As real estate securities analysts, most of the things we do have some basis in being knowable. For example, we analyze business plans, visit assets, build models, talk to tenants and reach conclusions about a company’s portfolio, prospects, management and stock valuation. While none of this is completely knowable, it’s partly knowable.
In the last 10 years, however, under the current administration, there has been a very concerning trend of government agencies reaching into the real estate business, often with politically motivated goals. This has introduced an aspect into the business that is less predictable. Some instances are effectively zoning or permitting processes where, if the applicant (usually a company) has followed the rules, they ultimately get building permits or the equivalent thereof. Other instances are not so simple. There are dozens of examples we could talk about, but one in particular raises such concern that it bears discussion.
Some of the portfolios we manage own shares in a company that is developing the Cadiz Valley Water Conservation, Recovery and Storage Project (project description). For readers not in California, the State has an environmental review and vetting system – The California Environmental Quality Act, or CEQA for short. It is the result of decades of legislative efforts; it is costly, complicated, slow-moving and open to the public. It has its failings, but it is an established legal framework under which all the parties to the process operate.
At 30,000 feet, CEQA requires large real estate infrastructure projects to create an Environmental Impact Report (“EIR”) (CEQA process flow chart). For the Cadiz project and many others, these reviews are multi-year and multi-million dollar undertakings. They also provide fodder for the environmental plaintiffs industry, which sues project participants on many approved EIRs. Imagine putting together a 3,000 page review of anything, and environmental lawyers can probably find a potential nit.
What happens in practice is large projects like Cadiz are sponsored by government agencies, in this case the Santa Margarita Water District and the County of San Bernardino, so the defendants in these environmental lawsuits are generally government agencies.
The process is generally something like the following:
- Hire qualified, independent scientists and consultants to establish the project impacts under applicable local and federal law;
- Design or redesign the project to mitigate these environmental impacts;
- Create a 3,000 page document that covers any real, imagined or perceived environmental impact that your project may create;
- Pull this together into a draft copy and publish it for comment for 90 days; during the comment period, hold open meetings for citizens, project participants and other concerned people to address the lead agency (in this case the water district) face-to-face; and
- Collect all the feedback, consider reasonable commentary, incorporate plan design changes to address these reasonable concerns and put out a final copy of the EIR.
A scheduled vote is then held and a branch of the California government approves or rejects the project. This effort, start to finish, is typically two-to-five years, although in many cases it is much longer. In the case of Cadiz the vote was in 2012 and the project was unanimously approved. In the immediate time period after the approval, the environmental legal industry geared up and sued. No matter that a branch of the California government approved it. There were six challenges, all of which were dismissed in an Orange County court in 2014. (Judge Andler’s dismissals)
As expected, the losing plaintiffs appealed, as there is no material cost to do so and part of the effort may be focused on delay. In the Cadiz case, that appeal was heard on March 23rd and we believe the plaintiffs’ appeals will be dismissed.
At a high level, this should concern any right thinking person, as we start with a two-to-five year EIR process and add at least two-to-three years of litigation. So in California, any project of meaningful scale has a six-year approval process. We would imagine that if we had this conversation with Texas Governor Rick Perry, he would say that’s just great and remind us that Toyota is moving from California to Dallas.
Having said all this, at least the process is final, right? You get a certified EIR and off you go. Technically yes, but in the case of the Cadiz project, no. The Bureau of Land Management (“BLM,” a federal agency) is actively working to interfere with a state-approved project.
There are two particularly troubling aspects to this. For a California project like this, CEQA is law, plain and simple. The reason California has CEQA is to provide a slow-moving, open vetting process; not to engender backroom politics by other, including federal, agencies.
To transport water from the CEQA-approved project, the project sponsors (Cadiz and the various water agencies) are proposing to build a pipeline in an existing railroad right-of-way. Of course, the pipeline is covered in detail in the approved EIR. According to members of Congress and the U.S. Senate, the BLM is attempting to reinterpret 140 years of non-controversial railroad right-of-way law initially put in place by Congress in 1875. (1875 act) In short, this law allows railroads to lease space to other commercial users along their right-of-way (typically 100 feet of surface and subsurface on either side of the rail line). Historically, the railroads had the right to do this as long as it did not interfere with rail operations. More recently, the Solicitor General of the Department of the Interior issued a document called the “M 37025 Opinion,” which provides: “A railroad’s authority to undertake or authorize activities within an 1875 Act ROW is limited to those activities that derive from or further a railroad purpose” (M 37025 Opinion). This is the legal standard and allows railroads to lease space to all sorts of commercial users. The example provided in the M 37025 Opinion is MCI’s fiber line, which was clearly built for commercial purposes, but allows as a railroad benefit some of the fiber capacity for the railroad’s use. Cumulatively there are easily more than twenty thousand miles of railroad rights-of-way in the western United States. It is estimated by Congress that there are 3,500 existing utility uses on railroad rights-of-way over federal lands, which Cadiz believes are similar to its proposed pipeline.
So Cadiz, the Arizona and California Railroad, and the Santa Margarita Water District submitted a proposal that had more than a handful of attributes (e.g., water conveyance pipeline, fire suppression system, access road, power line and supported facilities, and a steam-based excursion train) they felt should qualify as “further[ing] a railroad purpose”. In particular, the railroad along this route features crossings constructed of creosote-soaked wooden trestles, which are flammable. Trestle fires are common. Hence, the pipeline is designed with automated fire suppression equipment to assist the railroad in preventing or containing fires.
In our opinion, it is reasonable to conclude that automated fire suppression is preferable to having railroad employees hop in a truck, race miles to the fire and throw sand on it. Yet the BLM argued in their non-binding letter of response that since the traditional method was the throwing of sand, adding automated fire suppression would not “further in part, railroad use.” (BLM letter) The BLM director that made this statement has since left the California office of the BLM.
Congressional reaction has been swift in condemning this (Congress letter to BLM). Nine Congressmembers, both Democrats and Republicans, have co-authored a letter to the BLM Director saying that the ruling is contrary to the M 37025 Opinion. Congressmen Tom McClintock and Tony Cárdenas in particular have met with the head of the BLM in Washington in person to convey the same opinion. Senator Orrin Hatch is also on record as being “deeply disturbed” by the actions of the BLM.
What is particularly troublesome to members of Congress is that the BLM’s action has clouded the title of all existing uses within railroad rights-of-way. The discretion applied by BLM to reject the opinion of the railroad that the Cadiz project furthers railroad purposes means that BLM, not the railroad, will be the arbiter of the question. This diverges from the M 37025 Opinion where the railroad’s opinion formed the basis of the determination that the fiber optic cable was providing a communication railroad benefit.
Consequently, in addition to the initial backlash from the legislative branch as to the Cadiz project, the issue is being subsumed within a larger cause that has enlisted many members of Congress in an effort to explore every available legislative and administrative means to clarify the scope of railroad rights-of-way.
The problem goes beyond the railroads themselves. Hundreds of millions, if not billions of dollars have changed hands in consideration for the use of these rights-of-way. How would the BLM propose to unwind those transactions if the railroads did not have the authority to lease in the first instance? How will projects be financed in the future? The impact of the BLM’s action effectively is that now every potential use of a railroad right-of-way will have to secure sign-off from the BLM before it may be financed to remove the cloud. But now even if the BLM were to sign-off, its decision would be subject to second guessing by parties in the Courts. The issue seems ripe for action by Congress.
The Cadiz project itself has widespread approval, with at least 30 politicians in favor as well as dozens of community leaders (support for project). As far as we can tell, the only current political opposition is from Senator Feinstein (whose office made no comments and asked no questions of either the Santa Margarita Water District or San Bernardino County, the parties reviewing the Project under CEQA). She has recently indicated her opposition was based on her belief that the project would damage the environment. Since the EIR is approved under California law and indicates the opposite, we fail to see how her opposition has any merit.
Ultimately we believe the project will be approved, hence our investment, but this federal process is adding time and has strained our faith in the operation of the federal government.
Disclosure:
This is a summary and does not constitute an offer to sell or a solicitation of any offer to buy or sell any securities. Views are as of April 13, 2016 and are subject to change at any time based on market and other conditions. The author’s assessment and opinions of a particular company, security, and/or other information discussed in this article is not intended as research or advice. While the statements reflect the author’s good faith beliefs, assumptions and expectations, they are not guarantees of future or actual performance or results. The securities and companies discussed are for illustrative purposes only and do not represent all of the securities purchased, sold or recommended for advisory clients. The reader should not assume that any securities discussed were or will be profitable. Furthermore, American Assets Capital Advisers, LLC (“AACA”) disclaims any obligation to publicly update or revise any statement, including forward-looking statements, to reflect changes in underlying assumptions or factors, or new information, data or methods, future events or other changes.
This document may contain forward-looking statements that are based on current expectations, forecasts and assumptions that involve risks and uncertainties that could cause actual outcomes and results to differ materially. The following factors, among others, could cause actual results to differ from those implied by the forward-looking statements in this presentation: changes in general economic conditions; political factors; changes in specific markets; legislative/regulatory/policy changes (including, but not limited to, environmental laws/regulations/policies and laws/regulations/policies relating to railroads, rights-of-way, land management, and real estate); and changes in generally accepted accounting principles. While forward-looking statements reflect AACA’s good faith beliefs, assumptions and expectations, they are not guarantees of future or actual performance.
