Real Estate Issues in US Wind Deals

Real Estate Issues in US Wind Deals

August 01, 2005

Wind developers learn quickly that expertise in wind technologies, electricity transmission and tax credits is not enough — they must also be savvy real estate developers.

They need to understand the basics of leases, easements, mortgages, option agreements, title insurance and surveys, as well as quirks in local laws relating to wind farms, in order to make projects financeable and avoid mistakes that waste time and money. Securing the site for a project can be straightforward if the site is one tract of land with a willing landowner, but most sites consist of many landowners and many, sometimes even hundreds, of parcels.

The Site

The size of the site needed for a wind farm varies based on the speed, strength and consistency of the wind flow over the site and the type of terrain. According to the American Wind Energy Association, about 50 acres are needed to produce one megawatt of installed capacity on a flat terrain, although only 5% (2.5 acres) or less of this area may actually be occupied by turbines and equipment. A wind farm in a hilly area may only need about two acres for each megawatt of capacity.

The developer will also need a right to cross over adjacent land to get access to the turbines and for a transmission line to connect the project to the local utility grid. The developer can get access to the land for meteorological testing and gathering of wind data through a letter agreement, option agreement or through a wind farm lease or easement.

The developer should have an understanding of the boundaries of the property, either through initial discussions with the landowner or preliminary survey work. A title insurance company or local attorney should be hired to perform a title search of the land to verify that the person answering the farmhouse door is the sole owner of the land and to check for liens and title irregularities.

In some states, title search costs can be reduced by entering into a contractual arrangement with a title insurance company whereby the title insurance company performs searches for a fixed fee with the expectation that it will issue title insurance for the entire wind farm for a set premium at a later date. The availability of this arrangement varies from state to state, but it is worthwhile to develop a relationship with a title insurance company early on in the development stage of a project.

If there is a mortgage on the land, which is often the case, then negotiations over use of the land will also have to involve the lender holding the mortgage. The developer will probably need not only a formal consent to the lease or easement from the lender, but also a “subordination and non-disturbance agreement” in which the lender agrees not to disturb the developer’s use of the land for the wind farm and that any lender who finances the wind farm will have first claim over the land. Such an agreement is a prerequisite for the project to be financeable. If a landowner has not been current on his mortgage payments, then the developer will probably have to cure the defaults, or even pay off the landowner’s mortgage, before a lender will finance the wind project.

A title report prepared by a title insurance company or an attorney will also tell the developer whether the land has already been leased to a third party, or if others have rights to use the surface or the subsurface of the land. It is not uncommon to find that lands are encumbered by long-term oil and gas leases or mineral leases. If such leases exist, then the developer must obtain a waiver from the holder of the lease that its right to use the property (or at a minimum, its right to mine the surface of the property) is limited or waived.

Multiply these situations by 100 tracts of land and the wind developer quickly becomes more knowledgeable about real estate and its pitfalls than Donald Trump.

Main Business Issues

The developer will need both a site lease and easements over surrounding property. These documents usually range from 10 to 30 pages in length and should address, at a minimum, a dozen issues.

Term: The typical lease has a term of 25 to 30 years. Perpetual easements are not favored; they may not be enforceable and, in some states, may create tax consequences for the landowner as they may be characterized as a sale.

Renewal terms: Most leases have one or two renewal terms, at the developer’s option. Renewal terms usually last five or 10 years, at an increased rental rate (based on the consumer price index or percentage increases).

Use: The lease will describe how the developer can use the land. The use clause should allow collection of meteorological data and environmental testing, construction of wind turbines, roads, transmission lines, communications facilities and other equipment, wind conversion, the gathering, collection and transmission of electricity and ancillary uses.

Rent: Typical methods of compensation to the landowner include an upfront lump-sum payment, annual fixed payments per wind turbine, variable payments based on a percentage (usually 1% to 4%) of the gross revenue generated by the turbines, or a combination of these approaches. Sometimes “tax credits” are included in the definition of gross revenues. Some states require that payments to the landowner be made at least annually.

Additional payments: Developers occasionally offer additional fees to landowners for the right to build improvements other than turbines on the property, such as meteorological towers, substations, transmission lines or roads. Optically, these varying payment categories give the impression that the landowner will be receiving a lot of money, but this may be misleading, for payments only get made if the improvements are built, which is in the developer’s discretion.

Other uses of the land: The landowner is frequently permitted to use the balance of the land for farming or grazing, subject to the developer’s security and safety requirements. Sometimes this is a material business point for landowners.

Existing liens: The landowner represents that there are no liens, encumbrances or leases affecting the land, other than as specified in the document. The landowner is required to obtain subordination and non-disturbance agreements from any existing or future lenders.

Environmental issues: The landowner represents that it is not aware of any contamination of the land by hazardous materials and may indemnify the developer for existing environmental conditions (although some challenge this practice of expanding the landowner’s liabilities as unfair because it might make a landowner responsible for a larger share of any later cleanup of the land than is required by law). If hazardous materials are present on the property, remediation costs must be addressed. The wind developer indemnifies the landowner for any hazardous conditions it creates.

Transfers and liens: The developer has broad rights to sublease, assign and mortgage the property. Some complicated wind instruments have provisions permitting multiple simultaneous subleases and subeasements to various parties, permitting phased construction of the wind project and limiting the liability of the various subtenants and easement holders. The developer’s lender must be given notice of any default under the lease or easement and be given the right to cure the landowner’s defaults.

Removal: The developer owns the turbines and improvements it constructs and either has the right to or must remove them at the end of the lease term. Sometimes, the landowner has the right to retain one or more turbines at the end of the lease or easement for personal use.

Early termination: The developer often has the right to terminate a lease or easement at its option. Certain farmers’ rights groups criticize these provisions as being unfair, as the landowner’s land is tied up for a period of time and he may ultimately receive little or no compensation. One fair compromise is that the landowner receives a termination payment if the developer terminates early. The landowner should not have the right to terminate the lease or easement, as that would make the project unfinanceable.

Purchase option: Some wind leases give the developer an option to buy the land on a specified date based on the fair market value of the land or other agreed-upon compensation.

If the project is in the infant stage, some developers begin the process by presenting an option agreement to the landowner. An option agreement provides the developer with the option to purchase, lease or obtain an easement over the land for wind energy use, at the developer’s option. The landowner is paid for keeping his property off the market. The option terminates automatically if not exercised by the developer by a certain date. There is no single “market” price for such an option, as it is based on local real estate conditions and potential sales or other uses of the land that the landowner must forego during the option period. Sometimes option payments made by a wind developer are credited against lease or easement payments due once the option is exercised.

Developers occasionally obtain “noise easements” over neighboring properties to avoid conflicts or litigation. In return for payments, the abutting landowner agrees not to object to noise generated by the turbines.

State-Specific Requirements

Not just any form of lease or easement will do; the requirements for the lease and easement vary from state to state. Therefore, before signing any agreements, a developer should consult with an attorney about local zoning laws, as well as about state-specific legal requirements for wind farm instruments.

Any lease, easement or option agreement must be executed by both parties and should contain a legible legal description of the property. In some states, a “memorandum” of the document should also be executed by both parties. A memorandum is a short form of the document that contains a few material provisions, such as the term of the lease or easement and describes the property. In some states, a memorandum of the agreement can be recorded in the public records instead of recording the entire document. “Recording” means that the document is listed in the county records. By recording a document (or, where permitted, a memorandum), the wind developer is protected against someone else claiming conflicting rights over the land later. Lenders financing the wind project will want the property rights the developer has to be recorded. Recorded documents lay the foundation for a mortgage or deed of trust to be granted to a lender.

In the last few years, certain landowner advocacy groups have advised landowners to insist that the entire wind farm lease or easement be recorded in the public records, with only the financial terms redacted.

Several states have passed laws concerning the form and content of wind farm conveyances that may become traps for an uninformed developer. In South Dakota, for example, a wind lease or easement cannot exceed a term of 50 years. Furthermore, under South Dakota law, a wind lease or easement will automatically terminate if no development of the potential to produce energy from wind power has occurred on the land within five years after the lease or easement began.

A lease or easement should also describe the real estate with specificity. For example, in Kansas, a vague property description stating that the lease or easement burdens all of a developer’s land in the county (known as a “Mother Hubbard clause”) may be subject to challenge. Sometimes horizontal and vertical information about the turbines must be included in the wind instrument. Kansas, Minnesota, Montana, Nebraska, Oregon and South Dakota have laws requiring that wind instruments include a description of the vertical and horizontal space on the land (expressed in degrees or distances from the turbines) that must remain unobstructed to accommodate wind flow.

Surveys and Title Insurance

Most lenders will insist that a survey of the property be completed as a condition to closing on the financing. The survey must conform to established rules called the “Minimum Standard Detail Requirements for ALTA/ACSM Land Title Surveys.”

The lender will also require that a title insurance policy be issued at closing. This insures, among other things, that the mortgage held by the lender will have priority over other liens and that there are no title defects that might lead to a loss of the property or restrict use of the property as a wind farm.

Developers would be wise to establish a relationship with a title insurance company as soon as a potential site is identified. There are several steps in the title insurance process, beginning with a land record search of the property — called a “title report” — issuance of a policy insuring an option agreement, if any, in favor of the developer, issuance of an owner’s policy or a leasehold owner’s policy in favor of the developer when land is purchased or a lease is executed, and then later issuance at financial closing of policies in favor of the lenders. In certain states, it is possible to combine the search costs and title premiums into an overall package rate, so that the developer is not charged for each step in the process. In other states, the form of the title insurance and the premiums are not negotiable.

Title insurance is one of the least understood components of real estate development, but it is a necessity for secured lenders. In a title insurance policy, the title insurance company insures the owner of the land and the lender against title defects and adverse claims up to a specified amount of coverage. The cost of the title insurance policy (known as the “premium”) is set by statute in some states and is negotiable in other states.

The title policy contains a list of risks or “exceptions to title” that are not insured against, and the developer and lender review this list with particular care.

In certain states, title insurers can provide additional coverage through “affirmative insurance” or “title endorsements” that provide protection against specifically-identified risks. Common title insurance policy endorsements include such things as the property has access to a specified public road, there are no restrictions on use of the land that will extinguish the lender’s lien, the land is the same land as shown on the survey, the property has been validly subdivided, and the zoning for the property will permit its use as a wind project.

Title insurance is insurance to cover a loss in the value of real property — including the wind turbines — as a result of any title defect. The question arises: are wind turbines “real property” or “personal property” (which would typically not be covered by title insurance)? In some states, it is possible to purchase an endorsement to the title policy that covers this legal uncertainty. The endorsement states that the policy will cover the value of the wind turbines, transmission lines and other wind facilities (even if such facilities have not yet been located on the land). Without this endorsement, the value of the turbines, transmission lines and wind facilities may not be covered.

In sum, the real estate aspects of a wind project can be a complicated process and will likely involve many parties–the landowner, the landowner’s lender, its neighbors, leaseholders, a title insurer, surveyor, governmental officials, the project’s lender, attorneys on all sides and parties who enter the story as a result of any title defects or unforeseen issues. The last piece of real estate in a multi-site project is often the most difficult to secure, leading one developer to comment after an especially trying lease negotiation that acquiring the dirt was the “dirty little secret” of clean energy project development.