Environmental issues can be particularly vexing for small real estate development projects. A $200K-$300K cleanup may just be a rounding error for a $100MM project but could jeopardize the financial viability of a $5MM or even $10mm project. In most cases, the lender for a small project will hold back 125% to 150% of the estimate costs of the cleanup which not only means those funds will not be available for the project but that the developer will have to reach into its pocket or ask investors for the additional funds to cover the cleanup.
Add to this expense the increased interest and other carrying costs due to delays associated with completing investigation and remediation and it can be easy to see why these smaller projects cannot absorb any significant amount of environmental liability. The tangible property tax credits available under the Brownfield Cleanup Program (BCP) help to defray these costs, provide a source of reimbursement to the equity partners, and help lenders get comfortable that the project will be able to be successfully completed and that the loan will be paid back. Yet it is these very projects that will be hurt the most if the New York State Department of Environmental Conservation (NYSDEC) adopts the “underutilized” definition that it proposed for the BCP in the June 10th issue of the New York State Register.
The proposed “underutilized” and “affordable housing project” definitions were required by the Brownfield Cleanup Program (BCP) amendments that were enacted as part of the 2015-16 state budget (Chapter 56 of the Laws of 2015). These definitions, along with the other criteria for eligibility for tangible property tax credits (the site’s location in an En-Zone or the site meeting the statutory definition of “upside down”), will be used to determine whether a site in New York City will be eligible for those credits. The “affordable housing project” definition will also be used statewide to determine a site’s eligibility for the five percent affordable housing tax credit bonus. The rulemaking will also amend the “brownfield site” definition at 6 NYCRR 375-1.2(b) to meet the definition in the new BCP law as well as deleting 6 NYCRR 375-3.3(a)(1) to conform to this definition
The good news is that the proposed affordable housing definition is very broad. It includes developments that are subject to a federal, state, or local government housing agency’s affordable housing program, or comply with a local government requirement for minimum percentage of affordable housing units. Developers had feared that the NYSDEC would have linked BCP eligibility to building more affordable units than the minimum amount required so this definition will likely be well received.
On the other hand, the proposed “underutilized” definition (set forth at new subdivision 375-3.2(l)) is extremely narrow. According to the NYSDEC regulatory statement, the intent of the BCP amendments was to address “regional imbalance within the BCP” due to “high development costs for some Downstate projects.” NYSDEC goes on to state that:
“The primary driver for the regional imbalance within the BCP is attributed to high development costs for some Downstate projects, which were reflected in excessive tangible property tax credits. Limiting the eligibility of New York City sites to specific affordable housing projects and underutilized properties through criteria established by regulation should help to target projects in New York City areas with the most need.”
The agency then explains that the proposed regulations will “reduce the amount of tangible property tax credits available to applicants for brownfield sites in high-value real estate markets while further incentivizing development on brownfields where certain project criteria are met.”
Unfortunately, the stringency of the proposed underutilized test will not only apply to “high-value” properties but also exclude large swaths of small commercial properties in the outer boroughs of New York City from the BCP and have a devestating impact on owners and developers of small contaminated properties such as dry cleaners, gas stations, and vehicle repair and maintenance shops.
To qualify for the underutilized gate, a property must satisfy ALL of the following four criteria:
(1) For the five years preceding the application, 50% of the existing building or buildings have been vacant based on the permissible floor area under the zoning rules that have been in effect for at least five years. New York City would have to certify that the property satisfies this criteria.
Commentary: During the March negotiations that led to the 2015 BCP Amendments, representatives of the business community had proposed that a property should be considered underutilized if the gross square footage of a building was 50% or less than that allowed by the current zoning in effect for the past 18 months. This test was borrowed from that used in the CEQR process when determining if a building was likely to be redeveloped as part of a rezoning action. NYSDEC negotiators balked at this concept on the grounds that the property values would have increased in rezoned areas and therefore owners of these properties did not need any further state incentives for redevelopment.
By focusing on the vacancy of the building itself rather than what is allowed by the zoning, the NYSDEC proposal ignores the realty of commercial real estate. Because of the high real estate taxes, only the largest developers can afford to keep individual sites vacant while they assemble the number of parcels required for their development projects. The rest of the commercial property owners will need to generate rental income to pay property taxes and other carrying costs. Thus, very few buildings are going to be more than 50% vacant much less for five years.
The proposal would also undermine the purpose of the rezoning which is to incentivize redevelopment. Indeed, the proposed would incentivize the very conduct that has led to the creation of brownfields—warehousing of contaminated properties by deep pocket property owners who can afford such tactics. Given rising rents, well-financed property owners could simply keep their property off the market for five years and rent just enough of the property to a non-conforming but grandfathered use to pay the real estate taxes (but see item 4 below) to the detriment of the neighborhood. Meanwhile the mom and pop owners whose one-story commercial building may be the primary source of their net worth and income will be stuck with contaminated properties that cannot realize their full potential under the rezoning because the parcels will not quality for the BCP “underutilized” gate even though by all other reasonable measures their properties are not fully utilized.
(2) the proposed development is solely non-residential
Commentary- This criterion would preclude residential or mixed use developments to enroll in the BCP even where the purpose of the zoning is to encourage such use. Given the scope of the proposed affordable housing definition, this criterion may not be overly onerous depending on how the outcome of the 421-a tax abatement negotiations. If the affordable housing mandate is significantly expanded, then many developers will be able to rely on the affordable housing gate and this criterion would only apply to luxury condos and rentals.
More problematic is this interplay of this criterion with item 4(iii) below. It is unclear if this criterion will be used to exclude commercial uses such as office buildings and only allow developments with industrial use.
(3) The development could not be developed without “substantial government assistance”, as certified by the City of New York; and
Commentary: During the March negotiations, the business community, Legislature and the Executive all agreed it would be preferable to develop objective criteria that had little room for interpretation to avoid the kind of Article 78 litigation that occurred after NYSDEC adopted an unnaturally narrow view of what constituted a brownfield site. The use of the phrase “Substantial government assistance” could not be further from that stated goal and is about as vague a definition as one could craft—perhaps because NYSDEC would not be the agency making this determination.
The proposed rule defines the phrase as “a substantial loan, grant, land purchase subsidy, or land purchase cost exemption or waiver, from a governmental entity; or for properties to be developed in whole or in part for industrial uses, a substantial loan, grant, land purchase subsidy, land purchase cost exemption or waiver, or a tax credit, from a governmental entity, or a low-cost loan from an industrial fund managed by the municipality and partner financial institutions.”
This test places the City of New York in a pivotal role in BCP application process—a role which we suspect it does not welcome since this would put the City in the litigation cross-hairs if it declines to certify a project. Obtaining project approvals in New York City is already a costly and time-consuming process. Requiring yet another layer of approvals only adds further complications to sites that are already challenged by the presence of contamination and the uncertainties over the extent of the cleanup costs.
(4) New York City certifies that the property is subject to one or more of the following conditions:
(i) Property tax payments have been in arrears for at least five years immediately prior to the application;
Commentary: This test will create a perverse incentive by punishing property owners who pay their taxes. Owners of contaminated properties often complain that their properties are assessed as if they are clean and that their tax payments should be reduced. Until now, the primary option was to challenge the tax assessment. If adopted as proposed, the underutilized definition will give property owners a reason not to pay what they feel are excessive taxes. Since the New York City Tax Lien Trusts Trust will no longer acquire tax liens associated with contaminated properties much less foreclose on them, this criterion may actually have the effect of creating more brownfield sites as these sites are placed in tax foreclosure limbo with no one controlling the property. Private bidders would likely only be interested in the property if it would be eligible for the BCP. Thus, the test could actually undermine the purpose of the BCP and cause properties to go into disuse and become delinquent in taxes.
(ii) The site contains a building that is presently condemned, or exhibits structural deficiencies certified by a professional engineer which present a public health or safety hazard; or
Commentary: This criterion could also incentivize property owners to not maintain their buildings so they could qualify for the BCP.
(iii) The proposed use is in whole or in substantial part for industrial uses.
Commentary: The reference to industrial use is puzzling and injects further confusion into the application process. Does this criterion mean that only applications involving industrial uses may qualify for the underutilized gate? Item 2 above which refers to non-residential use could be interpreted to allow office and retail buildings which bring new jobs to communities. Yet obviously commercial. Such a limitation would be contrary to the bulk of the NYC rezoning that has shifted away from industrial uses as manufacturing operations have left the City.
While we do represent some large developers, the bulk of our BCP matters are small projects consisting of one or two tax lots that contained single-story buildings that are projected to generate between $2-3MM in total brownfield tax credits. We doubt that the legislature would have amended the BCP law twice for these projects. Yet based on the proposed definition, it appears that the following small BCP projects located in the Bronx, Brooklyn and Queens would not be eligible for the BCP after July 1st under the new criteria.
- Six BCP projects involving former dry cleaners/laundries (not vacant);
- Three BCP projects currently used for truck maintenance (not vacant);
- Two BCP projects that were operating gas stations at the time of the application (not vacant);
- A former gas station site that was used for parking at the time of the BCP application (not vacant);
- A site with two one-story commercial buildings that have only been vacant for one year at the time of the BCP application;
- A one-story building occupied by an auto repair that has been vacant for less than three years at the time of the BCP application;
- A one-story building occupied by automotive repair operation at the time of the BCP application;
- A one-story bus garage and metal door/storefront fabricator at the time of the BCP application
- A one-story commercial building occupied by former metal operation until three years ago with potential off-site contamination. The BCP application deferred the site from being placed on the registry of inactive hazardous waste sites as a Class 2 Site;
- A one-story commercial building vacant less than five years at the time of the BCP application;
- A site that was an active junk yard impacted with PCBs at the time of the BCP application.
After the NYSDEC released its proposed rule on its website, we became aware of a number of proposed transactions were now in jeopardy because of the sites would not qualify for the BCP because of the proposed underutilized definition. None of these projects was anticipated to generate more than $500K in brownfield tax credits yet they would be swept by NYSDEC’s effort to prevent up “excessive tangible property tax credits.”
- An elderly couple wanted to sell a one-story commercial building in Queens that used to contain a dry cleaner. They hoped to use the sale proceeds to support their retirement. Prior sampling detected PCE in groundwater from the historic use. The owners reduced the purchase price but the potential purchaser has now decided to walk away from the transaction because of concerns that the contamination may have migrated off-site and that the site could be placed on the state superfund list. The purchaser does not plan on constructing a luxury condo but simply wanted to upgrade the existing building and increase income stream generated by the property. If the site was eligible for the BCP, purchaser could have limited its cleanup costs to the property and the income stream would likely have been able to support this limited cleanup.
- A Brooklyn business owner wants to buy a vacant land across the street for additional parking to support business expansion. However, the parcel was formerly a gas station and sampling has revealed the petroleum may have had migrated off-site. He declines to exercise his purchase option because he is concerned he will become liable as a discharged under the Navigation Law. If he was able to enroll in the BCP, he could limit his liability to removing the contaminated soil. The state of New York would not have incurred any tangible property tax credits but is not eligible under the proposed underutilized definition.
- Two potential purchasers walked away from an abandoned dry cleaner property in Brooklyn after learning the NYSDEC planned to place the site on the state superfund list. The owner defaulted on its mortgage and NYSDEC ended up implementing a remedial investigation/feasibility study (RI/FS) and finalized a Record of Decision (ROD). After the BCP amendments made Class 2 sites eligible for the BCP, the private lender planned to foreclose on the defaulted loan, enroll the site in the BCP and construct a townhouse development. Because of the proposed underutilized, though, the lender reconsidered its plans. Not only will the property remain in foreclosure limbo but NYSDEC will not be reimbursed for its past costs and will have to pay for the remedy.
The NYSDEC has used the proverbial hammer to kill the fly on the glass pane when a fly swatter would have worked. It is our sincere hope that the NYSDEC will take another look at its well-intentioned yet ill-advised definition to avoid the damage that will be inflicted on small property owners if is adopted. We think NYSDEC should consider using a version of the CEQR 50% FAR test-perhaps based on the zoning in effect for the prior five years. At the very least, the proposed rule should be changed so that property owners only have to meet ONE of the criteria, not ALL four. However, NYSDEC should consider allowing projects of a certain size (perhaps three or fewer city lots) or developments below a certain threshold ($10MM) to be eligible for the underutilized gate. After all, according to NYSDEC, the purpose of the 2015 BCP amendments was to “correct regional imbalances …attributed to high development costs for some Downstate projects, which were reflected in excessive tangible property tax credits.”
In an old Star Trek episode titled “Operation Annihilate”, Mr. Spock temporarily loses his sight. After he regains it, Dr.. McCoy mumbles a compliment that Mr. Spock overhears. Capt. Kirk tells Dr. McCoy “You were so worried about his Vulcan eyesight that you forgot about his Vulcan ears”. Likewise, NYSDEC seems to have beecome so concerned about reining in “excessive tangible property tax credits” from the larger projects that is has forgotten or ignored tthe small commercial real estate developments outside the En-zones that are the lifeblood of New York City. Developers of small contaminated sites will not live long and prosper unless NYSDEC reconsiders its proposed underutilized definition .
The proposed rule and associated rulemaking findings are available on the NYSDEC website. A legislative hearing will be held in NYC on July 29th at 1:00 PM at the New York City Department of Health auditorium at 125 Worth Street. NYSDEC will accept written public comments through August 5, 2015.