Brownfield RedevelopmentThomas O. Jackson, Ph.D., AICP, MAI, CRE, FRICSTexas A&M University and Real Property Analytics, Inc. www.real-analytics.com

Pricing Environmental Risk in Contaminated Property Transactions

October 28, 20062006 Fall Professional Conference – Charlotte, NC USA

Environmental Risk and Stigma

• Stigma reflects risk and uncertainty• All real estate investments have risk• Risk is inherent in homeownership• Stigma is risk related to additional uncertainties

– Environmental condition of property– Potential future liabilities– Unknown hazards– Undisclosed or hidden costs– Fear of the unknown

• Stigma damages v. remediation costs– Does one "cure" the other?– Temporary v. permanent condition

Environmental Risk Factors

• Nature and extent of contamination• Existence of approved remediation plan• Degree of reliance placed on regulatory authority• Indemnifications by responsible party• Potential for third party (toxic tort) liabilities

– Adjacent property owners

– Employees and tenants

• Cost and timing of remediation effort– Risk based remediation standards

Environmental Risk Factors (continued)

• Effects of remedial activities on economic use of property

• Residual land use restrictions subsequent to closure• Environmental insurance

– Remediation cost cap

• Market conditions– Strong market demand has mitigating effect

– Weak market conditions exacerbate environmental risk

– Conditions specific to location and use

Remediation Lifecycle

• Degree of perceived risk (stigma effects) changes over remediation lifecycle

• Before cleanup stage– Little knowledge or certainty about nature and extent of contamination– Perceived risks and adverse property impacts at a maximum

• During cleanup - risk decreases, value increases• After cleanup

– No further action, regulatory closure– Risk declines to market levels– Value increases

• Unimpaired levels• Higher levels - sales research

Market Perceptions of Environmental Risk

• Perceptions of risk by market underlie property value impacts and damages

• Understanding perceptions is key to understanding the effects of contamination on value

• Stigma is a perception issue• Results from scientific national study of lenders and investors

conducted (funded by the National Science Foundation)• Representative sample, results allow for inference• Property referred to is source site, income producing commercial

or industrial property with groundwater contamination• For lenders, assume borrower is creditworthy • For investors, assume investment otherwise meets criteria

Lender Risk Perceptions

• Before cleanup:– would make loan without adjustments: 1.3%– would make loan with adjustments: 5.5%– would not make loan: 93.2%

• During cleanup:– would make loan without adjustments: 6.4%– would make loan with adjustments: 54.2%– would not make loan: 39.4%

• After cleanup:– would make loan without adjustments: 65.3%– would make loan with adjustments: 30.5%– would not make loan: 4.2%

Investor Risk Perceptions

• Before cleanup:– would invest without adjustments: 5.6%– would invest with adjustments: 35.2%– would not invest: 59.2%

• During cleanup:– would invest without adjustments: 20.1%– would invest with adjustments: 69.3%– would not invest: 10.6%

• After cleanup:– would invest without adjustments: 62.4%– would invest with adjustments: 37.1%– would not invest: 0.6%

Income Capitalization Analysis (Uncontaminated Properties)

Unimpaired

Value

=$238,246 per year

9.30%= $2,561,78

5

Capitalization Rate

Net Operating

Income

Note: Based on an analysis of 120 retail centers sold in the southern California area from 1994 to 2004.

Copyright Thomas O. Jackson, Ph.D.

Income Capitalization Analysis (Contaminated Properties Sold Before Cleanup)

Impaired Value

=$238,246 per year

11.27%

= $2,113,984

Capitalization Rate

Net Operating

Income

Note: Represents property value diminution of $447,801, or 17.5% of value in unimpaired condition, and an environmental risk premium of 197 basis points in the capitalization rate.

Copyright Thomas O. Jackson, Ph.D.

Income Capitalization Analysis (Contaminated Properties Sold After Cleanup)

"Cured" Value

=$238,246 per year

9.34%= $2,550,81

4

Capitalization Rate

Net Operating

Income

Note: Difference in value of previously contaminated properties not statistically significant from uncontaminated properties.

Copyright Thomas O. Jackson, Ph.D.