Land Use Regulations and Valuation

Chapter: Land Use Regulations and Valuation

Introduction

This chapter delves into the intricate relationship between land use regulations and land valuation. Land use regulations are governmental controls influencing how land can be utilized, impacting its potential and consequently its value. Understanding these regulations is crucial for accurate appraisal and development decisions.

1. Land Use Regulations: An Overview

Governments employ land use regulations to promote planned growth, ensure compatibility between different land uses, and protect public interests. These regulations dictate the permissible activities on a parcel of land and influence its development potential.

• Forms of Land Use Regulations:

  • Zoning: Zoning ordinances classify land into districts (e.g., residential, commercial, industrial) and specify permitted uses, density, and building height within each district.
  • Subdivision Regulations: These regulations govern the division of land into smaller parcels, ensuring adequate infrastructure and compliance with planning standards.
  • Building Codes: Building codes set minimum standards for construction, ensuring safety and structural integrity.
  • Environmental Regulations: These regulations protect natural resources and limit development in sensitive areas.
  • Historic Preservation Regulations: Regulations protect historically significant properties and districts from inappropriate development.

• Master Plans and Comprehensive Land Use Plans:

Many jurisdictions have master plans or comprehensive land use plans outlining long-term development goals and policies. These plans provide a framework for land use regulations and guide future development decisions.

• Development Approvals and Entitlements:

Real estate developers often require approvals from public agencies before proceeding with a project. This process involves submitting detailed development plans and obtaining zoning and building department approvals. Citizen groups can influence the approval process, potentially affecting the project’s design, cost, and timeline.

• Impact on Land Value:

The value of land typically increases after formal site plan approval and permit issuance, signifying that the site has full entitlements and is ready for development. The entitlement process removes regulatory uncertainty, making the land more attractive to developers and investors.

2. Government Powers Affecting Land Value

Governments possess certain powers that can significantly impact land value:

• Eminent Domain:

The government can acquire private land for public projects or economic development through eminent domain. This power allows the government to take property even if the owner is unwilling to sell, provided just compensation is paid.

• Transferable Development Rights (TDRs):

TDRs allow landowners in designated sending zones (e.g., agricultural areas) to transfer development rights to receiving zones (e.g., urban areas). This mechanism can affect land value by shifting development potential from one location to another.

• Tax Policies:

Preferential tax treatment for certain land uses (e.g., agricultural land) can influence land value and development patterns. Lower property taxes can incentivize landowners to maintain agricultural uses.

3. Easements and Restrictions

Easements and restrictions on land use can permanently affect its value and development potential:

• Conservation Easements:

Conservation easements restrict development on a property to protect its natural resources. These easements are typically held by government agencies or land trusts and can significantly reduce the land’s market value.

• Open Space Easements:

Open space easements preserve land for recreational or aesthetic purposes, limiting development potential and impacting land value.

• Water, Mineral, and Air Rights:

These rights represent distinct interests in land and can be bought, sold, or leased separately.

*   **Water Rights:** Govern the use of water resources, impacting agricultural and industrial land values.
*   **Mineral Rights:** Allow for the extraction of subsurface minerals, potentially increasing land value in resource-rich areas.
*   **Air Rights:** Enable development above existing structures, particularly valuable in dense urban environments.

4. Physical Characteristics and Site Improvements

Land becomes a “site” when it is improved and ready for a specific use. Physical characteristics and site improvements affect the use and value of the land.

• Physical Characteristics:

  • Size: Larger parcels may have different development potential and unit values compared to smaller parcels.
  • Shape: Irregularly shaped parcels may be more difficult to develop and less valuable.
  • Frontage: The amount of street frontage can impact commercial property value.
  • Soils: Soil conditions affect the suitability for construction and agriculture.
  • Location: Proximity to amenities, transportation, and employment centers influences land value.
  • View: Desirable views can increase property value, especially in residential areas.
  • Topography: The slope and elevation of the land impact development costs and potential uses.

• Site Improvements:

On-site and off-site improvements can enhance a site’s usability and value.

*   **On-site Improvements:** Include grading, drainage, utilities, and landscaping.
*   **Off-site Improvements:** Include roads, sewers, water lines, and public transportation.

5. Highest and Best Use Analysis

Land valuation is closely tied to the concept of highest and best use. The highest and best use is the most probable and legal use of a property that is physically possible, appropriately supported, financially feasible, and results in the highest value.

• Valuation as Though Vacant:

Even if a site is improved, it is often valued as though vacant and available for development to its highest and best use. This approach facilitates a systematic analysis and solution of appraisal problems.

• Impact of Existing Improvements:

The value contribution of existing improvements is determined by subtracting the market value of the site from the market value of the property as improved.

• Holding Land for Future Development:

Sometimes, the highest and best use of a property is to keep it vacant until land values rise to support new development.

6. Excess and Surplus Land

Understanding the distinction between excess and surplus land is critical for accurate valuation:

• Excess Land:

Excess land is not needed to support the existing improvements and can be sold separately. It has its own highest and best use and must be valued accordingly.

• Surplus Land:

Surplus land is not needed to support the improvements but cannot be sold separately. It may or may not contribute value to the overall property.

7. Land Valuation Techniques

Several techniques are used to value land, each with its own applicability and limitations:

• Sales Comparison Approach:

This is the most common and preferred method when comparable sales data is available. It involves analyzing sales of similar vacant parcels, adjusting for differences in property rights, financing terms, market conditions, location, physical characteristics, and zoning.

Example: Suppose you are appraising a 1-acre vacant lot zoned for single-family residential use. You find three comparable sales:

*   Comparable 1: 1.1 acres, sold for $100,000, similar location.
*   Comparable 2: 0.9 acres, sold for $90,000, slightly better location (adjust -5%).
*   Comparable 3: 1.0 acre, sold for $95,000, sold six months ago (adjust +3% for market appreciation).

Adjustments are applied to the comparables to reflect differences from the subject property. After adjustments, a value range is established and reconciled to arrive at an estimated value for the subject property.

• Market Extraction:

The contributory value of improvements is deducted from the total sale price of a comparable property to arrive at an indicated land value. This technique is most applicable when the contribution of the improvements is small and easily identifiable (e.g., in rural areas with minimal improvements).

• Allocation:

A ratio of site value to property value is extracted from comparable sales in competitive locations and applied to the value of the improved subject property. This method is often used for valuing residential lots where ample sales of improved properties are available.

**Formula:** Land Value = (Land Value Ratio) * (Property Value)

The land value ratio is estimated from comparable sales of improved properties.

• Land Residual Analysis:

The net operating income (NOI) attributable to the land is capitalized, or the cost to construct an improvement is deducted from the value as if completed to produce an indication of the land’s contribution to the total property. This technique is applicable in financial analysis of alternative uses of a particular site and when land sales are not available.

**Formula:** Land Value = (Property NOI - Building NOI) / Land Capitalization Rate

Where:

*   Property NOI is the net operating income of the entire property.
*   Building NOI is the net operating income attributable to the building.
*   Land Capitalization Rate is the rate of return expected on land investments.

• Ground Rent Capitalization:

A market-derived capitalization rate is applied to the ground rent of the subject property. This method is useful when comparable rents, rates, and factors can be developed from an analysis of sales of leased land.

**Formula:** Land Value = Ground Rent / Capitalization Rate

Where:

*   Ground Rent is the annual rent paid for the land.
*   Capitalization Rate is the rate of return required by investors in leased land.

• Subdivision Development Analysis (Discounted Cash Flow Analysis):

Direct and indirect costs and entrepreneurial incentive are deducted from an estimate of the anticipated gross sales price of the finished lots or units, and the net sales proceeds are discounted to present value at a market-derived rate over the development and absorption period. This technique is applicable when subdivision development is the highest and best use of the land and there is market support for immediate absorption.

**Formula:**

PV = ∑ (CFt / (1 + r)^t)

Where:

*   PV is the present value of the land.
*   CFt is the net cash flow in period t (sales revenue minus development costs).
*   r is the discount rate.
*   t is the time period.

**Note:** This method requires significant amounts of data such as development costs, profit margins, sales projections, and the pricing of developed lots or units, together with a supportable forecast of market absorption.

8. Conclusion

Land use regulations play a vital role in shaping land value and influencing development patterns. Appraisers and developers must understand these regulations and their impact on land valuation to make informed decisions. This chapter provided an overview of land use regulations, government powers, valuation techniques, and their applications. The sales comparison approach remains the preferred method when adequate comparable sales data is available, while alternative methods can be used when sales data is limited or when evaluating specific development scenarios. Understanding the principles of land use regulations and valuation is crucial for successful real estate appraisal and development.