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June 15, 2021
The late Lord Harold Samuel, founder of the UK property company Land Securities, has been credited with coining the expression: “There are three things you need in property, these are: location, location, and location.” [1]
While what makes for a “good” location varies widely depending on the use, certain sites command premium pricing. Inpatient or outpatient healthcare uses located in high density, urban settings often must grapple with high underlying land values, which can affect the financial feasibility [2] of a particular use. Furthermore, in high density urban locations where the supply of potential development sites is low, healthcare users may have to compete with other buyers who intend to use a property for office, multi-family, or mixed use. Many urban locations may also feature ground leases (or be offered to the market on a ground lease basis); ground leases within urban markets are common, and the valuation considerations associated with ground leases can be complex [3], whether the site is located on a hospital campus or not.
Ultimately, when evaluating land transactions and underlying site value, it is important to consider factors such as: a) entitlements; b) assemblage/synergy; c) size/highest and best use; d) bulk zoning regulations (including floor area ratio and building height); and e) other factors related to urban settings.
This article will provide an overview of some of these considerations. For specific questions concerning healthcare real estate and premium site value considerations, please contact VMG Health’s real estate division.
Entitlement – “In the context of ownership, use, or development of real estate, governmental approval for annexation, zoning, utility extensions, number of lots, total floor area, construction permits, and occupancy or use permits.”[4]
In certain parts of the country, separate markets exist for entitled properties; this is primarily driven by the risk and time associated with the entitlement process. In these markets, some buyers will acquire a property, secure entitlements, then sell the property to another buyer who will proceed to develop the property. The arbitrage between these two transactions may represent the value associated with the entitlements (though other factors, such as a change in market conditions or navigating other development risks during that period, can also impact the pricing differential). The magnitude of the premium can vary widely from municipality to municipality, even within the same metro area. For instance, some municipalities are more challenging to get zoning variances in than others. If the approval timeline is twice as long in one location, then, generally, the value of a fully entitled property will be higher (assuming that the entitlements obtained are consistent with the property’s highest and best use). Legal issues (i.e., neighborhood residents suing to prevent a proposed development, or site-specific environmental challenges) can also create significant additional development risk or timing delays.
During the course of a variety of healthcare real estate valuation and consulting assignments, VMG Health has evaluated the impact of entitlements on land transactions in high cost, core urban markets across the United States.
Assemblage [5]
Synergy – “The total effect of combining enterprises, which is greater than the sum of the independent actions combined to create the effect; in real estate, usually applied to multiuse properties in which the value of the total development is greater than the sum of the individual parts.”[6]
According to The Appraisal of Real Estate, 15th Edition, “Sometimes highest and best use results from assembling two or more parcels of land under one ownership. If the combined parcels have a greater unit value than they did separately, plottage value is created. Plottage is an increment of value that results when two or more sites are combined to produce a larger site with greater utility and probably a different highest and best use…Plottage value may also apply to an existing site of a special size or shape that has greater utility than more conventional, smaller lots. Neighboring land uses and values are analyzed to determine whether an appraised property has plottage value.”
Value premiums associated with assemblages are highly variable. In the article “Estimating assemblage value to help buyers and sellers” dated August 15, 2013, John Galvin from Andrews & Galvin Appraisal Services, LLC discusses the economic theories of supply and demand as it relates to an assemblage. “The buyer wants a specific finite product creating demand. The seller holds the only commodity that will work for the buyer creating the supply. In an active market with steady demand and supply, the two reconcile an exchange of the product in the form of a price, hence creating the current market value of that product. However, if the seller is not willing to sell, the point of equilibrium of the exchange has to shift in order to reach a point where both parties can make a satisfying exchange. For an abutting/assembling property owner, this often means a premium has to be paid to entice the seller to make the exchange… When the buyer is highly motivated to generate a return by the assemblage, yet the seller is not motivated to sell, a premium is almost always involved in the conveyance. For motivated sales, the appraiser is taxed to extract that premium in order to equate the market price paid to make a comparison… A buyer is willing to pay a premium until the point where assembly is no longer feasible.
Sometimes the “assemblage value” is not enough to entice a seller to depart with their property or property rights. One notorious example of this was the “Chicken-man” case in Downtown Hartford. In 1969, Travelers Insurance Co. offered the owner of the Connecticut Live Poultry Market on Grove Street and Columbus Boulevard a sum of $110,000 for his small retail facility. This was considered a very high price for the time period, reflecting the premium the buyer was willing to pay above the fee simple market value of the property. The owner, Dominic LaTorre, who became nationally known as the “Chicken-man,” refused to sell out on the grounds that he was essentially “standing up for the little guy.” Travelers Insurance Company ended up redesigning their class A office building around the small retail store (Hartford Courant, July 7, 1993).”[7]
Some assemblage transactions can effectively represent bilateral monopolies, whereby the only site that facilitates a particular development is held by one specific seller – yet the only realistic buyer may be an entity who has already assembled all of the adjoining parcels and is seeking to acquire the one remaining parcel. In these situations, the relative leverage of either party (along with whether it is possible to develop the assemblage absent the one parcel, as noted in the example above) can result in a wide range as compared to what would be expected in a typical transaction without any assemblage considerations.
In the article, “The Added Value of Assembling Parcels” in Right of Way magazine, the author states that “In general, applying the assemblage theory may be appropriate when the following conditions exist in the before condition:
In the San Francisco Bay Area, a recent case employed the assemblage theory. It involved the condemnation of a half-acre vacant parcel needed to expand an adjoining one-acre city-owned vacant parcel for future development as a city park. The half-acre parcel was substantially impacted by two earthquake fault-lines that traversed through it, thus limiting the potential area for future structures to approximately 900 square feet. The city’s one-acre parcel was generally not impacted by fault-lines and did not face nearly the same developmental limitations as did the half-acre parcel. Absent the park project that resulted in the condemnation, the city would not have needed the land for public use. It would therefore have been faced with not having to condemn the half-acre parcel and surplusing its one-acre adjoining parcel. It was determined by the property owner’s legal team that the joinder of the half-acre with the one-acre parcel would have resulted in the highest and best use scenario for both parcels. The combined 1.5-acre site created through assemblage would have allowed for a greater range of developable land uses, such as a fast-food restaurant or service station. These uses would not otherwise have been feasible if the parcels were developed independently. The assemblage would have further allowed the half-acre parcel to be utilized for the required parking and much of the required landscaping, thus greatly increasing its potential land value. This case ultimately settled prior to going to trial.
Therefore the assemblage of parcels and the resulting increased acreage can create certain opportunities. For example, commercial parcels containing less than a half-acre are often restricted to uses requiring limited building floor area and parking, such as retail or office. However, if assembled with adjacent land, the combined acreage may reach an area threshold that allows for additional uses, such as a fast-food restaurant or service station. Substantial additional acreage may have the potential to accommodate even more intensive uses, such as a hotel, mixed-use project or high-rise development. An increase in acreage may also justify the construction of a parking structure. From a highest and best use standpoint, parking structures allow much greater building floor area to be constructed, thus further increasing the number of potential highest and best use candidates. Whether or not to construct a parking structure of course involves many factors of which adequate acreage is an essential one.
An increase in land area through assemblage, along with the removal of the previously shared property lines, can help to lessen the impacts of certain local development standards. This in turn results in the potential for greater developmental intensity and land value. When parcels are combined, the shared property lines that separate them disappear, as do the setback requirements on both sides of those property lines. The proportionate impact caused by the setbacks on development also diminishes accordingly. For example, two five-foot side yard setbacks on a 100-foot wide parcel (ten percent of the total setback area) are far less impacting than the same setbacks on a thirty-foot wide parcel (33 percent of the total setback area) because they allow for a greater percentage of the site to be developed.”[8]
Per the working paper “Estimating the Holdout Problem in Land Assembly,” from the Federal Reserve Bank of Atlanta dated December 2013 and written by Chris Cunningham, the author notes: “I find that properties sold before an assemblage command a statistically significant and economical large premium of 13 dollars per square foot, a seventeen percent premium relative to non-assembled land sold in the same census tract. This finding is robust to inclusion a rich set of control variables for time and space. Consistent with the game theoretic literature, the premium decreases with an individual parcel’s share of the total assemblage. Finally, parcels at the center of ultimate assembly may command higher premiums than do parcels at the edge, suggesting that developers retain, or at least are able to convince would-be holdouts that they can build around a holdout.”[9]
In some cases, an assemblage may facilitate a change in highest and best use or may allow for a zoning change. In these situations, due to the change in economics associated with the proposed development, the value of the underlying site may also change.
VMG Health has interviewed individual developers, brokers, and investors in various urban markets concerning this issue. A common theme among these interviews is the variance regarding the extent to which assemblage affects a transaction – individual examples exist of assemblage sales which seemingly occurred at no premium, and others which occurred at a price well over what the property would have otherwise sold for, if there were no assemblage. Accordingly, the appraiser or analyst must carefully evaluate individual transactions to determine whether pricing was impacted.
Highest and best use may be defined as, “the reasonably probable use of property that results in the highest value.”[10] Highest and best use must meet the following four criteria: 1) Physically possible; 2) Legally permissible; 3) Financially feasible; and 4) Maximally productive. The appraiser’s (or analyst’s) determination of a property’s highest and best use as if vacant is key to deriving an opinion of land value.
Physical possibility is defined as follows: “[f]or a land use to be considered physically possible, the parcel of land must be able to accommodate the construction of any building that would be a candidate for the ideal improvement. [11]
Legal permissibility is defined as “a property use that is either currently allowed or most probably allowable under zoning codes, building codes, environmental regulations, and other applicable laws and regulations that govern land use.” [12]
Financial feasibility is defined as “[t]he capability of a physically possible and legal use of property to produce a positive return to the land after considering risk and all costs to create and maintain the use.” [13]
Maximally productive use is defined as “the physically possible, legally permissible, and financially feasible use that results in the highest present value.” [14]
According to the Appraisal Institute’s Advanced Land Valuation: Sound Solutions to Perplexing Problems, “if two or more uses are financially feasible, then the use that generates the highest residual land value is the use that is maximally productive and represents the highest and best use of the land.” The land residual technique, “a method of estimating land value in which the net operating income attributable to the land is capitalized to produce an indication of the land’s contribution to the total property” [15] is sometimes utilized to determine the maximally productive use (and as such, the highest and best use) for a proposed property.
Site size can affect pricing and development potential. Smaller sites may sell for higher per unit prices in some instances, though a larger site may command a higher per unit price in others, particularly if the larger site can accommodate a different array of uses. In high-density markets, slightly larger sites are sometimes considered more developable, and thus can be more attractive to a developer. In some cases, a change in site size may change the highest and best use (as discussed above), which can affect the value per square foot or per FAR. In other cases, larger sites which command a higher total purchase price may suffer from smaller buyer pools (which generally would drive down the price per square foot due to less competition).
Ultimately, highest and best use analysis is a complex topic, and the level of diligence required to appropriately assess highest and best use is project specific and site specific.
Bulk regulations are defined as “Zoning laws or other regulations that control the height, mass, density, and location of buildings, setting a maximum limit on the intensity of development to ensure proper light, air, and open space.” [16] Bulk regulations include limitations (both maximum and minimum) on floor area ratio, setbacks, lot coverage, building height, and required open space, among others.
Most pertinent to the discussion of high dollar land are 1) the allowable floor area ratio (or “FAR”) and 2) the maximum building height. FAR is defined as “The relationship between the above-ground floor area of a building, as described by the zoning or building code, and the area of the plot on which it stands; in planning and zoning, often expressed as a decimal, e.g., a ratio of 2.0 indicates that the permissible floor area of a building is twice the total land area.” [17] Floor area ratio may also be referred to as building-to-land ratio. In certain municipalities, the ratio of building area which can be constructed on a site, which can also be somewhat dictated by the maximum allowable building height, can be a better indicator of the value of the land than on a purely price per square foot of land area basis, since a higher allowable floor area ratio (as well as a higher allowable building height) would allow for the construction of a larger/taller building, all else equal.
The price per FAR foot can also be dependent on the allowable use for the site in question. It may not be financially feasible to develop a site to its maximum FAR, for instance – or the cash flows associated with one property use may differ from another (driving differential in price per FAR). VMG has investigated urban markets where a significant premium existed for multi-family versus office use, due to higher demand and superior projected cash flows for multi-family development (even if the allowable FAR was the same for multi-family versus office).
Bulk regulations and FAR should be evaluated carefully with regard to the subject site as well as any comparative transactions to understand the degree to which differing zoning regulations drove corresponding differences in per square foot or per FAR foot land pricing.
In urban settings, other considerations which can affect property value (and certain associated premiums) may also include a site’s proximity to public transportation (i.e., transit-oriented development or “TOD” locations) or ingress/egress, such as is associated with corner locations.
In many large cities, commuter rapid transit options attract pedestrian traffic to railway stations. This tends to benefit properties which are in close proximity (typically within half a mile or so) to these stations, and there is often a premium for TOD locations. The extent to which this premium exists varies market to market and site to site – and, furthermore, concerns emanating from the COVID-19 pandemic (related to mass transit, as well as congregate, in-person work environments) may have affected this premium since early-2020.
Corner locations, signalized intersections, and other ingress/egress issues can also affect the pricing of urban land parcels. Visibility, exposure, and signage can all contribute to making a corner site more desirable. However, while some corner sites may sell for more than similarly located non-corner sites, in other cases, setback requirements may limit the development potential of a particular site which could offset any corner premium.
While healthcare providers located in lower cost markets or in suburban settings may not have to grapple with urban land valuation considerations, many hospitals, physician groups, and other healthcare users face the issue due to the densely populated, urban markets in which they are located. Some older hospitals are situated in premium locations in core urban markets – these campuses must evaluate underlying land pricing if they plan to sell or lease any portion of their hospital campus. Furthermore, when considering the acquisition or leasing of other sites in an urban market, healthcare providers and investors should be aware of some of the key factors that drive pricing in an urban setting. As previously discussed, certain valuation considerations for high dollar land include but are not limited to: a) entitlements; b) assemblage/synergy; c) size/highest and best use; d) bulk zoning regulations (including floor area ratio and building height); and e) other factors related to urban settings. Due to the complexities associated with urban land valuation, an appraiser may use techniques including, but not limited to, the land residual method, the sales comparison approach, the market extraction method, or the allocation method. The appraiser or analyst may also need to have expertise in ground lease capitalization rates, yield capitalization, residual value, and so forth. For further discussion of ground leases, please refer to VMG’s ground lease article cited below.
If you are an investor, developer, or healthcare provider evaluating land pricing (or ground lease rates) in a high cost urban market and require outside expertise, please contact VMG Health’s real estate division.
For further commentary from VMG Health related to on-campus hospital ground leases, please see the following: Under All is the Land: Ground Leases and Hospital Campuses
For further commentary from VMG Health related to financial feasibility for medical office development, please see the following: Financial Feasibility & Speculative Medical Office Building Construction
[1] https://www.company-histories.com/Land-Securities-PLC-Company-History.html
[2] For more on the topic of financial feasibility within the medical office building (“MOB”) sector, refer to the following: https://vmghealth.com/blog/financial-feasibility-speculative-medical-office-building-construction/
[3] For more guidance specific to ground lease considerations on hospital campuses, please refer to the following: https://vmghealth.com/library/under-all-is-the-land-ground-leases-and-hospital-campuses/
[4] The Dictionary of Real Estate Appraisal, 6th Edition (Chicago: Appraisal Institute, 2015).
[5] The Dictionary of Real Estate Appraisal, 6th Edition (Chicago: Appraisal Institute, 2015).
[6] Ibid.
[7] https://nerej.com/estimating-assemblage-value-to-help-buyers-and-sellers
[8] https://eweb.irwaonline.org/eweb/upload/web_mar_apr12_AssemblingParcels.pdf
[9] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2579904
[10] Appraisal of Real Estate, 15th Edition
[11] The Dictionary of Real Estate Appraisal, 6th Edition (Chicago: Appraisal Institute, 2015).
[12] Ibid.
[13] Ibid.
[14] Ibid.
[15] Appraisal Institute’s Advanced Land Valuation: Sound Solutions to Perplexing Problems
[16] The Dictionary of Real Estate Appraisal, 6th Edition (Chicago: Appraisal Institute, 2015).
[17] Ibid.
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