Appraising development sites: With and without entitlements - by Thomas Jensen

Appraisers are often asked to estimate the value of urban parcels under two scenarios: As is and subject to the owner obtaining specific development entitlements. However, larger development sites tend to have a limited number of recent comparable transactions available for review. Therefore, a paired sales analysis of sites with or without entitlements is not always possible. In addition, changing market conditions rapidly impact land values making sales that closed only 12 months ago less reliable as an indicator of the current market value.

Entitlements are one of the most important factors contributing to a site’s value. Owners often seek Planned Development Area (PDA) or Planned Unit Development (PUD) zoning status to allow for a higher intensity of development typically making the property more valuable. These entitlements often require the developer to provide some form of impact compensation to the community such as a higher ratio of income-restricted residential units, community space or off-site improvements. The cost of these special requirements needs to be confirmed and carefully considered for later use as adjustments.

The first step would be to determine if the best comparable land sales had permits in-place at the time of transfer. Assuming the best comparable sales had entitlements, the subject valuation analysis would then estimate the value of the site accordingly followed by expense deductions related to the entitlement process in order to arrive at an “as is, non-entitled” value.

The deductions used to calculate these adjustments typically have the following steps.

The buyer would likely be required to make a good-faith deposit based on a percentage of the property sale price. The length of the entitlement process needs to be estimated based on the permitted time of similar size projects within the local municipality or submarket. The prospective buyer would likely require a certain annual return on their good-faith deposit during the entitlement process. The annual return on the good faith deposit would be considered necessary given the potential risk from potentially changing market conditions over that period. In addition, the outcome of the entitlement process would be unknown and may result in a less desirable mix and ratio of uses.

The deposit amount, length of entitlement process, and rate of return can be supported through conversations with real estate developers active in the local market for projects similar in size to what would be potentially approved on the subject site.

The soft costs related to the permitting process and infrastructure hard costs related to a project development need to be deducted. These estimated soft and hard costs can also be supported through conversations with real estate developers. It should be noted that infrastructure costs related to the Fan Pier and Seaport Square PDA’s ran $10 to $15 per s/f of potential building area. Higher density projects typically incur lower infrastructure cost per s/f of potential building area than that of a lower density development.

These deductions made to the fully entitled site value typically indicate a reliable value estimate of a site without entitlements. It should be noted that the percentage difference in value between sites with and without entitlements diminishes in higher value locations.

Most developers are reporting a sharp increase in construction costs diminishing their ability to pay as much for sites placed under agreement 12 to 18 months ago. Although the regional economy remains strong, downward time adjustments to comparable land sales are becoming necessary for certain use categories the first time in several years due to these rising construction costs.

So what are entitlements worth after market conditions change and the permitted use is no longer financially feasible? The owner can hold the site until market conditions recover. However, there is no reliable method to support the required recovery time. In addition, the holding costs will substantially diminish the eventual prospective value. The large number of variables makes any value estimate for a non-financially feasible use unreliable. Assuming an alternative use may be currently financially feasible, it becomes necessary to restart the site’s soft and hard cost deduction process for the alternative use.

Having appraised several large development parcels in central Boston and Cambridge, consulting with developers and municipal planners is vital to understanding the likelihood of project approvals and development costs helping to estimate a reliable market value.

Thomas Jensen, MAI is an associate director at Integra Realty Resources, Boston, Mass.