Market for environmentally flawed properties emerges.

Working out a distressed property has always been a challenge that demands the expertise of the best and the brightest of managers. Now, a manager on the leading edge of workouts, is seeking properties that are environmentally flawed.

These properties are typically in a good location with good market potential, but the environmental problem has stressed the numbers. Tenants refuse to rent in them, lenders throw up their hands in desperation and the death spiral is taking place.

"We are buying properties that are distressed not only for lacking tenants or being in disrepair, but we are buying properties that are environmentally handicapped," explained Ronald B. Bruder, president of the Brookhill Group, who manages primarily shopping centers around the country.

Richard G. Leland, a partner and head of the Environmental Group with Rosenman & Colin deemed Bruder's work a "terrific approach and gutsy." Leland said he has come across other owners who became involved in environmental issues after buying distressed properties in portfolios, but no one who is doing it on a wholesale basis like Bruder.

"It is a brilliant idea," he added. "If you know what you are doing and are properly represented, environmental problems are not fatal."

Price Reduced

Kenneth M. Block, a partner with Brown Reisman & Milstein, who is aware of at least one West Coast company also seeking these properties, agrees there is an immediate overreaction by a prospective purchaser to an environmental disaster. "A careful review of a site assessment survey by a professional can establish the realistic cost of removal and cleanup. Once the purchaser knows the realistic cost, he or she is in a better position to negotiate a reduced price."

As president of Real Estate Evaluation Services of Rye, Daniel Forbes conducts financial due diligence work for investors. "The key is not to be afraid of the contamination," he said, explaining that these properties can be obtained at steep discounts.

"If you have a problem that can be solved, the fear discount is substantial, so if it will cost 20 percent to fix, the fear discount will be 40 to 50 percent."

Bruder started in this unusual workout venture when he bought a distressed property that was also environmentally contaminated at a very favorable price. "We quantified it; we knew it, and we cleaned it up so it works," he said. He also made money on the property - a strip mall that is his nationwide company's specialty. Since then, Bruder has worked out environmentally distressed properties in several states, including Arkansas and Florida. He does not buy these properties to fix up and hold for years, but to clean up and get out.

"The exit is somebody else to buy it and somebody else to finance it," he said. But he warned, "Nobody is going to buy it and nobody is going to finance it unless you've gotten a major firm to sign off certifying it that it is clean."

There are reputable, experienced firms that specialize in environmental cleanups, backed by insurance that can stand behind their guarantees, notes Block.

Bruder's company obtains certifications indicating that the property is clean and meets Environmental Protection Agency criteria from an established, national reputable environment firm.

Hazclean Environmental Consultants of Birmingham, Alabama, with offices in Atlanta, Georgia and Jackson, Mississippi, are environmental engineers and consultants that have worked with Bruder. It's president, Bill Garvin, who holds an MBA from Purdue that helps with financial analysis, says they handle all phases of mitigating environmental problems.

The first step is to determine the type of contamination and the extent of the contamination, he said. The second part is to determine the range of cost and the time involved. "The client can take that information and under stand the downside and can negotiate to buy the property effectively," Garvin said.

There are fewer people willing to buy distressed properties, he added so it drives the price down. "There are a few that do distressed property but I don't think there is anybody who has the experience or financial wherewithal that Ron Bruder's group does," said Garvin. "There are people who say they are doing that but I have never seen it happen."

Leland noted that if several of these workouts are conducted, the principals can deal with the same contractors and same technology so there can be some control over the costs.

Once the hazard is cleaned-up, and certified it has been done in a lawful and safe manner, Leland believes the tenant or re-purchaser is actually better off than when moving into some other property where an environmental survey was never conducted. "As a repurchaser I'm buying some peace or comfort," he noted.

Forbes, however, says the property will always have some taint. "He has a smaller market to sell to," he noted of Bruder's opportunities. "Once environmentally dirty always dirty."

But even Forbes acknowledges that once the building has its bill of health, the concern is a "fear risk and not a real risk" and more important, that Bruder has been able to make a good deal.

If the cleanup is done properly, the reduction in price may exceed the cost of the cleanup, says Block. "There are opportunities for people to acquire contaminated properties that otherwise might have not existed."

Many of these properties, Bruder noted, have leases sitting in the wings, but no one can give the proper representations to the tenant. Once they are cleaned up, Bruder can represent them as clean properties. "Tenants don't want to be involved in situations where it's not 100 percent clear," he added.

Bruder said returns in the over 20 percent range are not unachievable for these workouts. "It's a very low risk because it's dependent on doing something that you've already figured out beforehand," he said. Besides, he said. "We've paid so little for it we can lease it well below market and still come out well."

One 200,000 square foot community shopping center in the Midwest, with a grocery store anchor, had revenue of approximately $7.5 million with an NOI (net operating income) of $750,000 going in. But the property had a problem with PCB's from transformers.

"We quantified that cost as approximately $800,000 but the cleanup cost only $150,000 because we prevailed on a local utility to do it," Bruder explained. Brookhill paid $6 million for the property with 75 percent financing. "We put up $1.5 million, which is now worth $4 million." Today the NOI is around $925,000.

Forbes agreed that since these properties can be purchased at a steep discount of 50 percent or so, when they are sold, Bruder has the ability to recoup anywhere from 20 percent to 35 percent, and the next buyer will still have a 15 percent savings. "But if someone is going to buy it, they will buy with cash and not with a bank or insurance company," Forbes warned.

Lender Liability

Lenders typically want a Phase I report on all properties, involving a site reconnaissance by an environmental expert, an investigation into the historical use and ownership of the subject property, as well as those near or adjacent to it that can potentially contaminate it.

Because of onerous problems with lender liability, most lenders do not want to get anywhere near the title on these properties. Unfortunately, this often means that rather than foreclosing, the bank dawdles. This is where Bruder comes in and surprisingly receives financing from the same lender, once the problem is abated.

"I've seen 20 instances where the lender sits by the sidelines doing nothing," he recalled, "not collecting any debt service, watching the taxes go unpaid - which is a prior lien - watching the environmental problem get worse because it's not remediated and not wanting to do anything because they don't want to cross the Rubicon of being or having any incidence of ownership and being a named party."

Bruder said his company will set up an entity and take over the lender's interest. "Sometimes we'll give them some cash and we'll have them take back some paper," he continued. "So we'll buy their mortgages at a discount but we'll become in essence their joint venture partner, depending on the mentality of the lender. And it's very exciting for us."

In the lenders' eyes, Bruder is mitigating their risks and having their problem solved, Forbes says. Their money is out already but they can justify further involvement by figuring that "as long as I have a clean site on my books, that's the best place to have my money."

While investigating these sites Bruder has also found that most lenders and owners are not willing or able to quantify the degree of the distress. "It reads either black or white: it's distressed or it's not distressed," he said. "We can look at it in a more objective reality and realize either the problem is very quantifiable and it can be remediated or it can't."

The Cleanup

A Phase II report is made when the environmental experts go back, Garvin said, and sample along the property lines and see if there appears to be contamination from soil and groundwater.

"With a distressed property going in," Garvin said, "we go right to a Phase II site assessment and find the extent of contamination, laterally, vertically and in a matrix of soil and water, and what chemicals contaminated the property. That tells us how easy or hard it is to clean up."

Phase III is the actual cleanup, and sampling and testing are continued until the agency in charge says no further action is necessary.

Bruder typically looks for other entities to pay for the clean-up, depending on the individual situation. Prior to closing, his company can often obtain a commitment from the government to pay for a clean-up out of Superfund money. "If they are willing to throw their money at it, we will make sure it is spent wisely," he added.

Leland noted that it is difficult to tap into Superfunds. "You use the potential Superfund claim against the prior owner to negotiate a claim," he said.

Bruder says sometimes they go to the offending party, if they are still around and financially solvent, and say |Bye the way, that problem you created needs to be fixed and when are you going to fix it?'

More often that no, Bruder says the contaminators are inclined to pay because otherwise, they could be facing adverse publicity and treble damages, and they will have to pay anyway. "If you can prove clearly that they are the cause of it, they know what the end of litigation will be," he advised. Local Department of Environmental Protection agencies can also be recruited to apply pressure.

Since these properties are generally distressed economically because tenants have left or stopped paying rent as the environmental issue came to light, Bruder says he can obtain a reduction in the real estate taxes just by talking about the reduced economics and the actual price he is paying for the site without flagging the other problems.

He advises discretion when taking over these sites. "Nobody is going to get hurt, the asbestos isn't friable, nobody is going to be inhaling it and having any problems with it," he noted. "If it's PCB and it happens to be in a transformer on the property, nobody is sitting there eating lunch on the transformer."

Bruder claims his biggest problem is finding properties that need his expertise. None of the environmental problems are insurmountable, he says, as long as enough money can be thrown at them. "It's all a function of the dollars," he rationalized, "but there are some properties where it doesn't make any economic sense to be throwing money at them." Among the problem properties he passes by are those where the groundwater has been impacted and those which are not good properties to begin with.

So if Bruder would not buy the property in good condition, he will not pursue it when distressed. "This has to be good real estate," he insisted. "I'm not going to buy environmentally damaged garbage and spend money cleaning it up and find out that I have bricks and mortar that I have to knock down anyway. The assumption is that we'll check out the real estate, check out the location, we'll do a demographics. We'll do everything as though we were buying any other property. It's more work, more risk, more reward. We're happy to do the work, we're happy to take risk and we like the reward."