Mitigating risk for lenders of brownfield sites
We are currently running our Brownfield Campaign to explore opportunities within this sector for our clients (you can follow the campaign at #FladgateBrownfield). As part of this we hosted a Lender Think Tank for clients and have been looking into the various risks associated with brownfield investment and development from a lender perspective. The key for our lender clients is working with reputable developers who can demonstrate a good track record so that they gain confidence that any arising issue during the course of the build can be appropriately managed to minimise both cost and delay. We aim to drill down into some of these issues to increase awareness amongst our lender clients and to explore solutions which help to protect the lender’s position. Through our campaign survey, it was revealed that 79% of respondents saw brownfields development as a growth area in the next three years. With that in mind, the sector represents an opportunity for lenders and developers who can properly quantify and mitigate any risk involved. Interestingly, our data also revealed that the highest commercial (as opposed to legal) risk in developing brownfield land was funding issues.
What is brownfield land?
By definition, Brownfield land is space that has previously been developed and is quite often industrial or commercial land that is now derelict or underutilised.
It is no more than a symptom of how our cities and towns change over time as society's needs and industries change. In the past, it has often been easier to develop on the “clean slate” of greenfield land, however, with ever growing pressure on greenfield land and changes in consumer requirements in terms of housing, brownfield sites can pose a real opportunity to those prepared to roll up their sleeves and tackle certain issues.
What are the common challenges for lenders?
- Contamination: it is almost a given that remediation will be required and unlike an investment facility where a lender can expect to see reports evidencing that remediation works have been successfully completed, with development finance the borrower will have yet to carry out these works as they will be funded from the loan monies. The funder is going to want to see evidence that the borrower has approached and costed the remediation risk properly. This means:
- A Phase 1 report has been carried out by a reputable consultant.
- The development budget includes a costing for remediation based on the Phase 1 report. This needs to be verified by the funder’s project monitor.
- If the Phase 1 report recommends a more intrusive survey (a Phase 2 report) can this be carried out before development works commence? Often this can only be carried out after demolition works have been completed i.e. after execution of the facility. A funder can mitigate its risk by including a condition subsequent to carry out the Phase 2 report and re-evaluate the remediation costing in the development budget after the report has been issued. The funder may also want to have staged drawdowns to ensure that only the funds required for demolition are advanced prior to the Phase 2 report being issued.
- Reliance letters will be needed for all reports and the professional indemnity insurance levels of each consultant checked.
In our Brownfield Lender Think Tank, interesting alternative solutions were put forward to resolve traditionally ‘difficult’ sites:
- The developer splits a larger development into phases which are funded one at a time. If contamination issues are addressed in relation to the first phase it makes funding easier for later phases. This can also be beneficial from a costs perspective, as once the contractor has successfully carried out remediation for the first phase the risks involved with subsequent phases will be lower (so pricing should decrease).
- If the site is in a wider area being developed then it is helpful if the developer can speak to neighbouring owners and collect information on how remediation has been addressed for neighbouring sites. Funders will be more comfortable if developers can evidence a pre-existing approach for addressing contamination in the area.
- The developer can price up a potential worst case scenario e.g. of removing the top three metres of soil from the site and disposing of this suitably. Once this is costed it can be considered in the context of the LTV (i.e. can this cost be paid out of the equity in the project), a provision can be made in the development budget or an appropriate guarantee can be considered for this amount.
- Planning: different councils will have different approaches to redevelopment of brownfield sites. Funders will want to be confident that their borrower has local knowledge. Most lenders will only fund where planning has been obtained (Lenders at our Brownfield Lender Think Tank confirmed this was not only because of the risk of planning being refused, but also the uncertainty in terms of timing – it could take six months or 24 months).
- Asbestos: older buildings are more likely to contain prohibited materials including asbestos. The funder’s monitoring surveyor will want to confirm that an asbestos survey has been carried out, that an asbestos management removal plan is in place if necessary and that the cost of this has been properly provided for in the development budget. A funder will want reliance on the asbestos management report.
- Utilities: whilst brownfield sites will already have utility connections these often need to be relocated to accommodate the new scheme and to increase capacities required by modernisation. Agreeing documentation with utility companies is a risk for developers because of the length of time it can take to agree these. One of the lenders at our Brownfield Lender Think Tank recommended using a utilities intermediary to help manage the process. Regardless, it is a process that developers need to start early to minimise the chance of a scheme being held up later on.
- Infrastructure: many brownfield sites have great infrastructure connections. However the flip side of this is that consents to development are often required (Network Rail, TfL, Highways Authority). Whilst the relevant bodies all have standard requirements it is again important to engage with these processes early to avoid delays down the line.
- Historic rights: the legal titles to these properties are more likely to be subject to historic rights and restrictive covenants as these will have been imposed when the land was originally developed (based on how the property and surrounding land was used at that time). They are likely to be historic and in most cases any risk can be easily insured against by obtaining defective title indemnity insurance.
- Unregistered parcels of land: Development sites are often the product of land banking which can lead to pockets of unregistered land making up the site. Ideally the developer will make an application to obtain possessory title of these areas – this will however require a clear history of possession of the land involved and providing evidence of this (such as statutory declarations). If this is not possible title indemnity insurance can be obtained and it is prudent to ensure that either the development can be reconfigured if needed to avoid building on this land if an ownership issue arose or to ensure the areas are used for ancillary uses like parking which are not key to the main value of the development.
- Rights of light: with any redevelopment in a built up area rights of light issues need to be considered. In derelict/under-utilised areas it is likely the risk of substantial claims will be low but it is important that a rights of light surveyor is engaged by the borrower to issue a report identifying any likely claims and their value so these can be provided for in the development budget and if necessary (because substantial claims are identified) a rights of light policy obtained. Again reliance letters will be needed and levels of professional indemnity insurance checked.
There are increasing opportunities to create value by developing brownfield sites as competition and demand for development land increases (particularly in the south and south-east of the UK). A number of factors will have to be taken into account in unlocking value from brownfield sites, and an increasing number of reputable developers are focusing on doing this. With the greater likelihood that issues will crop up during the diligence process funders will need to have:
- An involved monitoring surveyor to assist in verifying that a developer has properly provided for anticipated costs in its development budget.
- Lawyers who ensure that condition precedents and loan covenants are tailored to provide increased protection.
- Valuers who give more consideration to the issues arising from diligence.
The approach for lenders will therefore be more involved and demand a higher level of verification from all its advisors. However, for lenders that can become specialists at funding brownfield site development there are opportunities aligned with the opportunities attracting developers and investors to this market.