Real estate faces multiple global and national investment challenges, from climate change and trade wars to Brexit. The Dutch real estate sector has its own challenges, despite the fact that the market is performing well. In the quest for profit, these issues create market uncertainty. A good understanding of the challenges is key in making the right investment and development decisions
The Dutch government is increasingly confronted by public litigation in sustainability, environmental and societal issues. Following high publicity cases contesting its lackluster approach to meeting its own, European and international goals on sustainability and the environment, the state is now faced with several court orders requiring it to expedite efforts to reduce CO2 emissions (Urgenda case) and apply, in stricter ways, European requirements to limit emissions of Nitrogen Monoxide (NO) and Nitrogen Dioxide (NO2 ) and their negative effects on flora and fauna in Natura 2000 nature conservation areas.
At a first glance this may seem a minor issue, but its impact on nitrogen emissions and our sector should not be underestimated, especially for parties considering investments in the Netherlands. For example:
• Initial estimates of the financial and economic impacts of this decision amount to a loss of EUR 14 billion due to the suspension and/or cancellation of projects. Later estimates suggest as many as 18,000 projects may be affected, indicating even larger losses.
• It’s been estimated that at least 127 national projects are already or will be suspended and/or cancelled, including the development of airports at Lelystad and Twente, major national infrastructural projects and several residential developments.
• Major impacts are also expected on the agricultural sector, which is responsible for 45% of NO and NO2 emissions, and even an impact on speed limits on Dutch highways: these will have to be reduced from 130 kmph to 120 or even 100 kmph.
The fallout is not yet clear as new issues arise on an almost daily basis but real estate, as a key sector, will clearly be affected. The court decision could influence potential investments and so the operation and value of Dutch real estate, affecting investment decisions and due diligence for every party involved in the sector.
While this development will lead to uncertain times, it could also be an opportunity for investors with a good understanding of the critical questions that face the real estate sector, and the impacts of these changes.
The nature conservation framework
The legal basis for the recent court decision can be found in European law. Protecting the environment has always been a key policy goal for the European Union, and now includes further developing a European network of conservation areas to protect specific wildlife and habitats. To establish this, the EU has adopted directives (e.g. European Habitat Council Directive, Directive 92/43 EEG) that must also be implemented at a national member state level.
This European framework consists in principle of the following obligations:
• It is obliged to assess whether a certain project or activity will have negative effects in relation to a Natura 2000 area.
• If so, a further assessment (passende beoordeling) is required to assess whether these negative effects will impact the actual flora and fauna within the related Natura 2000 conservation area(s).
• If mitigation measures to prevent or sufficiently mitigate the negative effects are not possible there is an ‘escape’ in relation to “reasons of overriding public interest” – in Dutch, the so-called “ADC-test” (article 6 of the European Habitat Council Directive). This exemption is strict and stipulates the following steps to grant permission for a certain project or activity, despite the negative effects of the envisaged project or activities (article 6, section 4 of the European Habitat Council Directive):
• There are no alternatives for the envisaged project.
• There are overriding reasons of public interest.
• Sufficient compensating measures shall be taken.
“The court decision on nitrogen could influence potential investments and so the operation and value of Dutch real estate, affecting investment decisions and due diligence for every party involved in the sector.”
A distinction should be made between mitigation measures (mitigerende maatrgelen) and compensation measures (compenserende maatregelen).
Mitigation measures can be directly included or implemented into a project to decrease certain effects regarding the nature conservation area; for example, installing air washers. Compensation measures can be used to set off/compensate the established negative effects in general; for example, planting and creating new nature area outside the related nature conservation area.
Finally, if a project has negative effects and the ADC-test cannot successfully be adopted then a permission for such project or activity should be withheld.
The Dutch approach
The European legal test basically applies to all negative effects for nature conservation areas that arise from a certain project or activity. In the Netherlands, however, nitrogen emissions and their effects on flora and fauna are of a particular interest due to high volumes of nitrogen already present in the atmosphere.
To reduce these emissions and so improve protections of flora and fauna, the government implemented new legislation from July 1, 2015: Action Plan Nitrogen or APN (Programma Aanpak Stikstof, PAS). This includes:
• Actual measures to restore and improve the natural and ecological values of certain nature conservation areas.
• Actual measures to prevent further deposition of nitrogen within the nature conservation areas in the Netherlands.
• A national deposition bank operated under the principle that due to autonomous and newly introduced reductions of the emission of nitrogen, new/other permissions could be granted due to the availability of this new deposition space (depositieruimte).
The core principle is a nitrogen emission bank. The outcome of this set-off was calculated on the basis of a digital algorithm called AERIUS. This made a calculation between the future envisaged (autonomous) mitigation of nitrogen deposition and the nitrogen deposition caused by new activities or projects. The main advantage of this framework is that no individual assessment or any further assessment of potential effects, as prescribed by article 6 of the European Habitat Council Directive, was required for certain projects or activities below the following thresholds;
• No assessment and/or permit was required for projects or activities below a calculated deposition of 0.05 mole 1 per hectare.
• No assessment and/or permit or only a notification was required (to include the deposition in the algorithm) between the calculated 0.05 and 1 mole per hectare.
• A nature permit was still required if the threshold of the calculated 1 mole per hectare was exceeded, and a permit could then be granted if the activity/project did not result in a deterioration of the situation regarding nitrogen.
Following introduction of the APN, and in light of European requirements under the European Habitat Council Directive, academia and legal practitioners doubted if the APN would meet European legal requirements. The main concern was whether the Dutch government could implement a general assessment (passende beoordeling) that also included (as yet unknown) future and autonomous positive nitrogen emission effects in order to create a national emission bank, without requiring a specific assessment for each individual activity or project to assess if a permit was required.
“The economic impact of the nitrogen case is already visible and initially estimated at EUR 14 billion due to potentially annulled or delayed projects.”
The Dutch court’s decision on nitrogen emissions
Soon after the APN came into force, the first litigation proceedings were initiated. These argued the APN was infringing European law and in no time – pending appeals and the response of the European Court of Justice (ECJ) of the pre-judicial questions – the Dutch Council of State (Afdeling bestuursrechtspraak van de Raad van State) suspended more than 200 cases (projects/activities) relating to nitrogen issues or where such arguments had been raised.
On November 7, 2018 the ECJ answered these questions. It ruled that in principle the framework could be in accordance with the European legal framework, provided that the assessment used and input (emission bank) is thorough and there is absolute scientifically substantiated evidence there is no reasonable doubt that an envisaged project or activity will not have negative effects for the related conservation areas. The ECJ also ruled that potential (non-materialized) positive effects (i.e. lower or decreased nitrogen emissions) may not be included in such AERIUS calculations and assessments.
In conclusion, the ECJ ruled that the framework itself could, in principle, be in accordance with European law but the actual application and conformity of such a framework is for the national courts to decide. The ECJ established the following legal standard: “There is scientifically no reasonable doubt that no project or activities will have negative effects with regard to the related conservation areas”. This sets a high bar.
Bearing this test in mind, the Dutch Council of State had decided this had not been sufficiently established in the APN [ABRvS 29 May 2019, ECLI:NL:RVS:2019:1603]. This is in light of the fact that the APN includes future and potential effects that were not yet materialized, and could therefore not be used in the effect assessment under the APN (AERIUS calculation).
The APN framework is therefore annulled. Consequently, all applications or decisions based on the APN – pending in court or currently being assessed by competent authorities – are annulled. This is due to the fact that, in retrospect, these activities or projects require a permit and are no longer covered under the thresholds stipulated by the APN.
Impact of the nitrogen decision
The economic impact of the nitrogen case is already visible and initially estimated at EUR 14 billion due to potentially annulled or delayed projects.2 This court decision is currently seen as one the biggest risks within the Dutch real estate and infrastructure market. This risk becomes even more relevant given the Dutch real estate sector is also facing the obligation (and challenge) to construct multiple major projects to satisfy demand for houses, offices spaces and infrastructure. Specific risks arise from building and zoning permits, as of 2015:
• Irrevocable decisions and permits (zoning, environmental, building and nature) will remain in place.
• Pending and non-irrevocable decisions and permits based on the APN will have an almost certain risk of being revoked, annulled or denied.
• Non-permitted activities and projects below the thresholds of the APN and therefore allowed without further permission are now, in principle, conducted without the required permit and illegal.
Multiple projects or activities were annulled in recent months by the competent authorities or Council of State. The Dutch government estimates that 3,300 activities (below the APN thresholds) are now being conducted without the required permit and are therefore illegal.3 The government is currently reviewing the situation and for now maintains the status quo in relation to non-permitted situations. Indeed, the government takes the position that no active enforcement will be initiated against activities that are retroactively not permitted. However, the potential risk remains of a request for enforcement by a third party (verzoek tot handhaving) on which the government has, in principle, to act accordingly.
This means there exists a potential rather than theoretical risk that, for example, environmental non-governmental organizations (NGOs) could initiate such requests. This could lead to several outcomes for pending and new activities.
“The Dutch government is investigating ways to tackle these issues but, right now, there is no clear outlook on a solution or its timing.”
It’s crucial to understand that while irrevocable zoning plans based of the APN will not be affected by the Council of State decision, annulment of the APN does mean that contemplated activities that have not been permitted but require a construction permit, for example, will in any case face an appropriate assessment requirement. This effectively means that no potential nitrogen emitting activities that have not been irrevocably permitted can be conducted near Natura 2000 areas. It’s worth remembering that an application for a new nature permit always comes with the risk that such a permit may not eventually be obtained.
In addition, the Dutch government presented a report “Not everything is possible” (Niet alles kan) in September 2019 on solving the nitrogen issue. The title of this report demonstrates that solving this issue will not only require legal action but also demands practical steps and solutions. The report includes several considerations such as lower speed limits, reduced livestock numbers, and modular buildings and energy-saving construction. These recommendations will be heavily debated in political terms. Therefore the actual solutions and outcomes remain unclear.
The European and international perspective
Given this framework is based on European law, this is not only a national issue. It could potentially affect other European countries that have adopted a more or less similar framework. Other countries such as Denmark, Belgium and Germany have adopted certain forms of lower thresholds, below which no permit or further assessment is required. The currently established European court ruling could therefore affect the policies and litigation arguments in such countries. The associated risks should not be underestimated, especially in light of an increasing tendency of NGOs and private citizens to initiate litigation proceedings to demand that national governments act in accordance with international, European and national environmental laws and obligations.
Attention points for real estate businesses
This court decision will have serious ramifications for the real estate sector and all its players. We should keep this in mind at all times. While the regulations accord specific parties clear obligations that affect them directly, the indirect effects of these obligations – as well as identifying the persons responsible for taking the measures required – may be even more substantial. In any event, the nitrogen issue should form part of conducting technical due diligence in the Netherlands, especially in relation to buildings and operations dating from after 2015. It should also be considered in cost and profit estimates as part of financial due diligence. This is because the court order, and the potential risk of the requirement of a nature permit or the denial of such permissions or permit, could limit or terminate the operations of a company. This may have consequences for the tenability and value of the assets involved: a warehouse, for example.
We should stress that non-irrevocable permits subject to appeals are essentially void. Projects that fit within an irrevocable zoning plan that have been adopted using the APN but have not yet been permitted, or projects for which otherwise no appropriate assessment has been carried out, will be subject to appropriate assessment requirements. The exact way of conducting such an appropriate assessment is also unclear as the AERIUS calculation system used previously is currently out of order. While this may open up opportunities for market players seeking to alleviate concerns for developers, any new way of conducting appropriate assessment is almost guaranteed subsequent litigation and scrutiny.
For lenders that are financing assets and asset portfolios, key attention points include whether the owners are in compliance and have obtained the necessary permits, and may put debt service at risk. In addition, non-compliant assets will likely decrease substantially in value. The irrevocability of all permits underlying financed assets should be a condition precedent to any financing offered. At the same time, debt service capability should be reassessed for borrowers with financed assets near to Natura 2000 protected areas that operated solely on an APN notification base or that fell below the APN threshold. Lenders may consider developing products that cater to redevelopment or upgrading of non-compliant real estate.
Developers will face the requirements for new developments. While we do expect new rules on nitrogen deposition to be drafted, the content of a new legal framework is unclear. We also expect that lenders will be more reluctant to invest in assets and developments with a nitrogen deposition unless all permits are (already) irrevocably in place but will, on the other hand, have more appetite to invest in emission neutral new developments, an appetite that developers can cater to.
Property owners should have a full overview of their portfolio and especially assets that were developed or commissioned as of 2015. Activities and assets operated based on APN notifications or under the APN threshold should be considered to be at potential risk for enforcement, especially in areas with active NGOs e.g. nature conservation agencies. The asset value effects of non-compliance vis-à-vis compliance as well as running costs should also be factored-in when considering whether or not measures should be taken. Additionally attention points for non-compliant assets are whether the lease agreements accord the lessee termination rights in the case of statutory non-compliance of the property. Where new leases are entered into, lessees can expect to have specific requirements in this respect and/or obligations for lessees.
For lessees, the attention points focus on whether the leased real estate meets the statutory requirements, whether the landlord has obtained necessary permissions and addressed any non-compliances, and the continued non-compliance risks and related costs of having to relocate. Lease termination options in case of statutory non-compliance of the property should also be considered. Where new leases are entered into, this is equally if not more relevant.
Looking ahead: Expectations and possible solutions
In addition to these attention points for specific players, the recent court case and new regulations raise a number of pending questions that need to be fully appreciated, and we expect a number of developments in the market. The Dutch government is investigating ways to tackle these issues but, right now, there is no clear outlook on a solution or its timing, prompting the market to either come up with solutions or await the government’s plan. The latter option is not necessarily preferable.
While this could lead to further uncertainty, awareness of the issues could also help to provide a head start for some. Contributing to preventing or limiting emissions will, in any case, be profitable.
Possible solutions might be contemplated by local or regional authorities in essentially coming up with local emissions banks, or project areas that properly encompass a nitrogen deposition zone for which adequate measures are taken to immediately and to measurably decrease depositions elsewhere. This could potentially allow net deposition increases in the project zone with deposition decreases elsewhere. For large-scale developments, developers may seek to investigate such opportunities with municipal and provincial authorities who are competent authorities in these topics.