Have you ever wondered what impact zoning laws might have on the property value of a commercial real estate investment? In this video you'll learn the importance of zoning and get an inside look into an investor's strategy to change the zoning (aka rezoning) for big profits.
What is Zoning and Why is it Important?
Zoning is a set of laws set out by the city or county that regulate land use. One definition states, "Zoning protects the character, safety, and stability of residential, commercial, industrial, recreational, and agricultural areas, and promotes orderly development of such areas." Finding out what a property is zoned for is simple. All you need to do is call the city's zoning office, give them the address, and they will tell you exactly what the property is zoned for and what can be built on it.
Example of How Zoning Impacts Investors: Rich and Diane inherited 4.85 acres of lakefront property. The property has an older 20-unit apartment building, and the total value is $4 million. Since the property has no mortgage, Rich and Diane would like to refinance and use the money to add more A-class apartments and utilize the approximately 300 feet of lakefront. Their plan is to build a 12-unit apartment and then a 20-unit bringing the value up to $9 million.
It’s a great opportunity to increase both their NOI and property value, but there's a problem. Their 4.84-acre property is zoned recreational, not residential or multi-family. Any changes made to the property can only be for recreational purposes like camping, hunting, or fishing. They may own the property, but they don’t have control over what they can build on it. Can Rich and Diane rezone this 4.85-acre property to be used for multi-family? Well, when they petitioned for rezoning, the city denied their request. Their desire to build multi-family on this lakefront property didn't fit in with the city's plans for the area.
Location, location, location, or use, use, use?
You've heard it said, real estate is all about location, location, location. And that is true, but for commercial real estate only partially so. Location is important, but just as important as location is zoning. Or as we say in commercial real estate, “use, use, use.” As you can see from my example, zoning and how the property can be used determines how valuable the property can be.
How to Rezone for Big Profits
To illustrate how to rezone commercial real estate for big profits, I will use my protégé student Sam as a case study. He recently purchased a 387-unit RV Storage Facility with the intention of getting it rezoned for expansion. The plan has two phases of rezoning.
Current Zoning: Legal Nonconforming
The property is currently zoned legal nonconforming. This means the property was legally built and used but because the zoning laws have changed it no longer conforms to current laws. So, Sam can keep it there, because it’s been there for so long, however he can’t stop operating it as a RV storage and he can’t make any changes.
Now the current zoning doesn’t gel with Sam’s expansion plans so he will need to get the property rezoned. There are several steps in this phase:
- Obtain a permit for non-conforming because the property doesn't even have a permit yet.
- Hire a zoning attorney understands how city hall works. This is extremely important because this whole project is also political, so you need to make sure you play that game.
- Hire a city planning consultant who understands how the city planning department works.
Sam purchased the facility for $5.5 million and that is the current value.
Phase 1: Rezoning to Conforming for Big Profits
In the first phase, Sam will have the property rezoned from Legal Nonconforming to Conforming. This process will take approximately six months at a cost of $5,000 - $10,000. The goal is to rezone the property so that Sam can add canopies to the units. By adding canopies he can increase the rents $150 to $200 more per month for all 387 units. That will have an incredible impact on Sam's NOI. It will take time and money, but it will boost his NOI 30% to 40%. And it will more than double the value of the property to $12 million.
Phase 2: Rezoning to C3 for Big Profits
In phase 2, Sam plans to rezone from Conforming to C3, which in his area means General Commercial. Again, this transition will take time and money, but it will enable him to build and expand leading to big profits.
Steps to Rezoning to C3
- Amend the property's general plan with the city. To do this he will need to hire and meet with a civil engineer.
- There will be a design review by the city.
- Sam will meet with the city and get city approvals.
- Apply for a C3 use permit
As you can see, Sam will be paying consulting fees and the entire process will take at least 12 to 18 months. It may take longer so Sam has a three to five-year plan. It will take time and money, but once the property is rezoned C3, he will be free to utilize four acres of empty space and begin adding self-storage facilities and other building to the property. That will boost his NOI again and push the property value to 30 - $37 million.
You can find out more about Sam’s fantastic deal in this video: Beautiful Potential in Ugly Commercial Properties
One important lesson we can learn from Sam is that you can't go through this process of rezoning large commercial properties on your own. To try this yourself without help is a recipe for failure. The process is complicated and costly, which is why Sam has our team working with him. He also used our attorneys, who connected him to a zoning attorney, who then connected him with consultants. It has taken a team to get him this far, and that team will continue to work hard to get him through the whole rezoning process.