Real Estate Deals Demand a Delicate Balance

Thursday, September 3, 2015 - 10:47

MCC interviews Andrew P. Scott, a member at Dykema Gossett PLLCHe can be reached at apscott@dykema.com.

MCC: In a complex real estate project, any one stakeholder can crater a potentially lucrative deal. How do you keep everyone on board?

Scott: The key is meeting the needs of the different parties involved – the lenders, sellers, tenants, municipalities and the developers themselves. In that respect, it's no different from any other deal. For example, a lender stepping in to revive a project that went south halfway through construction wants certain protections, such as time to come in, stabilize the property, identify a new developer and so on; however, those interests are in conflict with the municipality’s interest in not having a half-finished project just sitting there. As a zoning and entitlements lawyer, my job is navigating between those two interests to strike a fair balance. While it can be a bit of a challenge, practically speaking, the municipality isn't going to be too obstinate about the timetable, and the lender that balked at granting the municipality consent rights over the new developer will come around because both recognize that they need each other to get the deal done.

MCC: What’s the key to winning over a municipality?

Scott: In my experience – and Chicago is my base, but I’ve also dealt with many other local governments around the country – obtaining a municipality’s buy-in on a major project usually turns on the project’s ability to generate (a) jobs and (b) tax revenue, because local officials can score political points with this. Good design? Not so much.

MCC: Lenders presumably are going to stay the course throughout the many months, if not years, it can take to secure project approval. Not so the political players. In representing a lender, is there any way to keep a deal from unraveling if there’s a regime change?

Scott: The reality is that sometimes a change in administration absolutely stops a deal and you just have to start over. It’s a risk you have to keep in mind when planning out the transaction schedule. My advice when you know you've got the support of a municipal body is to do everything you can to get your deal done and signed before the next election. Unfortunately, one of the challenges you often run into is that officials facing an election don't want to touch anything. In Chicago, there’s even a name for this period of inactivity: Silly Season. Starting about six months before election day, many elected officials flat-out stop governing to avoid providing their opponents fodder for political attack ads.

MCC: Is the uncertainty a turn-off to potential lenders?

Scott: No. First, there's a lot of money out there to be placed, and lenders know that if they pass on a deal just because it might go sideways, there would be someone else willing to take their seat at the negotiating table. And at the end of the day, they aren't really risking all that much. They don't put a dime into the deal until it's signed and the borrower's equity is in. While they may have to cover some transaction costs, lenders’ counsel generally protect their interests by negotiating an upfront deal with the owner or developer to reimburse the lender for costs incurred in connection with the aborted deal.

MCC: Do you advise on the tax implications of real estate projects?

Scott: I always give my clients the lay of the land as to what kinds of tax burdens they're going to face across different jurisdictions, such as the fact that in Cook County, where Chicago is located, real estate taxes are much higher than in nearby DuPage, Will and Lake counties. I also try to impress upon them the tremendous financial challenges facing Chicago and the state of Illinois, including huge unfunded pension plan liabilities, and their history of relying on property taxes to make up the shortfall. I recently told a client looking to lease industrial space in Chicago, don’t assume that your property taxes are always going to be $3 per square foot. About 50 percent of the city’s property tax bill goes to the schools and another 20 percent to the city. These are powerful forces that are always looking to increase property tax rates. A site that looks good today may not look so good two years from now after a 20-30 percent hike in the property tax bill. You need to bake this into your pro forma.

MCC: What about the flip side – tax incentives? Do you help your clients negotiate for these?

Scott: Cook County offers several tax incentive programs to relieve property tax burdens, the most popular being Class 6(b), a 12-year reduction in real estate assessments to encourage industrial development. Tax savings of up to 60 percent can put a Cook County manufacturing or industrial user virtually on the same footing as its competitors in the surrounding counties.
One of my goals in any real estate transaction is to add value by reducing the tax burden. Tax incentive programs further that goal, as does structuring the financing package to mitigate tax consequences and identifying other tax exemptions and abatements relating to real property sales and capital improvements.

MCC: How important is job creation in obtaining tax incentives?

Scott: It’s huge. But municipalities want to see quality (i.e., office and industrial) jobs. Nobody's going to give you money to bring a Starbucks to their municipality. But 150 jobs paying $20 to $30 an hour is, to a municipality, 150 people who can afford to buy or rent a home, patronize local retailers, and so forth.

MCC: Do you play a role in site selection?

Scott: Yes I do, mostly for manufacturers and clients who are doing industrial projects, but also, to a lesser extent, for retailers and developers of retail space. My advice to manufacturers deciding where to site a new facility is that availability of workforce should be their number one consideration, and proximity to customers should be their number two concern. If their customers aren’t right next door or within spitting distance, it’s important to consider how they’re going to get their products to their customers. Is there rail? Good truck access?

I advise retailers and retail and mixed-use developers on the pros and cons of particular locations. I recently dissuaded the developer of a 100,000-square-foot residential building from including ground floor retail space in its plans. Noting that there was already 10,000 to 20,000 square feet of vacant retail space in the immediate vicinity, I advised the client that the only way to diminish oversupply is to add to demand and, in the retail world, what adds to demand are “rooftops” – houses, apartments and condos inhabited by people with lots of disposable income. Even though this building was going to be in a nice area and close to a train station where there would presumably be a lot of pedestrian traffic, to my mind, the demand just wasn’t there for retail space that would allow the client to recapture the rent necessary to cover the cost of developing the space

MCC: What alternatives were left to your client? Ground-floor living space? A giant lobby?

Scott: In the case of this particular project, there was a lot of back and forth with the neighborhood, which wanted the street level activated. To create a pedestrian-friendly experience, we did a grander lobby than one typically would find in this type of building. We really opened it up and made it an inviting space. We also added interesting architectural treatments to the ground-level façade for a relatively low cost. Meanwhile, behind the ground-floor walls and out of public view were revenue-generating parking spaces and tenant storage units. Talk about striking a balance!

MCC: You've talked about what your clients are doing. Any observations about the sector in general?

Scott: I’m seeing a lot of transit-oriented development (TOD) playing out across municipalities, particularly here in Chicago. The whole idea of TOD is to encourage greater density in close proximity to transit stations, whether commuter rail or the  “L,” our rapid transit system, with the ultimate goals of reducing reliance on cars and the associated stress on infrastructure; increasing public transit ridership and, in turn, funding for needed infrastructure improvements; and converting car-centric drive-through environments into pedestrian-oriented neighborhoods that will attract more retailers and hopefully generate additional tax revenues.

TOD is a big trend in the metropolitan Chicago area. High-density clusters of apartments, condos and retail stores are popping up around train stations in cities and suburbs alike. It should be interesting to see how it all plays out in 10 or 15 years.

MCC: You've worn multiple hats in your career – you’re a practicing lawyer, but you’ve also worked in government and then for a lobbying firm. How does this inform the work you do for your real estate clients?

Scott: I understand the different perspectives that are brought to bear in land use matters. As a former member of my alderman's zoning board, I understand what’s important to neighborhood folks. From working in government, I also have a sense of the process, which is critical to navigating land use laws. Add to that my legal skills as a practicing lawyer and my practical business experience and, when all of those different elements come together, I believe my clients are extremely well-served. While I don't make business decisions for them, I'm able to give them a range of perspectives to help them make a more sound business decisions. Information is power, and my understanding of how the government works contributes to a more informed decision-making process and a better result.