Focus on Real Estate Analysis: comments on the probability of rezoning.

IN THE SPRING 2007 EDITION OF REAL ESTATE ISSUES, THE concept and definition of highest and best use was discussed in the article, "Comments on the Concept and Definition of Highest and Best Use." which can be accessed online at www.cre.org/publications. Several conclusions regarding highest and best use (HBU) were discussed, including the definition of market value and legal permissibility's impact on HBUs. The definition of market value is based on the economist's perfectly competitive market in which there are no barriers or obstacles to the entry of new firms or the exit of existing firms. Legal permissibility in the HBU process often is a barrier to entry. Because legal permissibility contains an element of manipulation, it could negatively influence the HBU, thus retarding the highest present value to the land or return on improved property. HBU determination and analysis can be flawed if legal permissibility is contrary to the economics of the property market.

THE PROBABILITY OF REZONING

The "probability of rezoning" rests on the issue of legal permissibility, which can be used as a barrier to entry. The result is a flawed rezoning process. The barrier violates the perfectly competitive conditions in the market. The idea and use of legal permissibility will not disappear from the zoning ordinance or the HBU definition, so its existence must be recognized. We must, however, eliminate legal permissibility's effect on HBU analysis by the market analyst and the appraiser.

The "probability of rezoning" is an educated evaluation (an expert's judgment) about the action that will be taken by the authorities of a local jurisdiction who have the power in the zoning ordinance to impose restrictions on land use. Local authorities base their decisions on any number of factors, such as the best interests of the property owner, the needs of the community, their personal preferences and biases and, in some instances, personal gain. The analyst or appraiser should not be involved in judging the "probability of rezoning" in this context. The analyst, a market expert, should not have to ponder the possible non-market motives of a set of individuals who may have non-market motives. The analyst should not judge and attempt to forecast the results of various underlying motives not expressed in the financial feasibility of a property's use.

The appraiser or the analyst, however, is a vital player in determining the financial feasibility of a property. These market experts have the knowledge to gather, array and interpret the facts to make the evaluation. While their knowledge is property market based, their evaluations should not be recognized as a study of the proclivities of the local authorities who may act counter to the desires of the market and the needs of the community.

The Appraisal Institute's The Appraisal of Real Estate (12th edition) (1), on pages 311-312, provides the appraiser with ideas about handling the probability of rezoning. The six statements are easily divided into two categories that represent the Appraisal Institute's interpretation. The appraiser is provided four "must considerations" when evaluating market needs:

* Trends in the market area

* The history of zoning requests

* Uses that are not compatible with the existing land uses in the area

* Land assemblage, removal of structures and new construction in the area

He or she must, in reality, keep in mind that the above four items are generally considered to be market driven but in reality each consideration can be subject to direct manipulation by the local jurisdiction.

Two additional items are presented that are subject to direct manipulation by the local jurisdiction:

* Documents such as the comprehensive or master plan

* Uses for which zoning requests have been denied.

According to The Appraisal of Real Estate, an appraiser preparing a "land development forecast" for the area "must fully disclose all pertinent factors relating to a possible zoning change, including the time and expense involved and the risk that the change will not be granted." This statement of disclosure should refer to market conditions and financial feasibility and not the personal views of individuals (zoning officials) who may or may not consider market conditions and financial feasibility.

The appraiser is instructed to "fully disclose all pertinent factors relating to a possible zoning change ...." Such reporting of the facts requires expert knowledge about the property market and the financial feasibility of the uses on the property. The appraiser can report the value of the property in a current and legal use, as well as in a future use, be it legal or not. The difference in value gives the owner important information that can be used in the decision to seek a rezoning. The appraiser can report a rate of return on the use of the property in a current and legal use as well as in a future use, be it legal or not. The difference in these yield rates gives the owner important information that can be used in the decision to seek a rezoning.

The exact "probability of rezoning" is the concern of the property owner, not the analyst or the appraiser. The analyst and the appraiser provide facts about the financial feasibility of the project in the form of property market value, residual values to the land and/or rates of return. The property owner evaluates these facts (with or without the advice and assistance of the analyst or appraiser) and makes the judgment about the "probability of rezoning."

However, if the market analyst or the appraiser has to step into the issue of the "probability of rezoning" (an educated guess about the action of the entity with powers of manipulation), a standard practice, or "well documented technique" is needed for making the determination. This is the discussion of a subsequent section. But first, a short discussion of the zoning ordinance and the rezoning request seem to be in order.

THE ZONING ORDINANCE AND THE COMPREHENSIVE LAND USE MAP

The zoning ordinance and the comprehensive land use map are developed with the best of intentions. As a police power of the local jurisdiction, the zoning ordinance serves the public interest by eliminating incompatible land uses that would reduce the property values of the citizens of the local jurisdiction. The key word is "incompatible" and the connotation of the word, which economists term "negative externalities," is a land use that has a reducing effect on the market values of adjacent and proximate properties. Often the intent of a zoning ordinance is interpreted as a deliberate act to separate different land uses from each other. Residential land use here, commercial land use there. As a matter of fact, this is the underlying premise when the zoning map is drawn. But economic sense must be applied to the boundaries between land uses. Property value is not singularly affected by the land use on the adjacent property. It also is affected by the land uses in close proximity as well. (2)

Let us consider a hypothetical illustration (Exhibit A below) to explain how zoning ordinances can separate different land uses. In our hypothetical situation, residential and commercial land uses are economically compatible. Households need retail and retail needs customers.

A subject site, let's call it "Commercial Site S," is being considered for rezoning from residential to commercial.

Will the rezoning of the subject property negatively affect the property values in the residential area? Not if the commercial use is needed by the community and is generally in line with the existing retail and other commercial uses in the commercial district. Will the rezoning of the subject property to commercial negatively affect the property value of property "X"? No more so than if the subject was affected by its location adjacent to the commercial district. If any negative effect occurs, it would be minor because the property is already located in close proximity to the commercial land users.

[GRAPHIC OMITTED]

If the commercial district does pose a negative impact on the residential area, the property values should increase with distance away from the commercial land use. This consequence can be investigated in the market area. Observation will generally show that value change will be gradual with small differences among the properties in close proximity to the commercial land uses. At a certain distance, say 1,000 feet, the negative effect should dissipate.

Should the subject property be rezoned? Yes, as long as the proposed commercial use is compatible with both the residential area and the existing commercial district, and the market demands the use to which the subject will be put.

The point of this example? The zoning ordinance is an economic tool. It is driven by the desire to maintain and protect property values and it affects property values. It is supposed to take the market into consideration when the zoning map is drawn and when rezoning requests are being considered. If the local economy and the local property market are dynamic and the changes are for the better and compatible and conform to the existing conditions, the zoning ordinance should be able to change to reflect the economic changes in the geographic market area.

EXPERT DETERMINATION OF THE 'PROBABILITY OF REZONING'