As the strong real estate market continues, many developers and investors are reevaluating projects that, although they may have received previous government land-use approvals or "entitlements," remain only partially built-out or undeveloped. Generally, properties with existing entitlements are thought to carry less risk than unentitled land and, as a result, sellers expect a premium price. While this general assumption often holds true, many projects, unfortunately, have their own unique skeletons in the closet.
In order to identify and deal with potential entitlement pitfalls, an effective, comprehensive evaluation of a particular project should be completed prior to its acquisition. This evaluation may often require key contributions from a broad spectrum of participants, including lawyers, civil engineers, financial analysts and lobbyists. The results of this evaluation should lead to a deal structure that adequately allocates the entitlement risks associated with a particular transaction.
Answers to the following three basic questions can go a long way towards making an acquisition a successful transaction:
1. Do the existing land-use approvals authorize the proposed development?
Often, property sellers tout that a particular project is covered by an approved development agreement, specific plan or other entitlement. While, in general, a vested rights mechanism such as a development agreement (which, for example, might state a minimum number of units for a large residential project) is a good foundation for a project's entitlements, it should not be the end of the inquiry. To analyze a project's feasibility, more detail is needed than the general information typically contained in a development agreement. Similarly, a specific plan, which may have been approved in a completely different political climate, provides only a helpful starting point for evaluating a development's current entitlement status because a specific plan rarely, if ever, authorizes development without requiring additional entitlements.
Even if a proposed project has a valid tentative tract map or plat, a conditional use permit or other site specific development approvals, it is possible that such entitlements do not authorize the particular development plan proposed by the purchaser of the property. Most developers, especially with property that has been sitting for a long period, want to "tweak" the development plan based upon market forces. Such changes often raise the likelihood of new or revised entitlements being required.
Even if no major changes are expected, the project as approved may contain conditions of approval that are so onerous that the project is unbuildable as a result of engineering, financial or other concerns. The need to revise onerous conditions of approval may open a project up to public review.
Where a major project with existing entitlements has not been developed for some time, it is extremely rare that development will proceed without additional governmental approvals.
2. If new land-use approvals will be necessary, how significant are they, and has the political environment changed since the earlier approvals?
When approaching changes to approved projects, one important consideration is whether the changes will open up the project to public review. Typically, a project is opened up for public review when a change requires a "discretionary" (i.e., political) decision by a planning commission, city council or board of supervisors. Examples of discretionary changes include plan amendments, zone changes and tentative tract map revisions. In contrast, a change that can be made without public review is more likely to be handled on a staff or administrative basis. Obviously, to the extent changes can be accomplished without public review, a project's entitlement risk is lower.
Whether a project change requires discretionary review is also important because discretionary changes require a reevaluation of the project under environmental review statutes such as the California Environmental Quality Act ("CEQA"). Such a reevaluation may result in a requirement to update or create a new environmental impact report or similar document, resulting in significant project delays. If a supplemental environmental impact report is likely to be required, the project's pro forma must build in the significant time and resources necessary to accomplish this task.
While a sophisticated legal analysis can indicate the entitlements that will likely be needed to update the project approvals necessary under the law, such an analysis must also take into account that the entitlement process is as much a political process as a legal process. In other words, if the political climate has changed since the earlier project approvals, the project may face a far different "re-entitlement" process than one might expect based solely on an objective analysis of the existing approvals. For example, in an area that has undergone significant surrounding development since the prior approvals, an emerging local slow-growth or no-growth sentiment may encourage local elected officials to direct staff to reopen a particular project to public review and environmental scrutiny. There may be little a developer can do in the face of such direction in light of the significant hurdles involved in seeking judicial review of such a decision.
Evaluation of the likely political sentiment is, of course, crucial to an evaluation of a particular project's potential for success. A political consensus to accomplish the development can go a long way toward making the entitlement of a difficult project a relatively straightforward process. On the other hand, a negative political climate can make the entitlement of a simple project a potential nightmare. Unfortunately, it is sometimes difficult to obtain a clear, accurate read of the current political environment.
Due to all of the above concerns, it is, of course, preferable to condition the closing of the sale of a project on the approval of all necessary project changes and required entitlements. As this is rarely possible in the marketplace, an interdisciplinary approach, as discussed above, is extremely important.
3. Is litigation likely?
Unfortunately, in the development context, virtually anyone who can pay a nominal filing fee can sue to oppose a project, regardless of whether the opponent has valid concerns. In California, even if a challenge to a project is unsuccessful, the opponent of the project cannot be required to pay the prevailing party's attorney's fees, except in extremely rare circumstances. Litigation, including all appeals, often takes several months, if not years, to resolve in court. A project opponent can often demand a large sum of money to settle a meritless claim because litigation itself can tie up a land sale and a buyer typically does not want to close on property that is the subject of litigation.
A fundamental question is whether a lawsuit is likely on a particular project. Typically, a city or county will have a known track record regarding whether or not a local individual or environmental group is likely to file a lawsuit against a major project. Some jurisdictions have never had a legal challenge while others have had one on nearly every major project.
If litigation is likely, it is helpful to be aware of basic principles of land use law. Generally speaking, the limitation period for filing a lawsuit relating to a land use decision is extremely short. This cuts both ways. For example, the statute of limitation relating to CEQA is typically thirty days after approval of the project and posting of the notice of determination. This means that after a relatively short period of time following approval of the project, the developer or a subsequent purchaser can usually be assured that there will be no CEQA litigation relating to the project.
Similarly, most statutes of limitation relating to tentative subdivision maps, zone changes, general plans, conditional use permits and other entitlements in California are ninety days. These statutes of limitation apply to challenges by the developer to onerous conditions of approval. This means that in the event that onerous or even illegal conditions have been imposed, a developer or subsequent purchaser may be time-barred from challenging the conditions in court. In effect, the developer becomes stuck with the conditions of approval unless the political will exists to change them.
Finally, the concept of exhaustion of administrative remedies should be considered. Generally, this means that prior to the filing of litigation in court, a litigant must have pursued all administrative remedies, i.e., appeals to the local agency. In addition, the issues raised in the litigation are limited to those issues that were in front of the local agency, such as the city council or planning commission. This principle can preclude new issues from being raised and can help to limit the scope of the litigation.
Successful development of long underutilized property can help meet the significant needs of today's growing population and workforce. As new sources of capital take extended looks at previously entitled property, actual development is likely to occur only if these sources of capital are allowed to make informed investment decisions. Such informed decisions depend upon a sophisticated evaluation of the likely entitlement risk for a particular transaction.
Christoper R. Cheleden is a Senior Associate in the Century City office and may be contacted via e-mail at ccheleden@pillsburywinthrop.com or by phone at (310) 203-1133.
Pillsbury Winthrop LLP is a global law firm with power and presence on both U.S. coasts and abroad, with core practice areas in: real estate, litigation, technology and intellectual property, energy, capital markets and finance. The firm has 17 offices and approximately 800 attorneys worldwide. For further information on the firm's real estate practice, please contact Jim Rishwain at jrishwain@pillsburywinthrop.com or (310) 203-1111.