 09.Secure

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Presentation on "Distressed Property Due Diligence: Tax Breaks, Incentives and Other Issues Impacting Value" at the ICSC/Real Property Law Section Con Ed Symposium for Real Estate …

Presentation on "Distressed Property Due Diligence: Tax Breaks, Incentives and Other Issues Impacting Value" at the ICSC/Real Property Law Section Con Ed Symposium for Real Estate Professionals on April 29, 2009


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  • 1. International Council of Shopping Centers In cooperation with the State Bar of Michigan Presents ICSC 2009 Michigan Continuing Education for Real Estate Professionals ROCK FINANCIAL SHOWPLACE, NOVI, MICHIGAN WEDNESDAY, APRIL 29, 2009 Distressed Property Due Diligence: Tax Breaks, Incentives and Other Issues Impacting Value Presented By:    Nicholas G. Maloof, Esq., RPG  President and General Counsel  Associated Environmental Services, LLC  Page 1 of 9 6001 North Adams Road, Suite 203 Bloomfield Hills, Michigan 48304 Tel: (248) 203-9898, ext. 104 Fax (248) 203-9372 Environmental Services Email: ngm@associatedenvironmental.net Land Development Web: www.associatedenvironmental.net Real Estate Consulting Copyright©2009 Associated Environmental Services, LLC.  All rights reserved. 
  • 2. Distressed Property Due Diligence: Tax Breaks, Incentives and Other Issues Impacting Value Distressed Property – Commonly viewed as a property that is the subject of a workout, foreclosure or bankruptcy proceeding Definitions of “distressed property” on the Web via Google Search: I. 1. Property that is in poor physical condition. 2. Property owned by an individual who is in poor financial condition. debbie.canequity.com/mortgage-resources/ II. A property which is to be sold in order to pay arrears on a mortgage. www.gibbons- realty.com/dictionary/D.html III. Property which either is in a dilapidated physical condition or is owned by an individual who is undergoing a period of economical instability. www.dreamtown.com/mortgage/mortgage-terms.html IV. A mortgaged property which has been foreclosed on. www.bettisu.com/ V. Real estate that is under foreclosure or impending foreclosure because of insufficient income production or mortgage payment. www.propertyaxess.com/GlossaryofTerms.htm VI. Property that is under a foreclosure order or is advertised for sale by its mortgagee. Distressed property usually fetches a price that is much below its market value. http://www.businessdictionary.com/definition/distressed-property.html In the event of default by a borrower, the lender has several alternative courses they can pursue: 1. Take no action and hope that the default remedies itself; 2. Require additional collateral and/or guarantees from the borrower; 3. Restructure the indebtedness with a longer amortization, lower interest rate, principal only payments or other loan alteration(s); 4. Temporarily suspend pursuing additional remedies against the borrower by agreeing to a forbearance. Forbearance is refraining from doing something that one has a legal right to do. In this case, it would be to not to enforce a claim(s) upon loan maturation and/or provide additional time for repayment of the loan; 5. Accept a discounted payoff of the indebtedness; or 6. Foreclose on the loan and sell the collateral (real property) by either selling the note at a discount or by taking physical possession and title and marketing the property. Another alternative is to have a Receiver appointed by the courts to marshal and sell the asset(s). Items 1-5 referenced above are typically encountered in the “workout” phase of a potential foreclosure and are a joint attempt by the borrower and the lender to salvage a valuable property Page 2 of 9 6001 North Adams Road, Suite 203 Bloomfield Hills, Michigan 48304 Tel: (248) 203-9898, ext. 104 Fax (248) 203-9372 Environmental Services Email: ngm@associatedenvironmental.net Land Development Web: www.associatedenvironmental.net Real Estate Consulting Copyright©2009 Associated Environmental Services, LLC.  All rights reserved. 
  • 3. and avoid the delays and expense generated in a foreclosure. If a deal can be made, it will likely benefit both parties to the loan (lender and borrower). A workout can also preclude any potential harm that may mar a project's reputation due to a default. The risk of harm to a project from a default due to lost sales or shaken confidence may eventually lead to a foreclosure or a bankruptcy filing. An effective and successful workout requires that both parties take reasonable steps to protect the value of the collateral in order to maximize its ultimate worth and thereby protect the investments of both the borrower and the lender in the project. A workout requires that both parties to the transaction have faith in the other. Each workout situation is distinct and usually is the result of a sudden and dramatic shift in project specific market factors or the market in general. The lynch pin to a successful workout is a recognition by both parties (borrower and lender) that under the correct set of circumstances the property or project can be turned around and successfully completed. Workouts should only be attempted for properties that have a chance for success, even if the likelihood for this is small. Attempting a workout of a property that is in such a bad or difficult situation or state of affairs that success would be unlikely may further compromise the loan collateral and financial position of the lender. In the event that both parties determine that a workout is appropriate, it is imperative to act as expeditiously as possible or there is a risk of one or both parties changing their minds or the value further declining and throwing off the deal parameters. This is also applicable to a prospective purchaser of a defaulted asset – the longer it takes to get the deal closed the higher the likelihood of losing the purchaser due to market forces, changes in value of the collateral or both. Workout, Foreclosure and Bankruptcy Due Diligence Workout Due Diligence ♦ What is the current condition of the collateral? ♦ Was environmental due diligence conducted when the loan was made? Was it conducted properly (was all of the research conducted or was it a white wash)? ♦ Was the collateral contaminated when the loan was made? ♦ Are the current operations of a high-risk nature (gas station, dry cleaner, industrial, etc.)? ♦ Are there any adjacent high-risk uses to the collateral that could have a direct or indirect impact? ♦ Are there any issues that could impact the value of the collateral or require out of pocket costs by the lender if the property is foreclosed upon? o If there is impact, can the impact be used as a selling feature to attract a new developer or purchaser by positioning the property for development incentives? Page 3 of 9 6001 North Adams Road, Suite 203 Bloomfield Hills, Michigan 48304 Tel: (248) 203-9898, ext. 104 Fax (248) 203-9372 Environmental Services Email: ngm@associatedenvironmental.net Land Development Web: www.associatedenvironmental.net Real Estate Consulting Copyright©2009 Associated Environmental Services, LLC.  All rights reserved. 
  • 4. Foreclosure Due Diligence ♦ What is the current condition of the collateral? ♦ Was environmental due diligence conducted when the loan was made? Was it conducted properly (was all of the research conducted or was it a white wash)? ♦ Was the collateral contaminated when the loan was made? o If so, by the borrower or a prior owner/operator (historical impact)? o If the impact is historical, did the borrower conduct appropriate due diligence (Phase II ESA, BEA, 7a Due Care Plan, etc.)? ♦ Are the current operations of a high-risk nature (gas station, dry cleaner, industrial, etc.)? ♦ Are there any adjacent high-risk uses to the collateral that could have a direct or indirect impact? ♦ Is the lender planning to take title, is a Receiver going to be appointed or is the Note being sold at a discount? o If the Note is being sold, the lender may only need a cursory investigation to evaluate the value of the underlying collateral; o If a Receiver is being appointed, it may make sense for the Receiver to conduct pre-acquisition due diligence to determine the condition of the collateral prior to or within a short period of time of being appointed Receiver; o If the lender is foreclosing and taking title, a thorough investigation should be undertaken to determine the condition of the property and whether the lender needs to prepare a Baseline Environmental Assessment (BEA) prior to taking title, possession or occupancy. ♦ Are there any issues that could impact the value of the collateral or require out of pocket costs by the lender if the property is foreclosed upon? o If there is impact, can the impact be used as a selling feature to attract a new developer or purchaser by positioning the property for development incentives? Bankruptcy Due Diligence ♦ What is the current condition of the real property? ♦ Was environmental due diligence conducted when the Bankruptcy Trustee took possession/title to the real property? ♦ Is the real property contaminated? o If so, by the Bankrupt Estate or is the impact historical? o If the impact is historical, did the preceding entity in title (a.k.a. Bankrupt Estate) conduct appropriate due diligence (Phase II ESA, BEA, 7a Due Care Plan, etc.)? ♦ Are the current operations of a high-risk nature (gas station, dry cleaner, industrial, etc.)? ♦ Are there any adjacent high-risk uses to the collateral that could have a direct or indirect impact? ♦ Are there any issues that could impact the value of the collateral or require out of pocket costs by the Bankruptcy Trustee? o If there is impact, can the impact be used as a selling feature to attract a new developer or purchaser by positioning the property for development incentives? Page 4 of 9 6001 North Adams Road, Suite 203 Bloomfield Hills, Michigan 48304 Tel: (248) 203-9898, ext. 104 Fax (248) 203-9372 Environmental Services Email: ngm@associatedenvironmental.net Land Development Web: www.associatedenvironmental.net Real Estate Consulting Copyright©2009 Associated Environmental Services, LLC.  All rights reserved. 
  • 5. Critical Questions for Due Diligence Activities In the case of a Workout or Foreclosure, who retains the consultants and other professionals? ♦ The Lender? ♦ The Lender’s Attorney? ♦ The Receiver? ♦ The Receiver’s Attorney? What liabilities/opportunities does a contaminated asset hold? ♦ Liabilities o Costs related to securing the operation o Costs/duties related to cleaning up abandoned wastes, chemicals, etc. from ongoing operations o Costs/duties related to cleaning up historical wastes, chemicals, etc. from former operations o Costs related to Due Care Obligations to render the site safe for its current or intended use o Securing the asset to ready it for sale ♦ Opportunities o Is the contamination an impediment to a potential sale? ♦ If so, it must be remedied or a potential remedy must be worked out ahead of a potential sale o Is there a potential buyer? ♦ If so, is the buyer sophisticated or a newbie? ♦ Do the buyer and/or their lender understand the issues/opportunities with the property? o What plan(s) does the buyer have for the property? o Is there a gap in value due to perceived/known contamination and costs to remedy? o Is the buyer planning an investment into the property? ♦ Has the buyer reviewed the potential incentives associated with the potential investment? As part of a loan workout or foreclosure, the lender needs to perform pre-workout or pre- foreclosure due diligence in order to identify the property's difficulties and whether they can be overcome. Due diligence activities must include a review and analysis of the following in order to better understand the property: 1. loan documents; 2. leases, if any; 3. construction documents, if any; 4. development and construction financing documents, if any; 5. current title and available land survey; Page 5 of 9 6001 North Adams Road, Suite 203 Bloomfield Hills, Michigan 48304 Tel: (248) 203-9898, ext. 104 Fax (248) 203-9372 Environmental Services Email: ngm@associatedenvironmental.net Land Development Web: www.associatedenvironmental.net Real Estate Consulting Copyright©2009 Associated Environmental Services, LLC.  All rights reserved. 
  • 6. 6. environmental reports; and 7. engineering reports. The lender should also obtain an updated appraisal and environmental assessment of the property as the appraiser will value the property without taking environmental condition into account and a competently performed environmental assessment should identify any current or historical issues that may impact the value of the property. The lender should also look at any structural deficiencies, defects or repair items for existing structures and obtain a repair estimate for these items as well. Many of the above referenced documents and reports are usually already in the lender's files, however, they should be updated as it is highly probable that environmental, structural and value related issues will be identified on the property that should have been obvious when the loan was originally made, but in the torrent of the events leading to the closing, were not. Many lenders use a different counsel for a workout than the one that represented them in the original transaction in order to make certain that any possible errors made during the initial loan process are not covered up. Probably the most critical decisions for any lender to make is whether to foreclose on a mortgage; exercise the power of sale; have a Receiver appointed; or take control of the property and replace the owner. This decision should never be taken without considering all the advantages, disadvantages and risks a lender can face because of a foreclosure. Notwithstanding the foregoing, if the lender has no confidence in the current owner (borrower's) ability to salvage the property, there may have little choice but to foreclose and sell the collateral, either directly or indirectly via a Receiver. Case Studies in Workout and Foreclosure Properties Example #1 - Multi-family Residential Rental Complex Scenario: AES was retained by a foreclosing lender to review a previously prepared Phase I Environmental Site Assessment (ESA) and determine whether a Phase II ESA was necessary for pre-foreclosure due diligence purposes. AES reviewed the report and concurred with the Phase I ESA recommendation that a Phase II ESA was necessary to investigate the historical use of the property as an orchard due to the high probability of the historical use of herbicides and pesticides at the site (lead arsenate, DDT, etc.). AES prepared a scope of work to assess the areas of the subject property that were identified as containing the former orchard as well as areas that were outside the suspected area in order to determine the impacted areas, if any. AES drilled twenty-six (26) soil borings and analyzed the samples for arsenic, lead, herbicides and pesticides. The suspected area of the former orchard was confirmed to contain arsenic in excess of the Michigan Department of Environmental Quality (MDEQ) Generic Residential Cleanup Criteria (GRCC) for Direct Contact (DC) at a depth between .5 and 1 foot below the ground surface. AES advised the client that should it wish to foreclose that a Baseline Environmental Page 6 of 9 6001 North Adams Road, Suite 203 Bloomfield Hills, Michigan 48304 Tel: (248) 203-9898, ext. 104 Fax (248) 203-9372 Environmental Services Email: ngm@associatedenvironmental.net Land Development Web: www.associatedenvironmental.net Real Estate Consulting Copyright©2009 Associated Environmental Services, LLC.  All rights reserved. 
  • 7. Assessment (BEA) would be required and that a 7a Due Care Plan must be prepared to address the arsenic concentrations exceeding MDEQ GRCC for DC. In addition, AES was requested to prepare a rough cost estimate for further investigation and remediation of the impacted soils. Outcome: The lender ultimately sold the Note at a discount rather than spend the additional capital required for continued due diligence and remediation activities. The main driver behind the lender’s decision to sell the Note and not foreclose was not necessarily cleanup liability, but potential tort liability from exposures to arsenic contaminated soils. Example #2 - Recreational Property Scenario: AES was retained by legal counsel representing a Court Appointed Receiver, appointed at the request of a lender, to prepare a Phase I ESA for a potential sale of the collateral (real property). AES identified a number of RECs related to the property and recommended that a Phase II ESA was necessary for pre-foreclosure or pre-sale due diligence purposes. AES drilled fourteen (14) soil borings adjacent to existing ASTs, former USTs and adjacent to floor drains inside a service building. The property was contaminated with petroleum hydrocarbons and qualified as a “facility.” Outcome: As the existing uses and operations would be continuing under the new purchaser, AES recommended that a Category “S” BEA and 7a Due Care Plan be prepared for the potential new purchaser and that Engineering Controls be installed in all high-risk areas to prevent exacerbation of the existing contamination. Example #3 - Multi-tenant Industrial Property Scenario: AES was retained by a foreclosing lender to prepare a Phase I ESA for foreclosure and potential sale of the collateral (real property). AES identified a number of RECs related to the historical use of the property and recommended that a Phase II ESA was necessary for pre-foreclosure due diligence purposes. It should be noted that three prior Phase I ESAs conducted on the property failed to identify the historical use of chlorinated solvents and related complaints of releases due to the fact that the national company hired to conduct them failed to check the local municipality’s Building and Fire Department files – even though they were retained to do so. Outcome: AES drilled fifteen (15) soil borings inside the buildings within the suites/units identified with the suspect high-risk past uses. The property was identified as being contaminated with perchloroethylene, a chlorinated solvent, caused by a former tenant, in excess of MDEQ GRCC and qualified as a “facility.” AES recommended that a Category “D” BEA and 7a Due Care Plan be prepared for the foreclosing lender and that Engineering Controls be installed in all high-risk areas to prevent exacerbation of the existing contamination and/or contamination by the current tenants of the building with different chemicals. Page 7 of 9 6001 North Adams Road, Suite 203 Bloomfield Hills, Michigan 48304 Tel: (248) 203-9898, ext. 104 Fax (248) 203-9372 Environmental Services Email: ngm@associatedenvironmental.net Land Development Web: www.associatedenvironmental.net Real Estate Consulting Copyright©2009 Associated Environmental Services, LLC.  All rights reserved. 
  • 8. Incentives There are numerous environmentally related incentives that could be used for an eligible property to enhance its sale-ability or develop-ability as well as its ultimate value to the Lender, Receiver or Trustee. A number of factors affecting these incentives include, but are not limited to: 1. the physical location of the property; 2. the current environmental condition of the property; 3. the proposed investment in the property; 4. the number and type of jobs being created, if any; 5. the type of development; 6. the municipality where the property is located, etc. Available incentives include, but are not limited to, the following: ♦ Tax Increment Financing (TIF); ♦ Brownfield Michigan Business Tax (MBT) Credits; ♦ Michigan Economic Growth Authority (MEGA) Credits; ♦ Local, County, State and Federal Grants and Loans; ♦ Neighborhood Enterprise Zone (NEZ); ♦ Obsolete Property Rehabilitation Act (OPRA); ♦ Renaissance Zones; ♦ Industrial Facilities Tax Abatement (IFTA) under P.A. 198 ♦ MDEQ Superfund Section Brownfield Redevelopment Assessment Investigations (to local units of government and developers); ♦ Clean Michigan Initiative (CMI) Waterfront Redevelopment Grants (WRG); ♦ USEPA and MDEQ Revolving Loan Funds (RLF); ♦ Historic Tax Credits; ♦ New Market Tax Credits (NMTCs); ♦ Low Income Housing Tax Credits (LIHTCs); ♦ Federal and State of Michigan Alternative Energy Credits; and ♦ Numerous others! How the myriad of economic incentives is used to leverage a possible transaction or development is highly specific to each property/deal and depends upon: 1. the parameters of the deal; 2. the amount over and above the purchase price being invested into the property to create improvements, create jobs or maintain jobs within the local municipality and State of Michigan; 3. the attitude of local and state governmental officials toward the proposed project; Page 8 of 9 6001 North Adams Road, Suite 203 Bloomfield Hills, Michigan 48304 Tel: (248) 203-9898, ext. 104 Fax (248) 203-9372 Environmental Services Email: ngm@associatedenvironmental.net Land Development Web: www.associatedenvironmental.net Real Estate Consulting Copyright©2009 Associated Environmental Services, LLC.  All rights reserved. 
  • 9. 4. the availability of a particular incentive (some incentives such as RLF, MBT Credits, etc. only have limited allocations); 5. how the mix of incentives work together or cancel each other out and tweaking these incentives (the term “layering” of incentives is currently in vogue) to offer maximum return on investment. Remember that each project is unique and the number, type and value of Economic Incentives applicable to a project will vary based upon the site conditions, type of investment being made, motives of the parties, timing and a multitude of other factors – no two deals are ever the same. Take Away Points for the Real Estate Broker ♦ Understand the motives of all parties in a Workout, Foreclosure or Bankruptcy transaction; ♦ Understand the property, its condition and the process track the property is following – know that it could change at any time; ♦ Make sure to get all listing and representation agreements signed by the appropriate party and know whom you are working for (i.e., where does your fiduciary duty lie?) ♦ Explore the options available for the property from an Economic Incentive standpoint – what about this property (its location, condition, etc.), the deal, the parties, etc. make the property or deal eligible or could make the property or deal eligible? ♦ If you need assistance understanding the myriad of issues with an Economic Incentive deal, call your trusted advisors and pick their brain (just make sure they really know what they are talking about!). For questions or to discuss a matter in confidence, please feel free to contact me. Nicholas G. Maloof is President and General Counsel of Associated Environmental Services, LLC (AES), an environmental services, land development and real estate consulting firm based in Bloomfield Hills, Michigan. Mr. Maloof is an active member of the State Bar of Michigan and has over ten years of experience as a transactional attorney and over nineteen years of experience in the field of environmental and real estate consulting. A majority of his work is conducted with or on behalf of attorneys, financial institutions, developers, investors, property owners and real estate brokers. He is also a Registered Professional Geologist in the State of Tennessee and a licensed Real Estate Broker and Title Insurance Resident Producer in the State of Michigan. Mr. Maloof has advocated and been involved in what would become known as Brownfield Redevelopment since 1989 when Site Reclamation Fund Grants first became available. Over the past 19 years, Mr. Maloof has been involved in thousands of real estate transactions and land development projects from a site selection, due diligence and development entitlement standpoint, as well as numerous Brownfield Redevelopment projects throughout Michigan. Page 9 of 9 6001 North Adams Road, Suite 203 Bloomfield Hills, Michigan 48304 Tel: (248) 203-9898, ext. 104 Fax (248) 203-9372 Environmental Services Email: ngm@associatedenvironmental.net Land Development Web: www.associatedenvironmental.net Real Estate Consulting Copyright©2009 Associated Environmental Services, LLC.  All rights reserved.