Backing Dirty Land Deals – Financing for contaminated sitesApril 1, 2013
Financing for contaminated sites can require co-operation and inventive mortgages.
Financing contaminated land is generally considered difficult, if not impossible. While it’s true many loan applications are rejected, development in B.C.’s lower mainland could not proceed at it’s current pace if remediation was always a precedent to financing is site acquisition or construction.
This article provides the framework to package commercially viable yet contaminated transaction for financing by Schedule A banks, credit unions and private lenders. The advice provided is based on supporting loan applications for contaminated sites over a period of 20 years.
A Vancouver wholesale produce distributor (“vendor”) wished to sell his warehouse to retire and retained a real estate agent to list the property for $2.25 million. The property was underlain by the contaminated fill common to reclaimed land in the False Creek area.
The vendor recognized that a purchaser would require a Stage 1 preliminary site investigation for due-diligence purposes and to obtain financing. Not surprising, the Stage 1 opinion concluded the likelihood of contamination was high. Drilling confirmed this and determined contamination extended throughout the imported fill to the depth of native soil.
The cost of remediation was calculated at $175,000 to obtain a certificate of compliance (COC) from the Ministry of Environment within one year’s time. Meanwhile, a selling agent had presented a full price offer subject to environmental due diligence and financing. The vendor was eager to accept.
How was mortgage financing structured?
The purchaser and vendor negotiated a reduction in the purchase price to $2,075,000 in exchange for the purchaser accepting liability for remediation.
The purchaser wished 65 per cent financing, which was $1,350,000. The account manager had no experience with financing contaminated land, but agreed to submit the application that wae packaged for review by his credit committee. The purchaser offered to reduce the loan amount by the cost of remediation, i.e., $175,000, for a period of one year until the COC was issued, at which time this amount would be advanced to him and added to his loan. The requirement for a COC was documented as an event of default, with the lender retaining the right to roll over that condition for a further year provided the borrower could demonstrate progress in remediation and confirm the delay was out of his control.
Why are some loan applications for contaminated sites successful and others rejected? Often is comes down to the lender’s experience with the issue.
Financing contaminated land occurs every business day in B.C. but it requires knowing your account manager and how much expertise he or she may have.
Unfortunately, there is little consistency in experience among branch-level account managers. Consequently, borrowers are often told that lender policy frowns on loan applications for contaminated land. In reality, those account managers may have a poor understanding of lender policy and a poor connection with the credit or risk department. Also, the account manager may simply be unfamiliar with how to characterize the contamination issue in the context of the loan application.
How does one overcome this hurdle?
Successful applications understand that the liability of contamination must be accommodated in the loan application. And, they can take the invitation of doing for the lender. This required teamwork with a business- minded and technically experienced environmental consultant who has obtained COC’s and can provide a credible cost estimate for that work.
How is that cost incorporated in loan documentation?
The cost of obtaining a COC is usually deducted by lenders from the estimated value of collateral, and hence from funds approved. Lenders also require assurance that a COC will be obtained within a reasonable time period from loan initiation. This requirement is generally documented as an event of default. Lenders want to ensure that their collateral is unblemished in the unfortunate circumstance that foreclosure is necessary. Lenders are generally willing to top up the loan with the cost of remediation after a COC has been issued and so additional equity or a temporary cash infusion is required only as an interim measure.
Borrowers must also make lenders comfortable that they are trustworthy in carrying out their obligations to complete remediation. And lenders need similar comfort that the environmental consultant is experienced and will be retained for remediation.