By Narendra Srivatsa
A map of the United States reveals lines both straight (think Colorado) and crooked (New Jersey) that divide the states and describe their borders. The straight lines unerringly have been drawn by the hands of a surveyor or lawmaker; curves and squiggles tend to be outlines of rivers and coastlines, the borders decided by the hand of nature.
In the same ways, zones in cities separate residences from industries and businesses and tend to be an unpredictable combination of straight and squiggly lines of both deliberate planning and happenstance. But every line still carries meaning. Unlike state borders that may be set in stone, urban zoning can shift — and often suddenly — to reflect changes in demographics, redevelopment strategy, political leadership, or other emerging realities. In those unexpected revisions, zoning maps can often be redrawn to introduce tangible opportunities for investors and developers that previously could only be imagined.
If looking through the right lens, an investor may be facing a map of hidden treasures. But how best to read that map? Without insider information or close watch of a given zone, it’s not very practical to try to predict proposals for rezoning. At the time of a commercial real estate sale, attorneys routinely use zoning reports for due diligence and as a relatively straightforward tool in legal compliance, and often not much more. Yet that practice vastly undervalues the importance and usefulness of a report’s information. For investors, a zoning analysis can be a leading predictor of value, because a zoning change can often signal an approaching market shift or a region’s growth potential six months or more ahead of time.
New zoning rules can change market conditions, create submarkets, and affect areas not subject directly to the new rules. Understanding the details can potentially help anticipate risks and opportunities associated with growing markets, saturated markets, and alternative uses. That’s how advantages in the competitive real estate market are often derived. Straightforward as they may be, the reports can prove to be a highly cost-effective element of a transaction, since they’re among the cheaper tools available when compared with property condition assessments, appraisals, and title reports. Zoning analysis done early has the potential to help avoid these transactional costs and provide insight useful in negotiating prices.
Expansion of commercial zones is frequently a strong indicator of economic growth, often leading to higher employment and a vibrant outlook for an area. For investors in the right property sector, returns can be tremendous. For example, if a large office building comes in as part of a zoning expansion next to a multifamily complex, the complex can likely achieve higher rental income and fill its vacancies. But if a poorly maintained property is located near a new multifamily complex, the rezoning can lead to lower rents for the older units and harm investment.
Zoning reports can also raise awareness of important nuances that sometimes come from zoning changes. Rezoning around burgeoning transportation hubs, known as transit-oriented developments (TODs), serves as an example. TODs can be created when the area around a transit center is rezoned to offer a high density of commercial and residential buildings that didn’t previously exist at the location. These often offer new opportunities for businesses to tap into an expanded market. In Connecticut, the struggling city of Meriden, which sits along the Hartford rail line, began rezoning and revitalizing its downtown to take advantage of the state’s rail program long before the first commuter train arrived. Smart property owners who saw the railroad coming positioned themselves to capitalize on the opportunity.
An example of the “build it and they will come (and rezone at a later date)” attitude has appeared in Red Hook, Brooklyn, a neighborhood that not long ago was believed to have everything against it. Virtually inaccessible by subway, Red Hook was hemmed in by a high-crime area and a highway. Yet, it did have several features in its favor, including picture-postcard views of New York’s harbor, numerous warehouses from the Civil War era, and a hybrid concept based on current and future zoning.
Red Hook’s vision was to repurpose existing commercial and industrial buildings for artists and events within current zoning regulations — then wait for interest and commercial demand to follow, when zoning questions could be revisited. And for the most part, the rezoning proved to be a more easily attained “down-zoning” from industrial to residential and commercial designations. With the creation of a special mixed-use zoning district, that strategy appears to be paying off with stores (including major national retailers), galleries, multifamily complexes, and offices in rejuvenated warehouses, as well as ferry service to augment new bus routes. The popularity of Red Hook’s creative reuses has boosted interest from investors and led to still more reuse.
So, rather than land barons dictating areas of growth, a new model is emerging in which investors can spot opportunities through an understanding of the current zoning code and the likelihood of favorable rezoning in the future. Another example is Long Island City, which sits within view of Manhattan and was once a mixture of low-rise industrial buildings, commercial garages, warehouses, and a smattering of small residences. Known for automobile factories and heavy industry in the early 1900s, the area morphed into warehouses, taxi companies, and light manufacturing. Despite its desirable location and availability of land, the area was largely ignored by commercial office and multifamily real estate developers for decades. By 1990, Citibank had built a pioneering 48-story office tower, but the building was not followed by comparable developments until the early 2000s.
Since 2005, Long Island City’s river views and single-subway-stop ride into midtown have attracted office buildings, residential high-rises, and hotels. When a pioneering developer was asked what drew him to the area, he replied that he simply “looked at a map.” He saw that the location and its accessibility to New York City, coupled with large tracts of single-story industrial buildings, were ripe for development, even if — at that moment in time — its zoning was not.
When zoning laws restrict growth in high-density regions, it’s important to understand the effect that it can have on individual properties. The rules may reduce the amount of rentable space possible if a structure is destroyed or severely damaged. Some properties have lost more than 20 percent of rentable space in such situations, leading to lower income, reduced property values, and even potential defaults.
Many large cities have height restrictions, setback requirements, or considerations for public space. Buildings erected before code changes might not retain their grandfathered status and may have to adhere to new restrictions. Zoning changes can limit new construction or structural changes that can affect a certain percentage of the property or its value. Limitations can include floor area ratio (FAR), which governs the relationship between a building’s area and the lot it sits on and curtail the amount of rentable space for rebuilding on the same footprint. A 30-foot-tall building rebuilt to only 20 feet loses a considerable amount of rentable space, income, and property value — and that’s valuable information.
A careful analysis of local zoning regulations can suggest alternative uses for properties. Market evolution is generally based on the local economy, demographics, and macroeconomic factors; and in some cases, an aging office building could bring more revenue as a multifamily dwelling. Zoning laws may limit changes, present legal hurdles, or increase costs. A property owner who can adapt to supply and demand — and has the flexibility to repurpose a property — often stands to gain a strong market advantage.
In another iteration, rezoning is opening up fallow land to develop new corporate parks, offices, and multifamily structures. Communities typically announce those changes months ahead of any groundbreaking. Long before a ceremonial shovel hits the dirt, careful analysis of the larger region, current zoning, building stock, and growth patterns can help identify areas where change can be influenced or might be in the offing.
Zoning overlays, which superimpose proposed changes to a zone (such as height restrictions for buildings), typically acknowledge and often encourage change by allowing alternative uses for properties; and those overlays can very often be done by the local government, without state involvement. A player able to transform a low-rise office building into a retail center — without undue delays from zoning regulations — will likely gain a strong advantage in the marketplace. What may have seemed status quo can suddenly show fresh potential, and an ordinary zoning map is transformed into a map of unexploited treasures — and projects ready for forward-thinking developers and investors.
Narendra Srivatsa is director of product development for Verisk Commercial Real Estate.