Infilling Abounds in Arizona

Great opportunity comes with corresponding need for due diligence
by Jason Wood

Phoenix is growing — but not in the same way it used to. While the city is still associated with development of large tracts at the edge of its boundaries, Phoenix residents have begun to move inward. It’s been well publicized that millennials are waiting to start families and delaying their move to the suburbs. The data on millennial trends is strong and well known, but baby boomers are now matching their pace toward the city. Both groups have been drawn in by the amenities in areas like Scottsdale and Central Phoenix: cultural institutions like Phoenix Art or SMOCA, nationally recognized cafés and restaurants, vibrant parks, and the public transportation to get them from place to place. Likewise, the efficiency of e-commerce has changed demand for commercial land — big box and other retail has shifted toward housing and experiences, like restaurants and concert venues.

Developers have quickly adapted to meet this demand with community-style apartment complexes, luxury condos and townhomes, mixed-use buildings, and rehabilitated historic properties in infill locations. This opportunity, though, is matched by legal challenges.

Many urban projects are born from land assemblages, and the parcels needed for an infill project may be owned by several discrete parties. This can create a holdout problem known as the “tyranny of the minority.” After several parcels are bought, owners of the remaining few dramatically increase their asking price knowing that the developer has amassed sunk costs. This can effectively end the project, since the owner is willing to hold out for the highest possible price. Counsel, however, can arrange cost-effective methods for buying land without revealing the end goal. This way, parties agree on a fair, market price for the land, without wasting time on endless negotiations.

Developing land in the Phoenix metropolitan area also begins a complex relationship with the applicable municipality and surrounding community. In many ways, it is advantageous to build in urban areas because the land has ready access to water, electricity and municipal services. But developers need to be aware of zoning requirements, and how to change them. Infill development may also require negotiations with neighboring property owners to agree on common areas, like shared parking. And with residential comes special considerations — and, oftentimes, higher scrutiny — from municipalities due to higher traffic counts and other factors.

Urban land may also be covered by historic covenants and easements that run with the land. In other words, sometimes the previous owners negotiated agreements with neighbors that still exist long after the owners have sold the land and moved elsewhere. Some land, for example, might require approval from its original developers or from an association of members before it can be improved. Those developers are often long gone and the associations are dissolved, even though the obligation remains. It is costly and complicated for most parties to find and remove these covenants and obtain suitable title insurance. Experienced counsel is key in these situations — bringing judgment and proficiency to bear so that the developer can build with assurance.

Finally, urban land can be contaminated by prior owners or even neighboring properties; everything from the usual suspects — dry cleaners, filling stations and landfills — to buildings that contain asbestos or historic uses such as dairy farms that may leave lasting effects. Many a pro forma has been busted by environmental issues discovered after closing or that were not properly addressed when discovered during due diligence. Before buying land, a developer needs to know the right questions to ask and understand how to leverage the results of his diligence investigations. Even where a property is being sold “as is,” performing certain environmental testing can provide the developer with safe harbor protections under federal law if environmental contamination is discovered at a later date.

Phoenix infill development is booming — but developers must be ready for its challenges. Retaining experts and coordinating the myriad players and strategy in the early stages of a project will limit uncertainties and other contributors to downside risk and, most importantly, improve the probability of project success.

Jason Wood is the Real Estate Practice Group Chair at Quarles & Brady LLP in Phoenix. His national practice helps clients restructure their existing real estate portfolios and overcome other challenges. He also assists clients to acquire, finance, develop, lease and operate real estate of all types, including shopping centers, residential developments, automotive dealerships, hotels, office and industrial parks, apartment complexes, and raw land, among others.

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