July 30, 1992 - From the July, 1992 issue

AQMD’s RECLAIM: Impact of Emissions Trading on Land Use

By Charles E. Loveman, Jr., Larry J. Kosmont and Susan Perry. Charles E. Loveman, Jr. is a prin­cipal and Larry J. Kosmont is Presi­dent of Kosmont and Associates, Inc. Susan Perry is an attorney and project coordinator with K&A. Kosmont and Associates is a real estate consulting firm providing real estate develop­ment, entitlement, finance, transpor­tation, and air quality services. (Mr. Kosmont is a member of the AQMD’s RECLAIM Advisory Com­mittee; Ms. Perry serves on RECLAIM’s Trading Market Work­ing Group and Mobile Source Work­ing Group.)

Is this a great country or what? A large, powerful public agency endows businesses with an entitlement to produce something, and then creates a market to exchange this endowment for cash if those businesses produce less than what they are entitled. Transfer of density? No, RECLAIM — literally a (dirty) air rights market. 

RECLAIM is a program to im­prove air quality through an incentive-based system for air pollution emitters. However, we anticipate that if and when the program is adopted, it will have important consequences to real estate acquisitions and dispositions. This article briefly explains the program and guesses at some of its real estate implications.


Larry Kosmont

Municipalities may choose to buy and “bank” air credits in order to attract industrial users as part of a local economic development strategy.

The RECLAIM Program 

RECLAIM, or the Regional Clean Air Incentives Market, was announced several months ago by the South Coast Air Quality Management District (AQMD)as a means of reducing smog and bringing the region into compli­ance with both Federal and State air quality mandates. Under RECLAIM, a revolutionary “smog exchange” will be created, whereby 2,800 companies in the South Coast air basin will be given an economic incentive to reduce pollution. 

These companies, located in Los Angeles, Orange, San Bernardino, and Riverside counties, are responsible for approximately 85% of the Southland’s smog-forming emissions from stationary (as opposed to automobile and other mobile) sources. The companies each produce 4 tons or more per year of either reactive organic gasses (ROG), sulfur oxide (SOx), or nitrogen oxide (NOx). 

Presently, these companies are monitored by the AQMD under a regulation-intensive system referred to as “command-and-control.” Many affected industries have criticized command-and-control for its lack of flexibility and high cost of compli­ance. RECLAIM represents a funda­mental departure from command-and­-control rules: as an alternative to compliance with scores of current rules, participating companies will be allowed to trade pollution credits. 

Under RECLAIM, a company will be given an annual emission allotment, based upon historic production levels. Over the next 10 years, these allot­ments will decrease annually, forcing improvements in air quality. For ex­ample, if a company receives an an­nual emission allotment in 1993 of 10 tons per year of NOx, in 1994 their annual allotment could decrease to 9.2 tons, and continue to decrease by 8% annually until 2003. Based on current discussions, the likely baseline against which decreases will be measured is a company’s 1987 level of emissions. 

If a company does not use its entire emission allotment, the unutilized portion becomes a credit. This credit can either be used by the company to meet future internal needs, such as increased production demands, or it can be traded for cash to another com­pany. The incentive of RECLAIM is that by creating a market for the sale of unused pollution credits, compa­nies are (presumably) motivated to find ways to decrease their emissions. A monetary value is placed on being environmentally clean. 

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AQMD staff is expected to present a formalized RECLAIM program to their Board by January 1993, at which time the Board will vote on whether or not to authorize RECLAIM trading. 

RECLAIM and Real Estate

Companies participating in RECLAIM can create smog credits by decreasing production from allotted levels, by installing emission-reduc­tion equipment, and/or by finding cleaner production methods. In addi­tion to these production-oriented approaches, an entire category of credit creation and trading is likely to emerge as part of a company's relocation and/or real estate acquisition and dispo­sition activities. 

For example, when an industrial user who fits the criteria for participa­tion in RECLAIM considers a corpo­rate relocation, their decision-mak­ing will need to address not only the disposition of their real property but also their annual emission allotment fromAQMD.

Depending upon the state of the smog-trading market, the firm’s al­lotment can be sold to another user, resulting in a financial windfall to the relocating firm. However, a potential buyer or lessee of the relocating firm’s property may need to purchase smog credits in order to conduct its busi­ness. This buyer/lessee may find that the cost of purchasing emission credits on the open market is prohibitive. Therefore, in order to dispose of its property, the relocating company may need to value its RECLAIM credits at a below-market price, and assign these credits to its underlying real estate. 

In time, the availability of emission credits which “run” with the land may affect land values, relocation and disposition strategies, and the property’s marketability. In extreme cases, the lack of emission credits for use at a specific site could result in the equivalent of condemnation, because no user can operate cost-effectively at that location. 

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In the short term, companies that are relocating in and out of the South Coast Air Basin should be mindful of the probable date of adoption of the RECLAIM program. For instance, if a company decides tomorrow to move its business outside of Los Angeles, it may want to postpone its real estate disposition until it can determine what kind of pollution allotment the pro­gram will credit to it. 

Once the smog credit market opens, the company can then sell its real estate with an enhanced residual value relating to the buyer’s right to pollute at the seller’s 1987 emission level.

RECLAIM As An Economic Development Tool 

Alternatively, municipalities may choose to buy and “bank” air credits in order to attract industrial users as part of a local economic development strategy. In the future, as regional economic policies focus on job cre­ation and technology innovation in the manufacturing sector, transfers of pollution credits by cities may be­come the 1990s equivalent of rede­velopment land writedowns that were common during the 1970s and 1980s. 

Under RECLAIM, each geographic subregion will have a maxi­mum emission “cap.” Therefore, a city intent on creating an industrial tax base can “corner the market” on such users by aggressively buying pollution credits in the open market, and conveying credits on a discounted basis to firms the city wants to attract.

Mobile Source Rules 

Also under consideration is ex­pansion of RECLAIM to include mobile sources of emission such as automobiles and trucks, with credits offered to companies that utilize low emission or zero-emission vehicles. Inclusion of mobile source emitters in RECLAIM could have a substan­tial impact on real estate decision making for the 2,800 businesses and others with large vehicle fleets. 

The mobile source program will be oriented at taking high-polluting cars off the street through carpooling, fleet upgrading and maintenance, the surpassing of Regulation XV re­quirements, and so on. Companies with large real estate holdings at multiple locations inevitably will employ strategies to convert pollu­tion credits into real estate entitle­ments, by internally transferring credits from one property to another, and then utilizing them as mitigation measures for new development.

In fact, the most creative “air credit for development rights” formula might reside with a public transit agency, such as the Los Angeles County Transportation Commission (LACTC), soon to be known as the Metropolitan Transportation Authority (MTA). Agencies such as MTA may be eligible to receive air credits for the replacement of gasoline-pow­ered buses with low-emission or electric-powered buses. These credits might be converted to development incentives to attract private invest­ment to the MTA’s joint development transaction for properties located ad­jacent to transit stations. 

Conclusion 

Although many of the details of the RECLAIM program are still unresolved and there is no assurance that the AQMD Board will adopt the program, it promises, if adopted, to have substantial impacts on real estate decision-making for certain types of users. 

In addition to improving air qual­ity, the program will at least indirectly promote and influence regional and sub-regional industrial strategies. Also, in conjunction with the host of transportation policies sweeping the region, RECLAIM will change the map on how and why owners and tenants choose a business location — and perhaps on whether or not one stays or leaves California.

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