Real Estate & Development

Top Ten Plays for Weathering a Softening Real Estate Market

October 2006

By Erik Newman*

This article is intended to provide real estate developers and investors with a toolkit for weathering a softening real estate market. If you cannot deploy your resources in building and selling in this market, then deploy them in other ways that save money and position your business to take advantage of opportunities when the market rebounds. The focus here is on action: offensive action to put more money in your pocket; defensive action to protect that capital from unnecessary expense and exposure. Since it is anyone’s guess how long the present real estate downturn will last, or how deeply it may cut, this article advances a strategy that combines both offense and defensive posturing.

Offense: Put More Money in Your Pocket

1. Carefully Police Real Estate And Brokerage Agreements

Carefully review any new or existing contracts and brokerage agreements for opportunities to reign in costs. In this market, for example, brokers may be willing to depart from normal compensation. Review existing agreements for compliance with any incentive-based compensation measures to ensure that incentive targets are being achieved. You might also consider renegotiating contracts where more favorable terms are available.

2. Pursue A Tax Abatement

Consider whether your property is appropriately assessed. Professional appraisers and legal counsel may guide your determination of whether the municipal assessor properly supported the assessment with market and cost data. Counsel can also help you navigate the abatement procedure before the local assessors, The Board of Land and Tax Appeals or the Superior Court to prove, by a preponderance of the evidence, that you are paying more than your proportional share of taxes. Remember that initiating a tax abatement procedure does not exempt the property owner from continuing to pay taxes. Should the abatement succeed, any excess will be refunded with interest.

3. Look For Stale Escrow Accounts, Bonds and Letters of Credit

These are not times to leave extra money lying around, so conduct a thorough review of project files to identify escrow accounts that may have been established but whose deposits were never fully depleted. Review all escrow agreements carefully to determine whether accounts should be closed and deposits retrieved. Also, look for terms in existing escrow agreements pertaining to interest accrual and ensure that any money you get back includes any interest due and owing. Conduct a similar review for bonds or letters of credit whose purpose has been satisfied or improvements completed and which might entitle you to reclaim funds. Since outstanding bonds and letters of credit will detract from a lender’s perception of your creditworthiness, this policing activity will help ensure that you are maximizing your access to capital.

4. Identify Impact Fees Collected But Not Spent

Although few developers are likely to give much thought to that impact fee paid several years back, it might prove profitable to research fees paid more than six years ago. By law, impact fees must be spent for the purpose for which they were collected during a reasonable period of time set by the town’s impact fee ordinance, not to exceed 6 years. RSA 674:21. Otherwise, they must be refunded with any accrued interest. By conducting due diligence at the municipality responsible for spending those funds, you might identify fees that were never spent within the statutorily prescribed 6 years. Also, note that if the impact fee funded some portion of capital improvement whose costs was also borne by the municipality, you are entitled to a refund if the responsible legislative body does not appropriate the municipality's share of the capital improvement cost within 6 years.

5. Pursue Creative Borrowing

With rising interest rates, consider creative borrowing opportunities such as the federal New Markets Tax Credit (“NMTC”). NMTC provides credits against federal income tax liability to investors in special Community Development Entities (“CDE’s”) that make loans to qualifying business (including commercial and certain residential real estate development) in qualifying low income geographic locations. Because the tax credit substantially reduces the CDE’s cost of funds, the loans made by the CDE are typically lower in cost and/or contain more flexible terms than would be available through traditional financing sources.

6. Inventory for the Future

Review properties that you had considered for development in the past, but rejected because of price, access, permitting or other difficulties. Their viability may be worth re-considering as attitudes in the market shift. Municipal attitudes towards permitting may soften and sellers’ aggressive pricing of development sites may have abated. Access issues could be resolved or upgraded where owners of neighboring property may be market driven to be more accommodating. Also, revisit properties where zoning had been an impediment to development. The law of variances continues to shift towards flexibility and the acceptance of economic hardships. A project which would have been a zoning impossibility 5 years ago may now be achievable.

Defense: Protect The Capital You Have

7. Understand the Risks of Mechanics Liens From Subcontractors

Costly problems relating to mechanics liens can come at a developer from a number of directions. An owner whose property is slapped with a lien may withhold payment to the developer/general contractor, a lender may withhold construction loan disbursements for failure to abide with lending terms, and a subcontractor who asserts the lien is likely to seek relief from the developer personally on account of their contractual relationship regardless of who was actually supposed to pay the subcontractor.

Understand that pursuant to RSA 457:5 subcontractors must give a property owner notice in writing before performing the labor or supplying the material at issue to successfully assert a lien on the property. Therefore, a developer should identify which subcontractors have complied with this notice requirement and could potentially assert a lien. To minimize that risk and the costs associated therewith, developers should diligently obtain mechanics lien waivers from those subcontractors. Waivers should be obtained as payment for labor and materials are made either by the developer or from the lender.

Developers might seek a contractual waiver of all mechanics liens from subcontractors before work is performed or materials furnished. In Duke/Flour Daniel v. Hawkeye Funding, 150 N.H. 581 (2004)the New Hampshire Supreme Court recognized that the statutory mechanics lien can be waived by contract. However, the Court noted that the contract purporting to waive that right must evidence an actual intention to forego a known right. Therefore, careful drafting of the contract or agreement is necessary for such a blanket waiver of mechanics liens to be upheld.

8. Know Your Three Hour Drill

It’s 3 p.m. on Friday and you hear through the grapevine that your owner or a major sub-contractor is going to be filing for bankruptcy before the close of business that day. Do you run to court to get an attachment, shore up your documentation, notices, etc., meet with the party about to file and seek assurances? Think of your response to these emergencies as your Three Hour Drill. Your response needs to be planned, easy to spring into action and second nature.

9. Maintain Corporate Records And Filings

Maintain timely corporate records and state filings to best insulate yourself from personal liability. Failure to adhere to corporate formalities such as keeping minutes of corporate meetings or filing annual returns opens the door to claims that the corporation is a sham or should be pierced. If a court is convinced that the corporation is a sham it may ignore the corporate form and impose personal liability officers and directors. Also, adhering to these corporate formalities may improve your image among lenders, thereby increasing your access to capital or even helping you obtain more favorable lending terms.

10. Reduce Carrying Costs on Land Not Ripe for Development

Consider alternatives to continuing to pay property taxes on land that would be unprofitable to develop in the foreseeable future. By enrolling land in “current use,” it will be taxed at its current undeveloped use value, and not its fair market value. RSA 79-A:2. However, a land use change tax will apply as soon as the property no longer qualifies for favorable current use tax status as “open space land.” If land is enrolled in current use, make certain that no one disturbs the land so as to trigger the land use change tax. During the present economic downturn, assessing officials are more likely to be vigilantly monitoring property enrolled in current use for violations that would entitle them to levy a land use change tax.

Alternatively, developers might consider placing land that would be unprofitable to develop into a conservation easement. The downside is that the land becomes permanently undevelopable and a developer is unlikely to recoup anywhere near market prices from a not for profit entity, such as the Society for Protection of New Hampshire Forests, which might purchase such an easement. However, donation of development rights through a conservation easement constitutes a gift for federal income tax purposes and may be deductible. Moreover, value in the form of generating goodwill with the local community and municipal government is likely to pay dividends on future projects once economic conditions become more favorable for real estate development.

* Erik Newman is admitted in New Hampshire.

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