Highest & best use question?

[Doug in NC]

A client intends to buy 2 currently-zoned residential properties with older dwellings on them (adjacent to his commercial property, both are now occupied residential homes in average condition) and convert them to a commercial-type use. Although, a commercial-type use would be the highest & best use, since they are currently zoned residential, can their highest and best use be commercial if appraised "as-is"?

It is likely that these properties could be converted to the desired commercial use since there are other commercial properties in the vicinity, but it cannot be said with certainty. With the present residential zoning in place, can it be said that highest and best use is as commercial? (commercial land sold as vacant would be more valuable than the current property which is zoned residential)

If highest and best use is commercial, does it make sense to give much value to the present residential improvements since they would (at a minimum) need to be converted for office or institutional use. My guess is that the buyer would raze the dwellings and replace them with new structures. Leaving the current residential structures would be out of character with the current structures on adjacent commercially-zoned properties. So, if commercial zoned, I would anticipate a cost to clear the land for commercial use rather than add the value of the present depreciated structures.

 

[Bobby Bucks]

..........legally permissible..............

 

[Austin]

The guy purchasing the two properties has already answered your question for you. Highest and best use is interim residential with speculative future conversion to commercial use. I could tell you some interesting stories about residential lots and buildings with the wrong zoning that could not be changed then being changed within six months. This is America. It is whom you know and how much you contribute.
One example: My dad was a real estate broker. He purchased an old house because it was near a commercial district and adjoined about 80 acres of undeveloped land opposite the commercial district that was zoned residential. He tried to get it rezoned commercial but the zoning board told him it was impossible, so he sold it. Six months later the 80 acres was re-zoned from single family residential to C-2 commercial. Guess what is on the land now? Wal-Mart, the regional mall, and the largest commercial district in Southside Virginia. Land prices start at $8 per square foot. I could go on all night. Never say never in a democracy, especially in NC.

 

[Joker]

Doug, I agree with Austin, the highest and best use is most likely an interim use. In order to appraise this property, you will have to compare it to other such sales where an investor speculated that the zoning could be changed. If there is reasonable probability that the zoning will be changed (interviews with the zoning board, applications filed, etc.), it can be appraised subject to the special assumption (hypothetical condition) that the zoning is changed to whichever commercial zoning classification is to be applied for.

 

[bradellis]

Doug,

All this talk about an "interim" use is useless. Highest and best use is highest and best use- as is. Period. What you are talking about here is really two or more assignments. Assuming a higher and better use in the future, as suggested by our friends, would require a crystal ball. Do you know what market demand for such a use would be in the future? Did your client ask you to forecast this?

Assignment one (or one and two): appraise the subject properties as a single unit- by that I mean land and building. Two appraisals- one for each parcel. IF current use indicates that the improvments contribute anything at all to value, current use is highest and best use. You test it by seeing if removing the improvments in order to replace them with something else will produce a higher value than the current value with the improvements included. It is an economic test. IF there is value to the improvments, then it follows that the combined value (land and improvements) are worth MORE than the land alone under the alternate use. This is, or at least was, called the Consistent Use Theory.

Next assignment is to determine if removing the improvements, combining the lots, and putting it to a commercial use produces a higher value than the sum of the two parcels under current use (plottage). Although residential now, you can do this by using a hypothetical condition.

If the owner intends to keep the parcels separate, and keep the improvments intact (i.e. converting the homes to offices, like lawyers digs, or even retail stores), all that would be required is a change in zoning. Again, since you KNOW it is not currently allowed, use a hypothetical.

brad Ellis, IFA,RAA

 

[Jim Bartley]

I have to agree with Doug Walker on this. You cannot stick your head in the sand and ignore what is probable, regardless of the current zoning. Also, he is correct and saying you need to find similar properties for comps (principal of consistent use).

 

[Ray Ohler]

However, it isn't going to help you much unless the lender wants an "unsaleable" piece of paper, that is, in the "normal" secondary market. There are 10,000 "financing programs" out there. One will fit but you have to do an "in depth" H&B Use Study. If after your analysis the determination is that conversion to commercial is its H&B Use, then you have to appraise it that way and the report would be subject to a "hypothetical condition". Once again, if a local run of the mill mortgage broker is trying to put the deal together you could have a big problem, which they won't want to hear about, not to mention that you'll be working for 50 cents an hour.

 

[George Hatch]

In regards the the concept of appraising it as other than it's existing zoning,

"... existing land use regulations, reasonably probable modifications of such land use regulations..."

The difference in value of the 80 acre site mentioned a couple posts up was that one owner made their decision based on the "as is" condition of the site, whereas the other owner threw the dice and made the right connections to get the speculative value. Both were right, based on their relative degrees of risk aversion. The 2nd owner could have just as easily struck out and wasted a lot of time and money to go nowhere. In fact, it may be that the 2nd owner's actions to achieve their ultimate value involved unforeseeable, unethical and even illegal behavior. An appraiser could not possibly be held accountable for these conditions and might even be taken to task for participating in such a scheme.

I agree with Brad. Unless the appraiser has some specific indications, other than the owner's say so, that the existing zoning could be legally changed, there is no way they can responsibly make that assumption. If there is a pending request for zoning change that has been tenatively approved, that's one thing. The market participants and the appraiser would make that assumption with a reasonable degree of confidence. If there are other examples of the zoning authority making such changes, or if there is some provision in the zoning regulations that would support a reasonable expectation of such a change, then that's another example. The owner or buyer's assertions that it can be done does not fall within those conditions and an appraiser could not rely on them enough to make such an assumption in an appraisal, although they should be mentioned in the report. If there isn't such an indication somewhere in writing or in example, there is no way the appraiser could articulate a reasonable expectation.

Again, my personal preference is that if there is any doubt, the appraiser should report both values ("As Is" and "Subject To") and let their client make their own decisions. If it turns out well and the changes are made, the appraiser is right. It it turns out badly and the changes can't be made or can't be made in a cost effective manner, the appraiser is still right.

George Hatch

 

[George Hatch]

OOPS!

I left out a comment in my comment above.

"... existing land use regulations, reasonably probable modifications of such land use regulations..."

Notice the above phrase from USPAP does not mention "reasonably possible", instead sticking with "reasonably probable".


George Hatch

 

[Austin]

Some of you guys have apparently never heard of the anticipation and change theory. Here is how re-zoning works in this market. If I own a site vacant or improved and it is zoned R-1 single family residential and the area is in transition to commercial, I cannot just ask for it to be re-zoned. To get it re-zoned I have to submit a development plan showing what commercial use I intend to put on the site and request re-zoning. You can’t just walk in and say I want my property rezoned. To further complicate matters, almost all such sales in this market of this type come about by the purchaser taking an option on a property zoned residential subject to re-zoning based on their plan of development. A local church just purchased a tract zoned R-3 multifamily residential and re-zoned it to R-1 single family residential. This creates a big appraisal problem because sellers are selling sites zoned residential and the purchaser purchases a site zoned commercial and another sells a site zoned multifamily residential and the purchaser down zoned it to single family residential. How would brad and George handle that? Most re-zoning request are approved, but the town council due to objection of adjoining residential property owners turned down one last night. The entire strip is going commercial as outlined in the city’s development plan but they voted 7-2 to turn down re-zoning to commercial. The city plan says one thing and the council is voting against their own development plan.
Another interesting feature of this market is that new commercial land is being created. A local developer moved a large hill across the road and filled in a river bottom creating a new commercial development and a new commercial development was created where the hill was. All of this right in the middle of a large commercial district. How do some of you guys handle increasing supply of commercial sites or land with this potential? Add to this the local population has not changed in the last 25 years but we have one of the highest commercial development rates in the region.
Again I ask, “Where is the uniformity in USPAP when differing zoning laws necessitate different approaches to appraisal problems?” Our different experiences reflect our different opinions on this question, so who can say who is right and who is wrong?