Lynne Heidel and Casey Gauntt, partners at Allen Matkins, are seeing an environmental trend in development, such as a requirement to prove water availability. (photo/lambertphoto.com)

Love may make the world go ’round, but real estate is a close second for many residential and commercial property owners in San Diego. Homeowners love the built-in equity piggy bank that 20 percent per year appreciation delivers. And the Downtown renaissance, symbolized by construction cranes dotting the skyline, and new tilt-ups and mid-rise offices sprawling from Carlsbad to Otay Mesa, have smitten commercial developers.

In recent years, real estate lawyers spent a lot of time contending with sellers trying to get out of deals because a better one had come along. That market has cooled. Today, they’re just as likely to see buyers who want out of deals that have lost their luster.

Many observers are convinced that the worst is behind the market. But the continuing uncertainty — more profound on the residential than the commercial side — along with a new overlay of environmental issues and a possible return of political activism related to eminent domain, make for interesting times for lawyers who specialize in real estate transactions.

“This year is likely to be a continued period of uncertainty like the last nine months of 2006,” says Greg Pyke, a real estate attorney and partner at Best, Best & Krieger. “Clearly the default rate is up, and the market is bearing the fruit of the refinance boom and teaser rate mortgage products. In down times, lawyers usually see more foreclosure work, and more bankruptcy.”

Developers who signed land deals in better times don’t always have the stamina to wait for the next boom.

“Builders who committed to tracts of land may be looking to get out,” Pyke says. “Carrying vacant land is an expensive proposition, so if they’re not going to develop it over the next two to three years, they may be trying to sell.”

So-called bottom feeders sit on the sidelines waiting for such an opportunity to buy, but they can run into complications because of the permitting and other governmental rights of way processes generally known as entitlement.

“Depending on where they are in the entitlement process, it can be more difficult because there are certain cities (in the county) where you can’t just assign your entitlements to someone else; you have to start the process over, which is very expensive and time consuming,” Pyke explains. “If you look at more difficult cities like Carlsbad that can take three, four or five years to get residential development entitled, depending on how long the build out is, you could have a 10-year project to build 200 homes.”

If the developer cannot find a buyer to take the tract off its hands, it may approach the lender and try to buy time.

‘Do your homework,’ Tim Konold, of Higgs, Fletcher & Mack, advises his building buyer clients. (photo/lambertphoto.com)

“Sophisticated real estate developers that are buying tracts try to buy them in phases, structured as options on future takedowns, so if they change their minds, they can just walk away without forfeiting a lot of money,” explains Tim Konold, partner at Higgs, Fletcher & Mack. “But if they’re under a hard contract to take down those phases there’s going to be some forfeited deposits.”

Enter the forbearance agreement. “This is where the borrower will go to a lender and say ‘cut us some slack, give us more time to find a way out or find a buyer,’” Konold says. “We haven’t seen these in seven or eight years in San Diego. Lenders always want a whole lot of waivers and releases, and they want to make sure they don’t end up in a lawsuit with a borrower, so these are drafted so that the borrower waives claims and/or defenses. The lender says I’ll give you time, but I don’t want to hear later that I funded the loan improperly or that it was usurious, or that we interfered in any way with your development. I want release of any claims you have against me; that’s the trade-off.”

Despite these developments, Konold says most of his developer clients have adopted the attitude that the residential development market “is not going to get much worse, and that we’re on the mend.”

With commercial transactions in less dire straits, Konold says he counsels buyers of buildings to do their due diligence in evaluating the leases in effect when they purchase a building.

“There’s a document called an estoppel certificate, which is when a buyer or lender goes to the tenants of a building and says ‘I would like you to certify to me that your lease is in full effect, and it hasn’t been amended and you don’t have options to buy and the landlord is not in default,’” Konold says. “Basically, the tenant is asked to sign this certificate saying everything is fine, because sometimes the buyer will find out there was a lease amendment that was done that grants the tenant a right of first refusal to buy the property.”

This can help the buyer of the building avoid possible lawsuits and properly figure out the lease amortization schedule, or how long the tenants will be in the building and how much income — and under what conditions — the new landlord can expect.

“Do your homework,” Konold advises.

Simultaneously occurring with the real estate slowdown is a new “green” development push. Sometimes landlords are worried about environmental improvements that the tenant wants to make.

A tenant who wants to go green now can install a solar cell on the side of a building rather than risking roof damage, says Kathy McKee. (photo/lambertphoto.com)

“One of the most popular improvements is that the tenant wants to conserve energy by using photovoltaic cells on the roof of the building,” says Kathy McKee, a shareholder with Wertz McDade Wallace Moot & Brower. “Owners get positively paranoid whenever the roof is involved because of insurance concerns, and because they’ve had telephone cabling people putting up various structures on the tops of roofs, to find it has damaged the roof, so they’re leery.”

However, McKee says she’s learned from the San Diego Regional Energy Office that the concern about solar cells may be overdone. “The newest cells don’t penetrate the roof, they are tethered to the side of the building, and they’re flat and not unsightly,” she says. “The only maintenance required is that they get hosed off once a year. This allays the building owners’ fear, along with drafting lease language that protects the owner. So the tenant makes a representation and warrants that (the photovoltaic cells) will be OK, and the tenant will be responsible if they’re not.”

Casey Gauntt and Lynne Heidel work on real estate matters and are partners in the San Diego office of Allen Matkins. Both say they’ve noticed the environmental trend in their practices.

“Last year, opponents of condo conversions used CEQA (the California Environmental Quality Act) to say that the city of San Diego should be doing environmental impact reports that address issues relating to the impact of loss of rental units, housing affordability, and availability of housing stock, because converters are taking rental units off the market,” Gauntt says. “Project opponents have used CEQA creatively to delay or stop a project, and, as with a lot of laws, there are ambiguities to make an argument that gets you in the door to be a credible opponent of a project.”

Bubbling under the surface of future development is the issue of water availability.

“There’s an ongoing negotiation about how Colorado River water is going to be divvied up,” says Gauntt. “Las Vegas, Arizona and Colorado are taking more and more, and California has been taking more than its share for years. That’s why cities like Carlsbad are looking at desalination.”

Heidel says a long-term trend will require developers to prove there’s enough water for their project. “Modifications are being done to require studies of water availability, tightening regulations to make it more stringent, to make you prove you‘ve got enough water,” she observes. “Drainage, runoff and water availability potentially are going to be huge issues.” Development also may be tested by ballot initiatives, says Pyke. “There may be some kind of eminent domain initiative, like ballot Proposition 90, that was defeated last year, a further reaction to the Kelo case,” he says. “These are initiatives designed to limit the power of eminent domain by governmental authorities. Some of the reading I’ve done says the groups that pushed the last initiative aren’t done and may come back with another try.”

Adding to trying times for developers, but keeping their lawyers busy.