Do More Regulations Mean Bad Business For Your Real Estate?
You would think increased scrutiny and more rules would be bad for business, but that’s not always the case. Here Dan Montagnani, Managing Director at Groundsure, looks at the commercial property sector and explains to Lawyer Monthly how fresh regulations could cause potential shifts in the real estate markets, but surprisingly not for the worse.
In our time at Groundsure we have supported a range of clients to meet their needs around understanding environmental risk. In this time the topic of environmental risk has gone from a somewhat exceptional item to a mainstream thread of general property due diligence.
Most professionals in the property ecosystem are now familiar with the broad topic of environmental risk and it is accepted as part of the overall due diligence process. However, it remains helpful to stop and consider some of the more commercial aspects of why we assess environmental risk and remind ourselves of the cost of mistakes.
We have statutes in law that consider contaminated land legacy issues and present day operational environmental liabilities that might arise on or in the vicinity of a property under consideration. Both of these carry potentially significant costs, should a landowner or operator be caught out, but are regarded at low frequency of occurrence. In other words, these are low probability but high-risk issues.
A far more frequent series of costs can arise in the course of development or even partial redevelopment. Costs in these scenarios are generally regarded as an add on to the overall cost of development. This approach is entirely reasonable and is something most developers are very familiar with. Indeed, the informed developer approaches these schemes looking to gain leverage where there may be tax advantages for dealing with legacy contamination. Incorporation of flood mitigation measures can also help developers actively inform a design, and provide for an evolution of a scheme whilst retaining positive engagement from the local planning authority.
However, unforeseen costs can still arise where the issues were not entirely known at the point of original consideration. Land acquisitions from some time ago may not have evaluated environmental risks or only considered headline issues relevant then for a purchase. Alternate land use or new ideas about redevelopment may introduce requirements to consider the significance of environmental risks in this new context. A lender taking possession of loan security without the benefit of environmental risk assessment at the point of lending is another good example. These are often areas where unforeseen costs can be incurred with a degree of surprise, as somewhere along the line it was assumed these had been considered to an appropriate level of detail.
Of course, some environmental risks may only have manifested themselves in the intervening period between acquisition and a development plan being brought forward, such as Japanese Knotweed. Aside from the surprise factor from a redevelopment perspective, some of these risks can place significant time schedule burdens on schemes and therefore impact cash-flow for a developer.
An area of more recent progression has been the interest in environmental risk from mainstream lenders. With increasing scrutiny around their general lending processes – environmental risk issues and costs arising from these have become a real feature on their agenda. With sophisticated processes in place to screen for problem secured lending scenarios, it is often the case that a lender’s standard credit risk process, can in actual fact be the trigger for a purchaser to actually identify the need to consider these issues further. Lenders are therefore, in certain cases, providing significant value add to customers that might otherwise walk into unforeseen costs that could render a project unviable.
Lenders have the ability to consider and manage environmental risks in a number of innovative and indirect ways. Clearly the term and nature of the loan can be flexed to ensure the lender remains within their comfort zone for any given scenario. With an established relationship between property owner and developer, the bank can see innovative models used, security portfolios can be manipulated to ensure the lender satisfies their own risk appetite while continuing to support the borrower who is able to press ahead with the required and necessary financial support.
Insurance can have a role to play in providing for financial redress to certain environmental liability situations. Insurance can also be a useful tool in helping funders and investors to get comfortable with their exposure. However, insurance does not prevent the risk from materialising in the first place, nor does it address the inconvenience and some of the consequential outcomes that might arise from a certain set of circumstances. Insurance is a useful tool, but should not be mistaken for a complete fix solution. For example, what is the forward sale position where insurance is a factor, will the insurance remain valid in the future? What if actions are undertaken at the property that invalidate the cover?
As an industry, we are significantly better at identifying environmental risks than we were 20 years ago. Surveyors, lawyers, lenders, developers and planners all have environmental risk identification strategies within their workflows that allow the majority of scenarios to be identified, examined and addressed. However, it would be careless and complacent of us to assume that these standard checks and balances take account of all scenarios.
It is important that changes and adjustments to projects and the reawakening of dormant projects include a degree of “refresh” in order to avoid costly mistakes. Approaching all scenarios considering whether more, (not less) environmental due diligence is required, is a sensible approach and one that may indeed prevent the next costly mistake from happening.
Increasing not decreasing regulation and visibility generally means costs for such issues are only heading in one direction. Evaluating environmental risks and mitigations better and at a more in-depth level than the next person will often lead to commercial advantage.