Land Restrictions Affect Value
Understanding potential uses of real property is valuable information. With this information, for example, you may confidently pay a premium for a single family home knowing you can build a multi-family rental property in its place. However, you must determine your rights to redevelop the property by examining land use restrictions such as municipal regulations, including zoning and environmental regulations, rights of access to the property, and lease restrictions.
Zoning regulations may restrict use of the land to residential or commercial or require zoning board approval of your intended uses. They may also limit the dimensions of a proposed structure to a particular land area on the property and define minimum width for access to the property. A title examination and survey will identify an owner’s rights of access to the property. Leases may limit the landlord’s rights to develop the property with restrictions for tenants.
Any number of land use restrictions could delay your project, increase your carrying costs and create uncertainty about your intended redevelopment plan. If land use restrictions apply, you may own property worth less than the amount you paid for it.
Tenant Restrictions May Prohibit Development
In a recent deal, my investor client intended to purchase a neighborhood shopping center with several tenants and to reconfigure the site with an anchor tenant in five years. With current leases expiring within two years, the investor intended to extend each lease using its standard form contract which provided the landlord with favorable rights to relocate each tenant and to redevelop the site.
During our due diligence of the Seller’s records, we discovered an informal letter agreement in which the landlord agreed to extend the lease of a tenant that occupied a large space on the site. The extension provided for an additional five-year term with five options to further extend the term for five years each, which essentially prohibited development of the site without the tenant’s approval for 30 years.
After several hours of negotiation with the seller’s counsel and tenant’s counsel before the closing, the investor secured an amendment to the existing lease to incorporate certain conditions to relocate the tenant and to include the investor’s standard contract development language. If proper due diligence had not occurred, and the investor purchased the shopping center without the relocation language in the lease, the tenant could restrict the investor’s redevelopment of the site. This would significantly reduce the landlord’s control and value of the shopping plaza.
4 Essential Due Diligence Items
Thorough land due diligence will identify limits to the development potential of land. The following four items are essential in your due diligence research:
- Zoning restrictions. Obtain a zoning certificate from a third party provider or a zoning verification letter from the municipality where the property located. Review the zoning ordinance or bylaw to determine whether the current use and dimensions of the existing building are allowed. Determine whether the future use and dimensions of the proposed development on the property are allowed. If any of these uses are not allowed, determine the procedure to obtain zoning relief. During this review, inquire with the municipality about any known violations of applicable regulations such as the building code, parking ordinance, or historic preservation restrictions.
- Legal access. Confirm access to the property through a public way by a title examination and survey of the property. If a driveway provides access to the property, verify the path constructed within the lot lines of the property. If the street is built on another land, establish a valid recorded easement covering the entire driveway provides access to the property. A valid recorded easement must set forth the time of use, purpose of the easement, and the area of the easement depicted on a plan.
- Current Leases. If you intend to develop the property, review all contracts and related correspondence between the landlord and tenants. Determine the expiration date of each lease, if each contract terminated at will or if the leasing arrangement is month-to-month. If a lease term is beyond the time of the development plans, determine if there is a right to relocate the tenant in the lease. As I described in the example above, a lease or written agreement to extend the lease term without a right to relocate may have a significant impact on the timing and cost of the development.
- Seller’s Documents and Knowledge. The purchase agreement should obligate the Seller to provide all documents about the property and to disclose any information within Seller’s knowledge that may materially affect the property. Request and review any notices of possible litigation, legal violations, environmental reports, or other Seller disclosures. Explore any issues that may impact the purchase and development of the property.
Spending the time and money in the short term for your due diligence of the existing and future use of the property before your acquisition will save significant time and money in the long run.
Have you discovered any land use restrictions that affected your developments plans? You can leave a comment by clicking here.