Real property is governed by the laws of the jurisdiction where the real property is located, which includes US federal law, the law of the state where the property is located, and the local rules and regulations of the particular county and municipality.
Despite concerns and fallout from the COVID-19 pandemic, the real estate industry finished with a flourish of activity in 2020 that matched the robust activity in the first quarter. COVID-19 slowed transaction volume to a near halt in the second quarter, which continued for much of the third quarter – this slowing was attributable at first to uncertainty about the economy and the ability to get debt and equity financing for deals, but continued because of buyers' inability to perform their on-site due diligence and to underwrite transactions while working from home. The transactions that ended up closing in the late third quarter and the fourth quarter generally had slower than typical timelines, caused in large part by the inability to travel.
The multi-family and industrial sectors all continued to see transactions, while very little transaction volume occurred in the retail and hospitality sectors, because of the effects of COVID-19 on those asset classes. While the office market saw some transaction volume, this asset class remains in a grey area while corporate office users figure out their long-term strategies for office space needs. Finally, alternative investment classes such as data centres, cold storage, logistics and medical offices remained a popular investment strategy with investors.
Investors and developers have invested in proptech in an effort to improve overall efficiency in asset operations, but there has been no widespread use of blockchain in the commercial sales process, nor any use of other disruptive technologies in the real estate industry. Disruptive technologies are expected to continue to be discussed and evaluated, but no significant deployment or integration of these technologies is anticipated over the next 12 months.
The biggest reform areas relate to COVID-19. The rent relief programmes, foreclosure moratoriums and related reforms will all have significant impacts on real estate and the fundamentals underpinning those assets. These reforms will have the biggest impacts on residential and retail real estate, but other asset classes will be affected as well. It is unknown how successful these reforms will be in getting passed at the federal, state and local levels and how long-standing they may be. The reforms and their impacts are likely to be known by mid-2021.
Property rights may be acquired in a number of forms, including fee simple ownership, possessory interests such as leaseholds, and non-possessory interests such as easements. The owner of a fee simple interest generally enjoys all aspects of ownership without limitation (subject to any public or private restrictions that may govern the property). Possessory interests such as space leases, ground leases, licences and life estates are more limited and temporary forms of property rights. The tenant holds a leasehold interest in the property for a certain length of time, while the owner continues to hold fee simple title. Easements are non-possessory interests in land that generally grant a non-owner the ability to enter property for a certain right of use, such as sidewalk usage within a retail project.
Laws governing the transfer of title to property vary by jurisdiction. In general, title to real property is conveyed by the execution of a deed that is recorded and indexed in the real property records of the county in which the property is located. In transactions involving the transfer of title to commercial property, including office, retail, multi-family, hotels or industrial projects, certain personal property is typically also conveyed by a bill of sale from the seller to the buyer. Generally, the form of conveyance within each state is promulgated by statute and is the same regardless of the type of real estate; however, many states require additional disclosures for residential property.
Almost all local governments maintain title registration offices where owners and lenders record various claims to real estate. A lawful transfer of title to real estate is accomplished by executing a deed and recording it in the applicable county in which the property is located. Recording and deed requirements vary in each jurisdiction and must be followed precisely.
Buyers of commercial property routinely purchase owner’s title insurance, which generally insures the owner against any superior claims in the real estate based upon rights existing prior in time to the purchase.
Commercial real estate buyers typically perform physical, economic and legal inspections of the property. These inspections typically occur during a due diligence period, which may vary substantially depending on the type of asset and the circumstances of the transaction. Buyers will often engage third-party specialists to perform physical and environmental inspections of the property. Buyers generally also perform diligence related to the revenue stream of the property and the tenant leases, and a review of the zoning of the property. Buyers also conduct a title and survey review of the property.
The COVID-19 pandemic impacted buyers’ diligence in a number of ways, mostly resulting from the inability to travel for much of 2020 and the inability of certain vendors (eg, environmental consultants, surveyors, etc) to get on-site in many jurisdictions because of stay-at-home or shelter-in-place orders.
Representations and warranties are some of the most heavily negotiated provisions in a real estate purchase contract, with few, if any, being provided by statute. In a sophisticated commercial transaction, sellers do not typically make representations and warranties with respect to items that the buyer can verify through diligence, such as the state of title or the physical condition of the asset. Most often, sellers will represent as to their authority to consummate the transaction, the existence and status of legal agreements affecting the property (such as leases and service contracts), the absence of defaults thereunder, the status of any litigation or claims affecting the property, and the absence of hazardous materials.
It is common practice to limit the buyer’s remedies against the seller for a breach of representations and warranties discovered after closing, both by limiting the time in which the buyer may pursue the breach and by capping the amount of buyer recovery. Where a buyer discovers a material breach of a seller representation or warranty prior to closing, they can terminate the purchase contract and potentially recover damages for their pursuit costs.
Contract law and land use law are critical for investors to evaluate potential purchases of real estate. Buyers should review and understand all of the documents that affect the property, including leases, service contracts and documents recorded in the local land records that impose obligations or restrictions on the property.
While there are many areas of law that are important for investors to consider when purchasing real estate, two areas that commonly create unforeseen consequences if not considered properly prior to a property’s acquisition are the tax structure and treatment of an acquisition, and public and private restrictions applicable to the use and development of the property.
The US Federal Tax Cuts & Jobs Act contains several provisions relating to items such as tax rates, depreciation and expenses that have affected investment considerations in real estate.
The creation of Qualified Opportunity Zones has created a number of new projects in commercial real estate across the United States. More than USD12 billion had been invested in Qualified Opportunity Funds by the end of August 2020.
The Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA) is the primary federal legislation governing events related to the exposure of real estate to hazardous materials in the US. CERCLA imposes strict liability upon “owners and operators” of real property for penalties and costs related to hazardous waste contamination and clean up. Strict liability means absolute legal responsibility for an injury imposed on a party without proof of carelessness or fault.
An owner that has not caused environmental contamination can limit its risk by following the US Environmental Protection Agency’s interim guidance regarding safe havens for bona fide prospective purchasers and innocent landowners. To qualify as a bona fide prospective purchaser, one must perform “all appropriate inquiry” into the contamination status of the property prior to purchasing the property. This requires an investigation of the environmental condition of the property by a qualified professional documented in a written report, typically in the form of a Phase I Environmental Report.
A prospective buyer should confirm the permitted uses of a parcel of real estate under the applicable zoning or planning law by researching the designation of such property by the local zoning or planning office. In addition to reviewing the zoning regulations promulgated by the local authority, a prospective buyer can obtain a zoning report that summarises the property’s compliance with the applicable zoning code.
If a proposed development is of significant value to a community, the applicable public authority may enter into development agreements with the developer, containing concessions and requirements with respect to the project.
Governments in the US have the power of eminent domain – ie, the right to take private property for public purposes. The Fifth Amendment of the US Constitution, which applies to the federal government as well as state and municipal governments, provides safeguards to protect property owners, including requiring compensation for any taking of property.
State and municipal governments typically impose some level of taxes and/or fees with respect to the transfer of real property, but the scope and reach of such taxes and fees vary widely by jurisdiction. Many jurisdictions impose excise or stamp taxes (commonly called transfer taxes) at the state, county and/or municipal level, which are determined based on the sale price of the property.
Whether transfer tax applies may depend on both the type of transfer (fee title versus lease) and the structure of a transfer (ie, a direct transfer or an indirect transfer through the transfer of the entity that owns the property). In some jurisdictions, the tax may only be imposed on the transfer of title to the property, while other jurisdictions may impose the tax on the transfer of a leasehold interest.
Certain jurisdictions only impose transfer tax on the direct transfer of real property, but not if the transfer is indirect – for example, where the entity holding title to the property does not change, but the ownership of that entity is transferred. In other jurisdictions, the tax is also imposed on indirect transfers of real property.
Foreign persons are generally permitted to acquire US real estate, although the federal government imposes economic sanctions and restrictions that prohibit transactions with certain individuals, organisations and nations. The PATRIOT Act also requires certain disclosures related to the identity of foreign investors. Foreign investors should also be mindful of the requirements of the Bureau of Economic Analysis of the Department of Commerce, the Foreign Investment in Real Property Tax Act (FIRPTA), the Agriculture Foreign Investment Disclosure Act of 1978, and Department of Defense regulations, among others. Notably, in February 2020, the Committee on Foreign Investment in the US (CFIUS) implemented final regulations that expressly authorise it to review controlling and non-controlling foreign investment in real property.
Commercial real estate acquisitions – whether of a single property or a portfolio – are typically financed with mortgage and/or mezzanine loans. The economic terms of a commercial mortgage loan vary depending on the type of property, the intended development plan, the reputation and financial strength of the sponsor, and the course of the financing. The financing may be structured with fixed or variable interest rates, may be fully drawn at closing or provide for additional advances over time, and is typically non-recourse to the borrower other than certain "bad boy" carve-outs. As a non-recourse loan, the security for repayment of the loan is limited to the property and the borrower’s other property-related assets.
Under a traditional mortgage loan, the borrower must provide the lender with a first-priority lien on the property as security for repayment. The lien is evidenced by a mortgage or similar instrument filed in the local public land records. Upon a default by the borrower, the lender’s remedies include the ability to foreclose on the security instrument and either sell the property to a third party or obtain ownership and possession of the property directly.
The security provided in connection with a mezzanine loan is a pledge of the borrower’s ownership interest in the property owner so that, upon foreclosure, the mezzanine lender is able to control the property by holding 100% of the membership interests in the property owner.
As additional security for a mortgage loan, the borrower is generally required to assign all property-related assets held by the borrower, such as all leases and rents and property-related contracts and agreements.
While there are no general restrictions or prohibitions on granting security in US real estate to foreign lenders, the receipt by a US person of loan proceeds from a foreign lender and repayment of the same is subject to US anti-terrorism and anti-money laundering regulations.
Historically, CFIUS’ jurisdiction was focused on mergers, acquisitions and takeovers of US businesses engaged in commercial activity, but CFIUS implemented new regulations in February 2020 that expand to also cover the purchase, lease or concession (including assets acquired out of bankruptcy) of US public or private property that is in or functions as part of certain US air or maritime ports (ie, major passenger and cargo airports by volume, strategic commercial seaports, civil-military joint use airports), or that is in close proximity to certain US government facilities.
In the February 2020 regulations, CFIUS published four lists of sensitive US government facilities, with the definition of “close proximity” depending upon the level of sensitivity (eg, property within the same county as a missile silo, within 100 miles of a fort, or within the territorial sea of an offshore base). Depending on the proximity test that applies, carve-outs exist for single-family homes, certain commercial or retail property, and/or US Census-designated “urbanised areas” or “urban clusters”. In addition, CFIUS will only have jurisdiction if the foreign investor acquires at least three of the four following property rights:
Notably, an acquisition of securities by a foreign person acting as a securities underwriter, in the ordinary course of business and in the process of underwriting, does not trigger CFIUS jurisdiction. A foreign lender to a US person for a purchase, lease or concession of US property – even if this creates a secured interest for the foreign lender – may not trigger CFIUS jurisdiction unless the foreign lender acquires equity-like rights or in the event of default.
The borrower will generally be required to pay various taxes and fees in connection with the recording of any mortgage or other security instrument in the public records, such as intangible taxes, documentary taxes and registration fees. The amounts of such taxes and fees are often based on the loan amount (or the portion thereof being secured by the applicable instrument), but the calculation will vary depending on the jurisdiction.
Before an entity can deliver valid security over its real estate assets, it must be duly formed and validly existing in its jurisdiction of organisation and, if this jurisdiction is different to that within which the property is located, authorised to do business in the state in which the property is located.
The entity must also have insurable title to the property as evidenced by a title insurance policy insuring the priority of the lender’s lien.
Generally, the loan documents will govern the enforcement of a lender’s security interest in real property, subject to the requirements and limitations of state law, such as notice to a defaulting borrower and other interested parties, public notice requirements prior to a foreclosure sale, and rights of redemption following a foreclosure sale. Upon foreclosure, lenders generally take title to the property free and clear of any properly noticed junior liens, but subject to any superior liens (eg, taxes).
Existing secured debt may only become subordinated to newly created debt pursuant to an agreement among the parties, as the priority from recording the security instrument of the existing debt would have first priority over any newly created debt. Typically, in order to effect such a subordination, the debt holders would enter into a subordination agreement and/or an intercreditor agreement.
Generally, a lender holding or enforcing security in real estate should not have liability under environmental laws; however, not all environmental legislation (eg, the Clean Water Act) contains protections for secured lenders, and secured lenders are generally not protected from third-party tort claims based on personal injury or property damage caused by environmental contamination. In addition, lenders who cause environmental issues or who exceed their role as a "lender" and act more like a property owner by participating in the management of the property (whether pre- or post-foreclosure) can be held liable under certain environmental laws.
Generally, the onset of a borrower’s insolvency would not affect the validity of a security interest granted by the borrower in favour of a lender. However, the filing of any form of bankruptcy petition would automatically stay any proceedings initiated by creditors against the borrower, including any enforcement proceedings or real property foreclosure proceedings.
With LIBOR anticipated to be phased out by the end of 2021, the key consequences for borrowers are what future interest payments will look like and how interest rate products will be affected by the new reference rate replacing LIBOR. Borrowers with loans having interest rates tied to LIBOR should review existing (and new) credit agreements to (i) examine the maturity dates to determine if the LIBOR expiry is applicable, and (ii) determine if there are “fallback provisions” defining the new reference rate. If so, borrowers should analyse the impact if the new reference rate index used in the “fallback provisions” of the credit agreement became the actual interest rate. In the event that the changeover to the new reference rate could cause a potential material increase, borrowers should discuss proposed amendments (or revisions) to the loan with the lender.
Local governments are typically responsible for strategic planning and zoning in their respective jurisdictions, and the degree to which local governments control the process differs tremendously. A variety of tools are used by local governments to regulate development, including special zoning districts, comprehensive plans, subdivision, site plans and unified development ordinances.
Building codes are typically used to create regulations regarding the method of new construction or refurbishment of an existing building. Building codes are expansive and contain varying requirements for different types of asset classes and uses. Jurisdictions often go beyond standard building codes and enact regulations for the design and appearance of new and refurbished buildings.
Local governments are typically responsible for regulating the development and designated use of individual parcels of real estate.
The entitlement process varies by local jurisdiction. Generally, if the project or refurbishment is permitted under the applicable use restrictions, the process would be administrative, with third parties not having the right to object to the proposed development. If the project or refurbishment is not permitted under the applicable use or zoning restrictions, then rezonings, variances or amendments to the comprehensive plan are some of the typical processes that must be utilised in order to proceed with the desired development. This would usually require public notice and public hearings, during which third parties would have the right to object to (or support) the project.
A local government’s decision regarding an application for permission for development or the carrying on of a designated use is subject to appeal in most jurisdictions. The specific right of appeal and related process will be specific to the jurisdiction. Typically, the right to appeal a decision related to a project that is permitted under the applicable use restrictions is narrow relative to a decision regarding rezoning or amendments to a comprehensive plan. While the timeline for an appeal will depend on the jurisdiction and the decision being appealed, an appeal must usually be filed within 30 to 60 days of the initial decision. In many jurisdictions, courts follow the "fairly debatable" rule, whereby they will not overturn a zoning decision that is supported by substantial evidence and was not made arbitrarily.
Applicants often enter into agreements with local governmental authorities or agencies in order to facilitate a development project, whether required by statute or ordinance, or merely as part of the approvals process for the development. In many cases, the local governmental authorities will condition approvals on the applicant agreeing to take (or to refrain from taking) certain actions. These agreements will bind the project and development either for a specific period of time or in perpetuity. For example, they may restrict the use of or require certain infrastructure improvements.
Local governments have many different tools to enforce restrictions on development and designated use. During construction of a project, the local government may impose a fine on the developer/owner of the development or, in the case of a more severe violation, may issue a "stop work" order halting any construction on the site. Additionally, to the extent that performance bonds have been required for the project, the local government could trigger rights under any performance bonds, which would allow the local government to complete any outstanding requirements covered by the bonds. After completion of the project, the local government may bring a suit for specific performance or otherwise enforce any regulations through the courts.
Real estate investments in the US may be held in any type of legally recognised entity, but two types of entities are most frequently used: limited liability companies (LLCs) and limited partnerships.
LLCs have the liability-limiting characteristics of a corporation, such that the owners are not personally liable for the debts and other obligations of the company, but they are taxed as partnerships, meaning the income of the LLC is passed through to its owners before it is taxed. Also, LLCs have very flexible governance structures granting the owner(s) (or member(s)) wide latitude under the applicable LLC statute and, unlike a limited partnership, an LLC may have only one owner (known as the sole member), making it a particularly popular choice for individual investors.
A limited partnership is formed by one or more limited partners, who generally provide the source of capital for the partnership’s operations (in this context, the investment in real estate), and a general partner that is responsible for the management of the partnership. Limited partnerships have two key features that make them popular for real estate investments:
The main drawback of the limited partnership structure is that it requires at least two parties (the limited partner and the general partner), and the general partner is personally liable for the debts and other obligations of the partnership, although in practice the general partner itself is usually a type of entity, such as an LLC or corporation, that shields its beneficial owners from personal liability.
There are also other ownership entity types under US law that can be used, such as S corporations, C corporations, general partnerships or limited liability limited partnerships, although they are less common than LLCs and limited partnerships.
A real estate investment trust (REIT) is any entity that elects REIT status, which allows it to pass income through to its owners. REITs are creatures of the tax code and are subject to complex tax rules that require the advice of experienced practitioners. For certain types of assets and for investors with certain tax postures (particularly non-US investors), a REIT may provide significant tax advantages over a conventional investment vehicle.
Limited liability companies are governed by an operating agreement. Where an LLC is owned by a sole member, the operating agreement is typically a simple document that sets forth certain basic formalities. Because there is only one owner, full control of the entity as well as all of the economic benefits and burdens are vested in that owner, so there is no need to allocate control and economic rights. Where an LLC has multiple members, the operating agreement will often grant day-to-day control of the company to one member (known as the managing member), to an entity that is not a member of the LLC but is controlled by a member (known as a non-member manager) or to a board of members, but the other member or members will have the right to approve certain decisions. The scope of these approval rights is negotiated between the members. In addition to governance, operating agreements establish the priorities of economic distributions, procedures for calling additional capital from the members and rights for a member to transfer or otherwise exit the LLC.
Limited partnerships are governed by a limited partnership agreement, which allocates the management rights and responsibilities of the partners as well as their economic benefits and burdens. By definition, the general partner is tasked with the day-to-day management of the partnership. Consent rights and other rights of the limited partners to participate in the partnership are negotiated between the partners, as are their economic rights.
Corporations are formed by articles of incorporation and governed by their by-laws. Among other things, these provide for governance rights, capital raising, distributions and exit rights.
The costs of forming and organising an entity vary by state, but filing fees, annual registration fees and taxes typically amount to a few hundred dollars. Some states also require a minimum capital to be invested in entities. Regardless of whether or not an entity is formed in a state that requires the entity to be minimally capitalised, failure to capitalise an entity with adequate funds to operate for its intended purpose may expose its owners to personal liability, since this is a factor courts frequently consider in claims to pursue limited partners or members for the debts of a limited liability entity.
Limited liability companies typically provide a lot of flexibility in allocating management responsibilities. The management of an LLC can be controlled by one member (member-managed) or by a non-member manager (manager-managed). Management may also be vested in more than one member. Additionally, the operating company may establish a board of managers to manage the entity. The LLC agreement provides for the procedures related to the governance of the entity, including frequency of meetings, elections and voting.
In limited partnerships, limited partners are generally permitted to have limited voting and control rights over the affairs of the limited partnership. Limited partnerships may have one or more general partners, who are responsible for managing the limited partnership.
Shareholders of corporations elect directors to the board that manages the corporation; however, state laws may require shareholder votes to approve certain matters. Additionally, the board of directors may appoint officers to manage the day-to-day business of the corporation.
Entity maintenance and accounting compliance costs vary based on both the state of the entity’s organisation and the state in which the property is located. Typically, states require an annual report and a filing fee of a few hundred dollars. Since most real estate investment vehicles are pass-through entities for US federal income tax purposes, most state income taxes are similarly passed through to the entity’s owners. However, a few states impose franchise, income or similar taxes on pass-through entities. Corporations will pay state income tax in the states in which they are formed or operate if those states have an income tax. Accounting costs will vary based on the states in which an entity is formed and operates, and on the nature of the entity and its assets and income.
Leases, ground leases, licences and easements are the most common agreements used to grant a right to occupy real property. Generally, leases differ from licences in two primary ways:
Ground leases typically grant the tenant the right to develop, construct and operate a building on the leased land during the term of the agreement, which is longer in duration than the term of a space lease.
An easement may also be used to grant a party use of a designated portion of another party’s property for a specific purpose. While some easements are granted with unlimited duration, easements can also be used for limited time periods, such as providing access to a construction site until development is completed.
Commercial leases can be broadly categorised based on the scope of economic and other responsibilities allocated to the tenant. This is typically based on the type of property being leased (multi-tenant v single tenant) and the duration of the lease.
Tenants under absolute net leases agree to assume the most responsibility. Under these agreements, the tenant is obligated to pay a base rent as well as all other operating expenses, including taxes, maintenance costs, insurance and utilities, and also the costs for any structural repairs that may be required during the lease term.
Under a triple-net (NNN) lease, the tenant agrees to pay base rent as well as all or part of the property taxes, common area maintenance and insurance, while the landlord’s responsibilities are typically limited to structural repairs.
A double-net (NN) lease commonly provides that a tenant pays base rent as well as its pro rata share of property taxes and insurance, while the landlord is responsible for common area maintenance and structural repairs.
Under a single-net (N) lease, the tenant pays base rent and its pro rata share of property taxes, and the other building expenses are the landlord’s responsibility.
Finally, under a gross or full-service lease, the tenant pays one rental amount per month, which includes the tenant’s share of taxes, insurance and common area maintenance costs.
Lease terms in commercial leases, including rent, are generally freely negotiable.
In response to the COVID-19 pandemic, the US federal government, as well as state and local governments, have issued a patchwork of regulations providing protections and relief to tenants, which have continued to evolve throughout the crisis. These relief efforts vary widely across jurisdictions, and are typically divided between residential and commercial tenancies.
For residential tenants, the Centers for Disease Control and Prevention issued an Agency Order entitled Temporary Halt in Residential Evictions to Prevent the Further Spread of COVID-19, which went into effect on 4 September 2020. The CDC Order prohibits residential landlords nationwide from evicting qualifying tenants who are most vulnerable to losing their homes as a result of COVID-19 until at least 31 March 2021 (as of this writing).
In addition to the CDC Order, US federal government agencies have enacted three additional eviction moratoriums by banning evictions by landlords whose mortgages are insured by the federal government. Specifically, the Federal Housing Association (FHA) has banned evictions from properties secured by FHA-insured single-family mortgages until at least 31 March 2021. Also, the US federal government-backed mortgage buyers Freddie Mac and Fannie Mae prohibit landlords owning single-family properties with Freddie Mac- and Fannie Mae-backed mortgages from evicting tenants until at least 31 March 2021. Finally, certain owners of multifamily properties backed by Freddie Mac and Fannie Mae mortgages are permitted to receive mortgage loan forbearance, and in return are prohibited from evicting tenants during the term of such forbearance.
It is worth noting that each state's courts are interpreting and responding to the CDC Order differently. Also, even with the CDC Order in place, states and local governments are permitted to enact more stringent prohibitions on evictions together with other tenant protections that provide additional relief for tenants beyond the scope of the CDC Order. At the time of writing, many states and local jurisdictions have enacted additional relief measures, and continue to update those regulations.
The US federal government and its agencies have not issued similar moratoriums protecting commercial tenants from eviction, but many states and some local governments in large cities enacted short-term tenant relief measures for commercial tenants. These include prohibiting commercial landlords from performing self-help evictions for reason of non-payment or late payments of rent due to COVID-19, prohibiting the forced eviction of tenants as a result of rent defaults due to COVID-19, and prohibiting landlords from using the courts to terminate a commercial tenant's lease or obtaining other judicial action to terminate a lease as a result of non-payment or late payments of rent due to COVID-19. Many protections for commercial tenants that were issued by states and local governments have expired as of this writing, but some discussion continues regarding re-enacting these protections.
For the latest information on eviction moratoriums and other tenant relief measures applicable to a property, interested practitioners should contact local counsel in the applicable jurisdiction.
Lease terms for commercial space are typically for a term of years. In some instances, a landlord and tenant may also negotiate for renewal options. Ground leases have longer terms, which allow the tenant to finance and develop the property as if it were the owner.
All leases typically require the tenant to maintain the leased space, including in many instances accepting responsibility for non-structural repairs in the leased premises. With respect to shared spaces, in a multi-tenant property, maintenance and repair obligations are typically placed on the landlord, and the tenants often contribute to those costs based upon their proportional occupancy.
Alternatively, a single tenant of a property (including a ground tenant) is typically responsible for handling maintenance and repair obligations directly at its own cost.
Tenants under space leases typically pay rent on a monthly basis throughout the term. The first payment is often made at the beginning of the lease term, and subsequent payments are made in advance of the next lease month. Ground leases can have variable rent structures, where the ground tenant will make an upfront payment upon commencement of the lease, together with periodic monthly or annual payments throughout the term.
As a result of the pandemic, many landlords and tenants reviewed their leases to see what rights, if any, were triggered as a result of the government shutdown, the loss of customers, and the forced or elective vacation of the premises. Of those leases that did include a force majeure provision, many did not specifically reference pandemics as an excuse for performance under the lease. Tenants and landlords have filed many lawsuits throughout the US to clarify their rights, avoid damages or enforce contractual remedies. Some of these lawsuits have even asserted excuse of performance on the basis of force majeure where no force majeure clause existed in the lease. The majority of these lawsuits remain unresolved at the time of writing, so no clear best practices have emerged that converge on a single standard for allocating risk between landlords and tenants in the face of the next pandemic. However, careful practitioners will keep the lessons from COVID-19 in mind when drafting their leases to account for their clients' concerns.
Rent is negotiated prior to signing a lease, including any rent escalations during the term. Rents typically escalate on a percentage basis at intervals during a lease term. Additionally, any pro rata share of taxes and other charges paid by the tenant to the landlord may increase during the term as costs increase.
Commercial leases may contain a schedule setting forth the amount of the base rent for each year of the lease term, or a formula to calculate the year-to-year changes in rent payable based on the applicable factors.
Additionally, many leases that provide an extension option by which the tenant can extend the term will provide for a determination of the fair market rent (often subject to third-party arbitration in the event of disagreement over the amount) to govern the extension terms.
Jurisdictions differ, but most states do not impose VAT on rent.
Many leases require tenants to post a security deposit with the landlord, which may be gradually reduced or returned to the tenant over the term of the lease. Additionally, many landlords require the tenant to pay the first month’s rent at lease signing.
If renovations or a build-out of the leased premises is required prior to occupancy, then the tenant will be responsible for the costs of this work unless the tenant negotiates for the landlord to provide a sum to be applied to these renovations.
Common areas are usually maintained by the landlord, but at the cost and expense of the tenants. Depending on the lease structure, the tenants will either pay their pro rata share of the cost of common area maintenance in addition to base rent, or these costs and expenses will be included in an all-inclusive rent that accounts for these costs.
Most commercial leases require each tenant to contract and pay for the utilities and telecommunications serving that tenant’s space, but utility costs for common areas of the building are typically allocated to, and paid by, all tenants on a pro rata basis.
When a single tenant occupies an entire building and is directly responsible for the operating costs at the leased premises, it typically maintains insurance for the full replacement value of the building. In most other instances, the landlord will carry property insurance covering the full replacement value of the building. Whether or not the cost of the insurance is ultimately borne by the tenant will depend on the type of lease (ie, whether the lease is a double- or triple-net lease). Property insurance will typically cover all perils that could damage a property, subject to certain exclusions and/or excluding specific perils (eg, earthquake or flood) that may be covered under separate policies.
Landlords frequently restrict the uses of leased premises. Restrictions may be imposed to induce tenants to lease space by guaranteeing that competitors or incompatible users will not be operating in the building.
Land use and zoning rules and regulations may also impose use restrictions on a property.
Most leases require the tenant to obtain the landlord’s consent prior to making any alterations or improvements to the premises. For substantial alterations, many leases will require the tenant to submit the plans and proposed contractor to the landlord for approval.
Residential leases are the most regulated type of leases. Laws and regulations vary by jurisdiction, but residential leases may be subject to rent control or regulation, health and safety requirements and laws that prohibit discrimination against individuals based on their sex, race, religion or national origin, for example. While commercial leases are generally not as heavily regulated as residential leases, they are subject to common law (including nuisance-related law) and zoning ordinances, among other rules and regulations that may vary by jurisdiction.
The COVID-19 pandemic did not drastically alter any existing legal regulations regarding real estate leases, nor result in new ones, other than eviction moratoriums (see 6.21 Forced Eviction). Instead, the majority of COVID-19 leasing impacts were done on a landlord and tenant basis (ie, rent abatements, deferments, loan modifications, etc). In September 2020, the Centers for Disease Control and Prevention enacted an eviction moratorium, which has since been extended and is set to expire on 30 March 2021. The federal moratorium does not create a prohibition on a landlord pursuing an eviction but is rather a defence that the tenant can raise in response to an eviction.
Generally, a tenant’s inability to pay rent will trigger a termination right on the part of the landlord. If the tenant files a petition for bankruptcy, it must typically assume or reject a commercial lease within 120 days of its bankruptcy filing; this timeline is subject to extension by the bankruptcy court. If the lease is rejected, the tenant will be forced to move out, but the landlord’s claim against the tenant will be subject to bankruptcy protections, including an automatic stay on any lease payments. The bankruptcy process commonly lasts for multiple years.
Many landlords require tenants to post a security deposit (in the form of either cash or a letter of credit) in order to enter into a lease. Additionally, the landlord may request a creditworthy guarantor to enter into a separate agreement to guarantee the tenant’s obligations under the lease.
A tenant generally does not have a continuing right to occupy the premises once the term of its lease has expired, but it is important for landlords not to acquiesce in a hold-over to ensure that no new rights inure to the tenant. To deter tenants from remaining in a premises after the term, landlords typically impose significant rent on tenants who hold-over, and make the tenant responsible for all damages incurred by the landlord.
Whether a tenant has the right to assign its interest in a lease or to sublease all or any portion of the applicable premises is negotiated between the landlord and tenant in nearly every lease. In most leases, landlords require a right to consent to any assignment or sublease, unless the tenant is assigning or subleasing to an affiliate. It is rare for a landlord to give a tenant a right to assign or sublease without the landlord having a consent right and/or imposing conditions. Typical conditions to an assignment or sublease include the following:
The other significant issue that is negotiated in any assignment transaction is whether the assigning party (ie, the tenant) is released from obligations arising under the lease from and after the date of the assignment.
Many leases provide that a material casualty, or the taking by eminent domain of a significant portion of the premises, will trigger a termination right for the landlord and tenant. Additionally, landlords may generally terminate the lease in connection with an uncured event of default by the tenant.
Each state has its own requirements relating to the formalities required for a lease to be effective – for example, some states require signatures to leases to be notarised or witnessed in order for the lease to be effective. Most states do not require leases to be recorded in the real property records in order to be effective; however, many tenants wish to record evidence of a lease in the real property records (typically in the form of a memorandum of lease), which protects the leasehold interest from the rights of certain parties, such as future buyers and lenders of the property. Nearly all states require nominal recording fees to be paid when recording a memorandum of lease, which are typically paid by the tenant, and a small number of states impose a transfer tax on leasehold interests; the amounts of those taxes vary depending on the term and value of the lease.
A court may force a defaulting tenant to leave by judicial action after the landlord brings a claim against the tenant. The timeline for a judicial action varies by jurisdiction, but eviction in many jurisdictions can take place in less than a month. Additionally, some jurisdictions allow the landlord to take "self-help" remedies to immediately evict the tenant, such as changing the locks.
As a result of the pandemic, many state and local jurisdictions enacted moratoriums on evictions of tenants, with the main focus of this relief being on residential tenants. Each jurisdiction had different time periods and rules regarding the eviction moratorium, ranging from shutting down the eviction courts in a jurisdiction to permitting a filing by a tenant to oppose the eviction on the grounds of COVID-19 hardship. One interesting aspect of the moratoriums is that in some jurisdictions the actual eviction of the tenant was prohibited but landlords were allowed to continue filing the eviction lawsuits in the applicable court to preserve the grounds for the eviction. This will likely result in a significant backlog of eviction cases once the courts are back to functioning on a normal process and schedule.
In September 2020, landlords and tenants reviewed their leases to see what rights, if any, were triggered as a result of the government shutdown, the loss of customers, and the emptying of the premises. Many of the leases that did include a force majeure provision did not specifically reference pandemics as an excuse for performance under the lease. Tenants and landlords have filed many lawsuits throughout the US to clarify their rights, avoid damages or enforce contractual remedies. Some of these lawsuits have even asserted excuse of performance on the basis of force majeure where no force majeure clause existed in the lease. The majority of these lawsuits remain unresolved at the time of writing, so no clear best practices have yet emerged that converge on a single standard for allocating risk between landlords and tenants in the face of the next pandemic. However, careful practitioners will keep the lessons from COVID-19 in mind when drafting their leases to account for their client’s concerns.
Where the government or municipal authority is not a party to a lease agreement, such authorities are not able to terminate a lease that was privately negotiated by other parties. However, a governmental authority could perform a taking of the real estate that is subject to the lease, thereby making the existence of the lease moot. The timeline governing the government authority’s taking of the real estate would depend greatly on the government authority and real estate at issue.
The most common pricing structures used on construction projects are:
Under a fixed price structure, the parties agree to a fixed price for the completion of the work, with the contractor generally bearing the risk of project costs exceeding the fixed price.
In a reimbursable arrangement, the owner pays for the costs of construction on a reimbursable basis, and bears the risk of extra costs. Traditional reimbursable pricing structures can be coupled with a cap or guaranteed maximum price in a hybrid approach.
Unit pricing is an arrangement where payment is based on actual quantities at fixed unit prices.
Responsibility for the design and construction of a project is typically assigned through two primary delivery methods: "design-bid-build" and "design-build".
Under a "design-bid-build" arrangement, the engineer or architect is responsible for the design of the project. Once the design is completed, the owner will separately engage a contractor to assume responsibility for constructing the project as designed.
Under a "design-build" arrangement, the contractor also acts as the engineer and assumes responsibility for both design and construction.
Construction risks should ideally be borne by the party in the best position to control and mitigate such risks. Once identified, the risks can be managed or allocated among the project participants through risk transfer (eg, through indemnities) or risk assumption and reduction (eg, through a limit of liability).
These risk devices are not without limitation. Most states have enacted some form of "anti-indemnification" legislation that prohibits or limits the rights of parties to shift certain risks (eg, the sole negligence of a party). Similarly, a court will not enforce a limitation of liability in the event of wilful misconduct or fraud.
Schedule-related risks can be managed through a combination of schedule milestones, robust schedule and reporting requirements, recovery obligations, liquidated damages, early completion incentives, and clear contractual provisions addressing when extensions of time are allowed.
Damages due to a delay in construction are often difficult to estimate, so construction contracts frequently contain a liquidated damages clause that applies if a contractor fails to achieve certain milestones or completion dates. An owner should carefully estimate its anticipated damages in the event of delay, and ensure that the amount of liquidated damages both covers its anticipated damages and is enforceable against the contractor. Such anticipated damages may include lost profits, additional financing costs and extra owner costs, including additional overhead, rent and personnel costs. Courts will not enforce liquidated damages provisions that are deemed to constitute penalties.
It is common for owners to require performance security from contractors, including payment and performance bonds, letters of credit, retainage and parent guarantees.
Bonds such as payment and performance bonds are typical in the construction industry. A performance bond protects an owner against contractor default by ensuring that the contractual obligations of the contractor will be fulfilled. Under a performance bond, the surety can either step in and perform the work if there is a contractor default, or it can pay the damages arising out of the contractor default. It is important to note that an owner should not anticipate that the surety will promptly perform or pay damages unless the default is clearly the fault of the contractor. In many cases, an owner will be required to sue the surety to recover damages, which may take years to collect.
A payment bond ensures that a contractor will pay its subcontractors for the work and materials provided. Similarly, if there is an issue, the surety will step in and pay the subcontractors.
A letter of credit is an instrument issued by a commercial bank that an owner may collect on upon demand of payment. It is not uncommon for owners to require a contractor to supplement a letter of credit with a parent guarantee or retainage.
Retainage is a common form of security that allows an owner to retain an agreed percentage of each invoice. It gives an owner immediate access to a pool of funds that grows over the course of the project and is released once the contractor satisfies its contractual obligations.
Lien rights for contractors and/or designers are typically available. They are statutory in nature and require strict compliance with statutory requirements (such as timely notice and filing requirements) in order for a claimant to attach a lien to real property. Property encumbered with a perfected lien is subject to foreclosure to satisfy amounts owed.
An owner can remove a lien by successfully challenging its validity, by paying the debt or by obtaining a lien release from the claimant.
All states have requirements that must be met before a building can be inhabited or used for its intended purpose, with the procedure and requirements for certificates of occupancy varying widely from jurisdiction to jurisdiction. Generally, a certificate of occupancy describes the type of permitted occupancy, legal occupancy limits, layout, and allowable use of a building. A certificate of occupancy confirms that necessary paperwork has been completed, fees have been paid, violations (if any) have been resolved, the building complies with all applicable laws, and the plans and specifications have been approved by the local authorities.
Value-added tax (VAT) and sales tax are generally not imposed on the purchase or sale of real estate.
A common technique to mitigate a real estate transfer tax is to sell the equity interests of an entity that owns real estate, rather than transferring the real estate itself. Some jurisdictions, however, combat this technique by also imposing a transfer tax on the sale of a controlling interest in an entity with significant real estate holdings. Mortgage recording tax may be mitigated in some jurisdictions by the assumption of existing debt.
Some jurisdictions impose special tax on business rentals. For example, New York City imposes a "commercial rent tax" equal to 3.9% of the gross rent paid for commercial premises located in certain parts of the city.
The income of foreign taxpayers is generally subject to one of two different taxation regimes. Income that is effectively connected with the conduct of a US trade or business ("effectively connected income" or ECI) is subject to taxation on a net basis at the same tax rates as apply to US taxpayers. Taxpayers who earn ECI or are engaged in a US trade or business, either directly or through a partnership or an LLC taxed as a partnership, are required to file a US tax return.
Foreign corporations are taxed at 21% on all ECI, while non-corporate taxpayers are taxed at up to 37% on ECI other than ECI that is treated as long-term capital gain, which is taxed at up to 20%. Under the 2017 tax reform legislation, certain “qualified business income” of non-corporate taxpayers qualifies for a special deduction of up to 20% of the amount of income, reducing the maximum effective rate to 29.6%. Rental real estate income generally constitutes qualified business income, provided that the level of activity associated with the rental income is substantial enough to constitute a trade or business, and that certain anti-abuse rules do not apply. The tax on ECI from real estate investment is generally not reduced by tax treaties.
Foreign corporations that have ECI may be subject to a second level of tax, called the "branch profits tax", which is generally equal to 30% of the after-tax earnings from a US trade or business, reduced by earnings that are reinvested in US business property (but increased by earnings that are withdrawn from US investments). The branch profits tax may be reduced or eliminated by treaty.
Certain types of non-ECI investment income, including dividends, interest and rent, are subject to a flat, gross-basis tax of 30%, which is generally collected by withholding at source. This tax can be reduced by treaty, but existing treaties generally do not limit the taxation of income from real estate. Capital gain that is not ECI is generally free from US tax (subject to the provisions of FIRPTA described below).
Taxpayers whose real estate investments do not rise to the level of a trade or business may elect to treat the income from those investments as ECI, thereby escaping the 30% withholding tax in favour of the graduated tax on ECI. This election is frequently favourable for taxpayers, as it allows them to use deductions for interest, taxes and depreciation.
FIRPTA provides that gain or loss from the sale of an interest in US real property or a corporation whose assets primarily consist of US real property is deemed to be ECI, even if the gain would otherwise be capital gain not subject to US tax. Certain "qualified foreign pension funds" (QFPs) are exempt from FIRPTA.
The tax on ECI is enforced through three significant withholding taxes. First, any US partnership (including an LLC taxed as a partnership) that is engaged in a US trade or business must pay a withholding tax on any ECI allocated to a foreign partner, which is generally calculated at the highest tax rate applicable to that type of partner (ie, 21% for a corporation or 37% for a non-corporate taxpayer). Second, a special FIRPTA withholding tax equal to 15% of the gross purchase price must be collected by a transferee of a US real property interest from a foreign transferor. Finally, a new withholding tax created by the 2017 tax reform legislation requires the transferee of an interest in a partnership that is engaged in a US trade or business to withhold 10% of the purchase paid to a foreign transferor. In certain circumstances where the required withholding is not made, the partnership may be required to pay the tax.
Many foreign investors in US real estate choose to invest through "blocker" corporations, which are separate taxpayers from their shareholders, and a shareholder is not considered to be engaged in a US trade or business solely as a result of owning stock in a corporation that is so engaged. As a result, shareholders of a blocker corporation may not be required to file a US tax return, nor to pay tax on their ECI. Capitalising a blocker in part with shareholder loans may improve the tax efficiency of a blocker structure.
A real estate investment trust (REIT) is a special type of blocker corporation. REITs must comply with numerous requirements for their organisation and operation, including restrictions on the nature of their assets and gross income. In return, REITs are subject to a special tax regime. Most notably, REITs can deduct dividends paid to shareholders from taxable income, which effectively eliminates the corporate-level tax on income that is distributed to shareholders. REIT dividends that are paid to foreign shareholders are subject to the 30% withholding tax, which may be reduced or eliminated by treaty.
Under FIRPTA, REIT distributions that are attributable to gain from the REIT’s sale of a US real property interest are treated as ECI, and the shareholder must file a US tax return and pay the tax on ECI (including, for foreign corporations, the branch profits tax). QFPs are exempt from FIRPTA and are generally not subject to US tax on a REIT’s distribution of sale gains. Gain from the sale of shares of a REIT that is majority owned by US investors is not subject to FIRPTA. Thus, it may be possible to avoid the FIRPTA tax on a REIT’s distribution of proceeds from asset sales by selling the REIT’s stock to a buyer.
Investments in US real estate benefit from certain tax advantages. For example, under the "like-kind exchange" rules, one real property investment can be exchanged for another on a tax-deferred basis, if certain requirements are met. Investments in buildings (but not land) can be depreciated over time, and real estate depreciation is generally not subject to the same "recapture" provisions (which treat certain sale gain as ordinary income) as personal property depreciation.
In the Face of Uncertainty, a Push toward Reliability, Flexibility and Redundancy
If there is one thing that we have learned during the COVID-19 pandemic and the winter storms of 2021, it is to appreciate the role of uncertainty. Although many had contemplated the impact of a rapidly spreading disease and a changing climate (historians, science fiction writers and epidemiologists, among others), few could have predicted the specific course and effects of COVID-19 and the deep freezes that affected the southern tier of the United States.
It is with a dose of humility, then, that we must acknowledge how the last ten months of 2020 and the first two months of 2021 differed from our expectations. Likewise, no examination of the trends in the real estate industry and the practice of real estate law anticipated for the remainder of 2021 would be complete without recognising the profound, pandemic-related changes. While many goals, including investing in renewable energy sources and sustainability, are expected to remain priorities (and to become even more important in regions where, for example, recent storm events have demonstrated a lack of preparedness for extreme weather), many private and public sector priorities have shifted considerably.
If anything, this look at trends and developments must take into account how the broader real estate market and its participants – including real estate investors and developers; corporations; educational institutions; cultural and civic organisations; energy companies and public utilities; and local and regional governments that depend on real estate for income, property and sales tax revenue – have had to quickly adopt new business, financial and operational strategies.
Fortunately, real estate remains a highly flexible asset. Its shape, form and usage may change over time, and the way businesses acquire, manage and divest themselves of real estate may evolve, but it will never go out of fashion; with billions of people on the planet needing food, shelter, healthcare, education and employment, it will remain a necessity.
With this in mind, this article will review some of the top trends in real estate that are anticipated for the remainder of 2021, while also taking into account how much the world has – and has not – changed in 12 short months. Key areas of focus include managing uncertainty in real estate markets, the importance of co-operation between investors, businesses and government entities in promoting sustainability, and the impact of climate change.
Uncertainty Leads to a Push for Predictability, Agility and Back-up Planning
Businesses, institutions and government entities responded to last year’s uncertainties and extreme weather events with a new focus on flexibility, reliability and redundancy. In addition, many existing trends were not derailed or replaced, but actually accelerated.
For example, online retailers, distribution companies and delivery businesses saw unprecedented demand for their services and nearly collapsed under the weight. The boom almost created its own bust, but not quite. In response, each step of the supply chain has had to be reconsidered, from the sizes, layouts and locations of existing and newly built warehouses, fulfilment centres and bulk distribution facilities, to fleet management and "last mile" delivery options.
Building such facilities has increased demand for skilled labour, and this will likely continue for several years. In fact, for much of 2020, construction workers were considered to be essential workers, and industrial and residential construction projects continued apace (retail and buildings were hit hard by lockdowns, but such restrictions also created demands for retrofitting and remodelling spaces to meet new social distancing requirements). This pace of construction activity is likely to continue into the future, as – and possibly because – vaccines will be distributed more widely and the threat of COVID-19 and its variants will become more manageable.
In the residential real estate market, two trends seem to be occurring in opposition to each other but in response to the same pandemic-related issues. In February 2021, the top human resources officer for Salesforce, a business software provider with more than 50,000 employees, noted that it is planning for most of its staff to work remotely, in full or in part, even after the pandemic loosens its grip. The company anticipates reducing its overall real estate portfolio and restructuring the layouts of remaining spaces – with the emphasis on “space”.
Many other major employers have yet to announce return-to-office dates for their staffs. This general uncertainty has remained relatively unchanged since a September 2020 survey of employee readiness for business reopening conducted by the Conference Board (a global think tank and business membership association, which found that just over one third of employees said that they did not know when their employers would require them to come back to the workplace in person.
Across the country, retirees and established workers – particularly professionals who have jobs that allow remote working and who have the financial resources to seek out less dense neighbourhoods – are leaving urban areas for suburban and exurban municipalities and rural communities. Such people are purchasing homes that can be remodelled to allow more room for offices and for greater privacy between family members. In the tightest residential real estate markets, many are purchasing homes online or sight unseen, while others are buying undeveloped land and simply building larger homes to meet these needs.
On the other hand, younger professionals and service workers are likely to need housing closer to those downtown jobs that will return. While this shift might partly offset the departure of older workers, particularly when it comes to demand for housing, it is unlikely to counteract the general trend away from core urban areas. Furthermore, such workers will likely remain concerned about their health and will demand fewer close-quarters spaces (such as gyms and recreation rooms) in return for apartments and condominiums with greater levels of privacy and separation, coupled with open air facilities.
All of these factors that indicated growth in the residential real estate market (increased construction activity, residential housing shifts to and from central-city neighbourhoods, and expanded COVID-19 vaccination programmes) will likely hit somewhat of a brick wall, or rather a wood wall: historically high lumber prices. The availability and cost of wood building products is likely to put some downward pressure on construction, especially while the acceptance and use of alternative building materials are growing at a less rapid pace.
The movement back to downtown or central-city neighbourhoods may also affect what appears to be an increase in downtown office buildings for sale rather than lease. Although some real estate professionals have expressed concern about a softening market, others point to the fact that many buildings continue to have strong occupancy levels and tenants in place, and that others might be converted to housing.
However, even cities with job markets that favour remote work (such as Seattle, San Francisco and New York) and that will likely weather the COVID-19 crisis somewhat better than other areas are seeing a net outflow of residents, according to recent data provided by the truck-rental company U-Haul. Many of these individuals and families are moving inland and south, a general trend that will tend to favour cities such as Dallas, Nashville, Atlanta and others that have the infrastructure and space to grow and support an expanded remote workforce.
Even more broadly, the impacts of COVID-19 are being felt in every corner of the US economy. Retail malls and shopping centres are losing their anchor tenants, and some are being torn down or repurposed entirely to make way for expanded, centrally located warehouses and fulfilment centres, as well as training centres, medical facilities, manufacturing operations and other purposes. Smaller, non-anchor tenants are finding themselves searching for new locations; this may partially help to fill empty spaces left behind when restaurants, bars, nightclubs and other businesses that often catered to large crowds of people were forced to close their doors.
At a macroeconomic level, many forecasters anticipate a rapid re-expansion of the national economy as the threat of COVID-19 becomes more manageable. This likely means that all of the changes that we are seeing will not dampen overall activity in the real estate market, but will simply change its face.
Investors, Businesses and Governments: Working Together to Promote Sustainability
Many investor-owned real estate assets are located in cities, suburbs and regions that are highly vulnerable to climate change and face heightened risks of heat stress, wildfires, extreme weather events and rising sea levels. Although sophisticated models can help predict the effects of such events, risk identification is just the first step.
To meet climate-related risks head on, investors are continuing to develop strategies such as risk-mapping for existing and future portfolios; implementing adaption and mitigation strategies for current assets and for buildings being developed or under construction; diversifying portfolios; and investing in mitigation technologies that can help protect property. Ensuring that climate factors are incorporated into due diligence and decision-making processes is a fundamental component of this process.
In this same vein, investors should continue to work with urban and community planners and government policymakers to co-operatively develop mitigation and resilience strategies that incentivise the implementation of best practices and technologies. The use of impervious surfaces can be changed to reduce flood hazards, and high-density developments can be moved away from areas facing wildfire exposure. Local governments such as those in Miami-Dade County in Florida and Baton Rouge and New Orleans in Louisiana can continue to prioritise infrastructure and land use changes to minimise the impact of rising seas, major hurricanes and increased rainfall.
Zoning codes can also be established, such as those being implemented in Pittsburgh, Pennsylvania that promote on-site power generation and distributed energy systems by awarding density bonuses to developers. In Pittsburgh, developers earn points toward these bonuses by implementing these and similar renewable energy, on-site energy storage, combined heat and power systems, and other technologies.
Of course, such programmes come at a cost. However, by factoring such costs into long-range planning, investors and economic development agencies can make more effective decisions that balance the risks of climate change with the opportunities that arise from mitigation, sustainability and resilience strategies. In other words, knowledge is power – literally and figuratively.
For businesses that are not in the real estate industry, per se, but for which real estate is a major resource, effective sustainability decisions can also help minimise climate-related risks. Many of the most effective strategies are developed in tandem with lenders, landlords and government entities. For example, Italian luxury retail company Prada secured a loan with interest rates based on the number of the company’s Leadership in Energy and Environmental Design (LEED)-rated stores.
Green leases are coming into vogue, and may include terms covering common-area lighting, solar energy use, transference of energy usage data, and other issues. Lumen Technologies recently became the second company in the United States to issue sustainability-linked bonds and the first to pay interest at one of three varying levels depending on its success in achieving its goals to reduce greenhouse-gas emissions. And Amazon has launched dozens of renewable energy projects around the world that will generate millions of megawatts of renewable energy to power its data and fulfilment centres.
Such technologies are likely to result in evolving requirements and considerations that influence site selection. As they consider renewable energy initiatives, investors and businesses must take a number of issues into consideration. Qualified legal counsel can help them understand and address myriad local and state laws governing mineral and surface rights; zoning and land use restrictions; federal and state energy, safety and health regulations; permitting and inspection processes; and more. Public perceptions are also key; neighbour buy-in is essential to ensuring the smooth implementation of these initiatives.
From a commercial and contractual perspective, renewable energy systems often involve complex energy land agreements, special lease provisions (including single payments or payments based on production, costs to decommission systems, and potential increases in property taxes), co-location agreements, shared facilities agreements and potential government subsidies. Other concerns include weighing potential costs associated with restrictions on the use of the land for other purposes, positive or negative impacts on property values, the ability to finance and build the additional infrastructure to store and transport energy, the useful life of the technology for the purposes of financing, and potential tax credits and other incentives.
Like their investor and business counterparts, local governments must be proactive while managing costs– particularly those hardest hit by the economic impacts of the COVID-19 crisis. Within these limitations, however, municipalities and local governments can establish programmes in a number of areas. Regulations concerning building location and construction – including the size and shape of buildings, interior spaces, thermal efficiency and energy sources, energy conservation codes, etc – can help to promote sustainable practices. As transportation systems respond to changing demand, traffic and ridership, alternative forms of transportation and the creation of walking and biking corridors can simultaneously promote good health while maintaining some of the significant drops in CO2 emissions noted during the pandemic in 2020.
Industrial carbon sequestration is another area that offers great potential for helping the environment and businesses. Emerging CO2 sequestration technologies do more than remove carbon emissions from the atmosphere; the stored compound can then be redeployed for a number of manufacturing processes and products, including beverages, fertilizer, polymers, and water treatment and welding supplies.
States such as Louisiana – which has naturally occurring underground geologic formations, including salt domes and pore spaces, that can be used to store CO2 – have passed legislation that promotes and regulates CO2 sequestration activities. In Baton Rouge, CO2 emissions captured from a landfill are used to power oil and gas operations. Across the US Gulf Coast, active projects include the use of CO2 generated from refinery activity to increase oil production, and a number of companies are testing biodiesel, solar and other solutions.
Energy Demand and Reliability Meet Climate Change: Challenges and Opportunities
While COVID-19 takes up a great deal of space in newspapers and in the national consciousness, it is not the only issue having an impact on real estate in 2021. Businesses are continuing to recognise the impact of climate change and many are calling for growth and profitability to walk hand-in-hand with wise environmental stewardship. As the ramifications of climate change gain attention worldwide – and as President Biden makes climate change a priority in his administration – companies are joining government agencies, public interest groups, trade associations and individuals in creating momentum toward the use of renewable energy sources and the creation of sustainable businesses.
This trend is being noted by industries of all types, including the legal industry. As reported previously, in August 2019 the American Bar Association’s House of Delegates unanimously adopted a resolution urging the private sector and all levels of government to “recognize their obligation to address climate change and take action”, and specifically encouraged lawyers to “advise their clients of the risks and opportunities that climate change provides.”
While certain, large-scale initiatives such as net-zero carbon emissions (via sequestration and other technologies) remain a distant goal, climate – and energy infrastructure – resilience has become the new mantra. A recent event highlights the importance of this shifting focus.
In February 2021, states across the southern United States were hit by a massive winter storm, coupled with a rapid, steep plunge in temperatures, which caused significant damage to power plants, water treatment systems and other infrastructure. Homes and businesses across Texas, Mississippi, Louisiana and elsewhere were left without power and water, leaving millions to fend for themselves. In certain cases, entire neighbourhoods and towns were without power and/or operated under boil orders (because of contaminated water supplies) for more than two weeks.
In Texas in particular, fingers of blame were pointed in both directions between proponents of traditional and renewable energy. Among other arguments, proponents of natural gas-powered utilities claimed that investment diverted to expanding renewable energy sources left traditional providers without the resources needed to winterise and otherwise update equipment.
Individuals and organisations with this perspective pointed to the fact that, with more than 10,000 wind turbines generating electricity and 80,000 turbines in operation for pumping water, Texas already has the highest wind-power generation capacity of all 50 states. The Texas Renewable Portfolio Standard (RPS), which was signed into law by then-Governor George Bush in 1999, mandated that utilities create 2,000 new megawatts of renewable energy by 2009. The RPS requirement was increased to a total of 5,880 megawatts of renewables by 2015 and 10,000 megawatts by 2025. In fact, these figures were achieved more than a dozen years ahead of schedule.
Defenders of renewable energy – wind, in particular – argued that, even if some turbines also froze, renewable energy still accounts for only a small fraction of the state’s overall power supply. Some also noted that renewable energy systems are, by their very nature, subject to variable winds, overcast skies and other factors beyond their control. They maintained that the February 2021 outages demonstrated the needed for more robust investment across a broad range of renewable energy sources in order to ensure a steady supply of reliable power.
As with all such controversies, the best answer probably lies somewhere in the middle. Although they are showing deep cracks and other signs of aging, there is growing recognition that the current energy, transportation, manufacturing, distribution and other systems cannot be disposed of immediately or entirely. We live and work in a world we have both created and inherited. Existing local and regional power grids must adapt to new, renewable energy sources. Likewise, new power generation facilities must be located within a reasonable distance of the grid in order to distribute the power they produce to businesses and homes.
More broadly, the types of fuels used by businesses to pursue their strategic missions are also changing. For example, the network of facilities that supports the trucking industry is likely to become further compressed, as trucks and delivery vehicles shift from diesel and gasoline to electric power, natural gas, biodiesel and other fuels. Charging and refuelling stations are likely going to need to be closer, geographically, in order to allow for more frequent stops, particularly in the all-important “last mile” of the network.
If all parties can agree on one thing, it is that energy resilience is a top priority. In this context, corporations, organisations and government entities for which real estate is a necessary and economically important asset must chart an effective – and, yes, profitable – path toward sustainability. Much of this activity will result in the repurposing of existing facilities and the construction of new infrastructure.
If there is one thing we can predict with certainty, it is that co-operation will be the source of some of the greatest innovations and opportunities. Over the course of the COVID-19 pandemic, and in light of the February 2021 winter storms, we have learned that, despite the necessary isolation, human beings remain mutually interdependent. The solutions to the challenges we face – from COVID-19 to a warming planet – require an “all hands on deck” approach. The real estate industry has a significant role to play in promoting better health, helping the economy rebound, and creating a better environment in which we all work, play and live.