Zoning Practice — March 2006

Ask the Author

Here are reader questions answered by Tony Smith, AICP, and Steve B. Friedman, AICP, authors of the February 2006 Zoning Practice article "Market Analysis: A Zoning Necessity."

Question from Lodie Venter, Pretoria, South Africa:

I am a town planner in Pretoria, South Africa. I am very interested in the issue of market and economic forces in city planning. The South African planning environment is extremely control-centered. The local property market is booming, but applications are subject to the view and opinion of the municipality. I enrolled for a Master=s degree in real estate at a local university. My thesis will focus on market and economic forces in city planning. I want to address the impact of restrictive policies on property values.

Answer from author Tony Smith:

Lodie, that's a very broad question, on which there are a number of excellent academic resources. I don't probably have much to add to that debate. Certainly, restrictive policies can diminish the value of individual properties. In the aggregate, these policies may have more of a redistributive effect on land values — directing more value into areas where significant development is permitted versus those held in agricultural preservation, for example. There's also the issue of whether unregulated areas are less valuable in the long run because development is more haphazard. My reaction would be that development regulations are useful and beneficial. However, they have historically been abused. In many cases, the highly detailed and discretionary form of regulation you describe in your question can be achieved through high-quality development codes that make the development process much more predictable and efficient. It is interesting to consider the lack of universal consensus on certain "big picture" development issues that is at least implied through the wide variation in land-use regulations that exist throughout the world. For example, some zoning codes include minimum setbacks, while others have "build to" lines and minimum building heights. Minimum parking standards are almost universal in the U.S., while maximum parking standards are apparently common in the UK.

Question from Douglas Wicks:

How could the potential economic impact and evaluation of creating a building envelope with sufficient remaining unconstrained land area after the new home has been constructed be evaluated? Are there any baselines to determine what amount of remaining unconstrained area is needed to establish a value for this future potential?

Answer from author Tony Smith:

I'm not 100 percent sure what you mean when you say "sufficent remaining unconstrained land area." It sounds like you are referring to a process of sizing building envelopes on being developed today to accommodate future teardown and replacement with a larger unit and/or accommodate additions to the primary home.

I have not attempted such an analysis, and if I'm interpreting your question correctly, it is a complex one. Let's say that the prototypical home under consideration for your analysis is 3,000 square feet. If your zoning envelope allows a 4,000-square-foot house and there is demand for that larger unit today, the market will probably deliver that larger unit today instead of the 3,000- square-foot unit in order to maximize profit and land value. If demand does not exist today but may develop at some unspecified point in the future, any value boost would be based on fairly long-term speculation that some day demand will exist for larger units in this location, and that additions or teardowns will occur if allowed by the building envelope. It is conceivable that the buyer market would recognize the additional development rights through a higher relative value today, but this sounds to me like a relatively subtle point in the eyes of a residential home buyer. However, if the larger envelope were perceived as allowing "overbuilding" of residential lots, the potential value enhancement could be negated by the threat that neighboring lots could be similarly redeveloped, reducing the overall attractiveness of the neighborhood in the market.

Since markets can vary substantially from place to place, I would suggest consulting a few local appraisers to see if future home expansion rights would cause them to apply an upward adjustment to value as compared to a comparable property without such rights.

If your example pertained to an existing built-out community with significant teardown pressure, the answer would be quite different. Increasing the allowable envelope in an area with these characteristics can have a dramatic effect on property value. This type of analysis would follow the same residual land value analysis structure as outlined in our article:

Sale price of new home allowable within development envelope
Less cost of developing this unit
= Residual land value

Residual land value
Less "as is" value of property
= Potential value boost from up-zoning

Question from Ayanna Fortson:

I am looking at the various methods of market analysis, and some look at the number of people working in an industry within a specified area in order to calculate a deficit or surplus of a certain market area, such as food eaten outside the home. However, I have had experience measuring this by the size of the stores that are already in an area and what services they provide. Do you see an advantage from one method to the other? If so, what would it be?

Answer from author Tony Smith:

I'm not sure I fully understand the two methodologies you're referring to. In general, market studies should consider both supply and demand issues. For retail products, which seem to be your area of focus, a supply-side analysis would look at the stores existing in the study area and its surrounding trade areas. Ideally, this analysis should consider such factors as:

  • Square footage of existing/planned centers
  • Retail mix
  • Rents
  • Vacancy/occupancy

The demand-side analysis would look at total trade area population and spending, both existing and projected. Based on how much competition exists in the market and the relative competitive position of the site being studied, one can estimate a "capture rate" that the study site could be expected to achieve of total potential market area demand. This, in turn, can lead to conclusions about supportable square footage of retail in specific categories.

For a high-quality analysis with detailed conclusions, all elements described above are necessary. If time or resources are not sufficient to get to this level of detail, a "market profile" can be a useful first step. This type of analysis focuses more on the competitive environment, running on the theory that, if retail is generally successful near the study area, the study area has a similar level of potential. This would be contingent, however, on the study site having competitive assets equivalent to the other nearby sites (e.g. access, visibility, site configuration, adjacencies, etc.).

Question from Christopher Holme, Associate/Planning, Frederick P. Clark Associates, Inc., Rye, New York:

First, I want to thank you both for writing this article. I absolutely agree that understanding the land and housing market is essential for the success of many planning actions, including designing affordable housing regulations, a transfer of development rights program, or the revitalization of commercial areas. For affordable housing, we need to know how much cost the market can bear in terms of requiring that housing be sold or rented at reduced prices, and what level of incentive or density bonus is appropriate and effective. For an effective transfer of development rights program, it is important to come up with a method or formula that can be in touch with changing market conditions over time, and which accurately and fairly determines the value of the development rights to be purchased from the sending areas, as well as understanding their potential market impact for receiving areas. For the redevelopment of a commercial or mixed-use area, knowing the point at which a potential new building's maximum size according to zoning translates into an economically feasible and likely event is very important.

For example, I recently did a development potential analysis of a Main Street for a small city in the New York metro area. We found that 500,000 additional square feet of gross floor area could theoretically be built along Main Street. However, we were also savvy enough to point out that, over the last 30 years, only four new buildings and no additions had been constructed along Main Street, a total of about 20,000 square feet of floor area. What we did not do was predict what kind of zoning or tax incentives would trigger a steady stream of new construction in the Main Street area. While acknowledging variables such as potential increases of residential population near Main Street (which could increase property values for commercial and mixed-use properties) and the ever-uncertain future of the real estate market, an economic feasibility analysis would help the citizens of the city determine a realistic strategy for managing change on Main Street.

My question is essentially, How can I learn more? What are the best resources for a straightforward explanation of the method of economic feasibility analysis, including where to get data and what to watch out for? Can a single method of calculations and analysis be applied broadly to a whole range of similar properties in the same zoning district via a spreadsheet?

Answer from author Tony Smith:

Christopher, I'm glad you got some value out of the article. To do a useful economic feasibility analysis, one would probably require at least a moderate level of understanding of real estate finance and development. This type of analysis is fairly specialized and might require the involvement of a real estate consulting firm. I've seen some planning processes get at this issue via other, more qualitative means, such as having one or more developers opine on the general financial feasibility of a proposed development concept for an area. The economic feasibility process is essentially trying to replicate for planning purposes the "back of the envelope" calculations that developers perform when deciding whether to pursue a given project in a given location. Another way of getting a feel for this is looking at comparable nearby communities that have recently achieved successful redevelopment projects, if such examples are available.

Provided the economic conditions (sale prices, retail rents, land prices, etc) are relatively similar, the uses and densities in these comparable projects may provide some clues as to what formulas may work in your community. To your question, a single analysis should be applicable to a set of multiple similar properties in the same area, provided the properties are not likely to differ too much in terms of:

  • Site capacity
  • Market attractiveness, particularly for retail
  • Underlying value (usually based on existing uses/buildings on site)
  • Extraordinary issues making development more costly, such as environmental contamination, extensive demolition, poor soils, floodplain, etc.

Unfortunately, I don't know of a good written source that specifically describes the process of economic feasibility analysis for planning purposes. However, the Real Estate Development section in Chapter 6 of the APA's new Planning and Urban Design Standards (article also authored by Stephen B. Friedman) does get into some real estate financial analysis methods that are probably relevant to your situation.

Question from Zachary D. Gordon, AICP, Senior Planner - Project Manager, Town of Huntersville, North Carolina:

The Town of Huntersville, North Carolina, collaborated on a Small Area Land Use and Economic Development Plan for an area that is currently undeveloped. As part of this plan, we are calling for an "Employment Center" at a major intersection, which would include offices (50 percent minimum) and storefront retail. A developer has proposed a 100 percent retail development at one of the corners of this intersection and been told that the plan is unacceptable. His argument is that this corner is ideal for retail and he can't understand why we would not allow his proposal. A market study did support the viability of office and other employment development. My question is, How can we best make the case for our land-use vision for this area, in the face of development proposals that are (short-sighted) and inconsistent with this vision.

Answer from author Tony Smith:

Without direct knowledge of the situation, it is difficult to offer definitive comments. I can provide some general thoughts for your consideration that may or not be fully applicable to the specific situation at hand:

It sounds like the Small Area plan that your town prepared included some market analysis indicating that office uses were viable in this location. If this market research is valid, current, and directly applicable to the site in question, the town has legitimate grounds for sticking to its guns and holding out for a mix of uses on the site that includes some office. Some caveats are in order, however. Market analyses tend to have a "shelf life" of about six months, or can be made obsolete by the introduction of new competitive projects within the market area. Also, some market analyses do not get very deeply into the economics or absorption potential associated with the proposed use — in other words, office demand may exist, but only in a very limited way or at rents that are not attractive enough to make new office development attractive to the private market.

Within the overall area designated as "Employment Center," there are probably sites that are more and less appropriate for retail uses, depending on their physical characteristics. Retail viability is highly dependent on traffic (pedestrian and/or auto), visibility, and access. Corner sites can be particularly attractive for retail, as the developer appears to have pointed out. Depending on how the parcels within the designated "Employment Center" lay out, it may make sense to develop 100 percent retail in some portions of the zone and 100 percent office in others, rather than requiring a mix for every individual project. Without benefit of actually seeing the site and reviewing the plan, this is all of course somewhat speculative.

It is also possible that market potential exists for both office and retail uses, but that the economics of developing retail are more favorable to the developer. Particularly at corner locations, storefront uses like banks and outlet retail can often pay significantly more rent than office uses. The developer would naturally want to build the higher-value use. This gets at the difference between "market feasibility" and "financial feasibility" discussed in our February article. Demand for office may exist, but at rent levels that either make the project economically infeasible or much less attractive than the alternative use. Zoning cannot legally remove all economic value from a given site, but by the same token, municipalities are under no obligation to zone property for the uses that would be most profitable to developers and landowners.

I would recommend that you ask the developer to submit backup information documenting his reasons for needing the zoning change/variance. Depending on applicable state law/case law and the type of regulatory relief the developer is requesting, you may be entitled to ask for a very broad set of evidence that the requirement to build office uses causes economic hardship. This could include market and financial analysis commissioned by the developer. If a compelling case can be made that office uses cannot be profitably developed on the site, the Town may have reason to be more flexible. If office is simply the less attractive of two viable alternatives, the town has every reason to remain firm on the existing use restrictions.

As a final point, it is important to consider the price paid for the land and the expectations underlying that price. The developer may have overpaid for the site under the assumption that he could get a rezoning or variance. The town probably does not want to get into the business of rewarding land speculation.