Volume 12, No. 2, Summer 2007

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Capturing the Full Value of Unique Assets

By John T. Schmick, Vice President; & Christopher J. Stockness, Senior Appraiser

Minnesota is known as the "Land of Ten Thousand Lakes" because it offers a diverse landscape and a wide range of lakes from small, natural lakes to large, recreational lakes. Each lake provides opportunities for Minnesotans and visitors to enjoy natural habitats through boating, fishing, swimming and a variety of other recreational activities. As a result, lakeshore property and property in close proximity to lakes are in high demand in the Twin Cities and surrounding areas. Because of the limited supply of land on or near the water, there is also a steady and significant increase in price. In today's market, lakeshore property sales may lead to redevelopment because the value of the land itself outstrips the value of the existing improvements.

Traditionally, residential lakeshore development was tied to the maximum number of water front lots allowed under the city's zoning regulations. If the zoning code allowed for many dock spots but the land area only supported the construction of four homes, four homes were built and the excess dock rights went unused. However, as the demand for lake access continues to increase and the supply dwindles, the market has reacted with some very creative solutions to the problem of how to utilize those excess dock rights. It is not unusual to find redevelopments which actually extend the benefits of lakeshore access beyond the lakeshore site itself. Projects like these result in significant additional value to the main site as well as to the adjacent sites. The developer carves out the maximum number of waterfront lots permitted, purchases additional land nearby and sells the excess dock rights to potential buyers who want a permanent access on that lake but either cannot afford the high cost of lakeshore property directly or are limited by the availability of lakeshore in the area.

Aging resort properties close to urban areas present unique development opportunities. With lakefront land available for residential use and a number of existing dock permits, the creative developer recognizes the potential for marketing lake-access lots in addition to lakefront lots. As urban sprawl approaches lakeshore areas, the highest and best use (HBU) of resort land often changes from recreational/resort use to residential use. Because resort properties typically have conditional use permits for docks/slips above and beyond what is necessary for the lake lots themselves, there exists the potential to transfer the excess dock rights to those who desire water access but own non-lakefront lots.

Typically, transferring conditional use permits for excess dock rights to developers for these maximum-use projects is at the discretion of the local municipality and its current policies. However, because the new development adds to the existing tax base, creates homes to meet the market demand, limits the development of large estates on lakeshore land and satisfies the community's desire to maintain the natural, pristine aspects of the lake, the community has much to gain from renewing the conditional use permits. Once the transfer of dock rights is guaranteed, there is still the issue of determining the value of the subject property.

In the process of appraising, it is essential to determine the highest and best use (HBU) of the subject property. During the HBU analysis, the appraiser ascertains what is physically possible, legally permitted and financially feasible in order for a prospective owner to realize the maximum productive use for the property. The process of determining the HBU is very similar to the process a developer employs to evaluate the merits of proposed development opportunities. The developer assesses the potential of vacant or improved land to see if there is potential above and beyond its current use. If an opportunity for development proves to be financially feasible, this will generally indicate a value for the land that is greater than that of the land under its current use. As mentioned earlier, with the demand for lakeshore land in the Twin Cities increasing and the supply diminishing, the prices for lakeshore land have skyrocketed.

Eager to redevelop existing properties, these developers and entrepreneurs have taken this opportunity to recognize and unlock the full value of lakeshore land. Many old resorts were constructed decades ago, during an era when the government followed a more hands-off approach to land use than it does now. Existing boat houses, guest or resort cabins, deeded accesses and excess dock rights offer additional flexibility for the developer who seeks to maximize the potential of the site. As local and state government agencies try to limit or prevent excessive development along lakeshore lands, conditional uses and grandfathered-in uses for existing improvements create strong incentives for developers.

A CASE STUDY

An irregularly shaped lakeshore property with 1,750 feet of lakefront and a gross area of approximately 10 acres operated as a seasonal resort and boat marina for over 40 years. The lake is located in an area that was primarily rural/agricultural. Over the last ten years, however, urban sprawl from nearby cities makes the surrounding area more residential in nature. The subject property is on a large, recreational lake which is now becoming more residential as well. Located less than half an hour from the Twin Cities and within 5 miles of other suburban developments, the property presents a unique opportunity for private development. Operating as a resort and marina, the resort features a single family home, several lakeshore cabins, a camping and RV area, various outbuildings and a marina with 30 dock/slip spaces. The owners, mindful of the increasing assessed value of their land and the fact that they are experiencing a stabilized net income from their resort/marina operation, are looking for a change.

A survey of the site indicates that, based on shoreline setbacks, approximately six of the ten acres are located above the ordinary high water mark. Those six acres are considered the net developable area. Zoning guidelines generally limit the site to single family residential use with a restriction of two developable acres per single family lot. Based on current zoning, the subject site can support three single family lots. A local land planner confirms that the site can be developed with three lots on the northern half of the property and, based on the layout of the site, the best subdivision of the site is for three lots of approximately 250 feet of frontage for each lot. The remaining 1,000 feet of shoreline is located along approximately four acres of land considered un-buildable due to the historical high water mark for the site.

Appraisal analysis indicates lakeshore lot values at the site in the range of $1,000 - $5,000 per frontage foot. Overall, the retail selling value as a single-family development is $2,250,000. In comparison, the resort is experiencing a stable income of roughly $100,000 per year. Assuming a capitalization rate of 9%, we see an "as is" value of $1,100,000. Based on this analysis, one can further determine that the value as a single family residential development significantly exceeds the existing value as a resort. But, does a single-family development represent the highest and best use of the site? What is the value of the un-buildable portion of the site? What might the market be willing to pay for an un-buildable lot? The answers to these questions take the developer in an entirely different direction.

Continued use as a resort is no longer economically feasible due to rising land values. However, the subject is permitted for 30 docks/slips which create additional value for the site. With high demand for lakeshore property and a severely limited supply available, buyers will pay significant premiums just for lake access rights, if they live nearby. A search of the sales of deeded accesses, un-buildable lots and dock rights revealed that the right to sell a permanent dock easement ranged from $50,000 to $200,000 per dock/slip. Assuming that three of the 30 dock rights will be assigned to the single family development, there are still 27 docks that can be included in the development, with a retail value of at least $1,350,000.

Thus, the subject's remaining acres have measurable value despite the fact that they are considered un-buildable; alternatively, a marina can be developed on the site to fully utilize the site's conditional use permit for 30 docks/slips. Therefore, in addition to its value as a single family development, the site has additional value due to the opportunity to provide lake access for as many as 27 additional boats. Overall, the value of the subject land is determined by the development potential of the site and the ability to extend lake access rights beyond the lakeshore itself. In this case, the appraiser and a land planning firm identified the potential for up to three residential lots on the lake, each with its own dock. In and of itself, this represents substantial value for the land over that of its continued use as a seasonal resort.

However, with its 27 additional docks/slips and four un-buildable acres, this site has far more to offer than three single-family lots. To realize this untapped potential, it was determined that the developers could offer lakeshore and non-lakeshore lots as well as a communal marina. If necessary, one or more of the single-family lots could be sacrificed to create a community marina. By buying up land around the lake itself, which was relatively cheap, they created up to 3 single-family lots on the lake and 27 non-lakeshore lots - each with its own dock. Determining the market demand for such a unique development is essential.

Market demand can be determined in several ways. One of the best ways to gauge the market is to research similar developments in the area. From the research it is possible to calculate not only the demand but also the potential price points. In this case, there was a similar residential development of 25 lots on a comparable lake nearby. As with our subject, the site had an allowance for 25 docks, accommodating 10 lakeshore lots with private docks and 15 docks/slips available for the non-waterfront lots. As a result of the site's topography and the amount of lake-frontage, the most suitable development was that of a central marina with 15 dock/slips - the maximum allowed. The dock rights for those 15 boat slips were included in the purchase prices of the non-lakeshore lots. The asking price for a non-lakeshore lot with boat slip rights was approximately $400,000. The lakeshore lots, including dock rights, ranged from $500,000 to $1,500,000 depending upon the location of the site and the amount of lakeshore frontage. This particular project proved to the developers not only that the market for this type of development exists, it also provided a benchmark for the price a potential home buyer will pay for a lot with dock rights in close proximity to the water.

Additional research of sales for similar, comparable lots (same size and location) without a permissible access to the lake revealed a price range of $225,000 to $275,000. Overall, the market indicated that a typical 2 acre lot in the same general area but without lake access sold, on average, for $250,000. In comparison, lots with a shared dock/slip and lots with private dock access sold for $400,000. In the final analysis, it appears that the additional value of access to permitted docks/slips is worth, on average, $150,000.

It is important that a buyer/developer recognizes the potential of lakeshore property with its excess dock rights and plans accordingly. To maximize economic return on investment, the knowledgeable buyer seeks to purchase land from nearby owners, thus creating additional lots with non-lakeshore access. The subject property, with its existing dock rights, is the "crown jewel" for a water access development. Without the dock rights, it is just another subdivision development with no signature features; the lot prices and the market demand will be significantly lower. The subject property, with its excess dock rights, is worth a significant premium in the open market. That extra premium is captured when additional non-lakeshore lots (with dock access) are included in the development along with up to three single-family lakeshore lots permitted under current zoning regulations.

To realize the additional premium associated with this particular lakeshore land parcel, the developer evaluated the costs of similar projects in neighboring areas. The results of the HBU analysis indicated that assemblage for residential development with water access was, indeed, the highest and best use for the subject property. The potential economic value of this scenario is far greater than that of the initial proposal for a residential development consisting of three single-family lakeshore lots and excess land. It appears that using the subject property as the cornerstone of a larger water access residential development provides the largest return on investment to the developer. In this example, the three lot scenario creates a retail value of approximately $2,250,000 for the subject whereas incorporating the subject property and its excess dock rights into an assemblage for development creates an additional value of roughly $4,000,000. At this point, the developers, land planners and appraisers will evaluate the economic projections by way of a sales comparison analysis based on the current market and a subdivision analysis.

In a subdivision analysis, the appraiser first analyzes the subject to determine its maximum productive use and its value based on the current market. Next, he or she estimates reasonable development costs and potential absorption periods as well as the projected retail prices for the lots to come up with a present value: the value of the land itself prior to development. For our example, it was necessary to use a reverse subdivision analysis. Because this scenario deals with excess dock rights, the appraiser worked backwards starting with an analysis of the former resort property and its 30 permitted docks/slips. Once the number of excess docks/slips was identified, the appraiser determined how much land must be acquired to fully maximize those 27excess dock/slips. The developer used this information to calculate the total projected cost of the development: purchasing the resort and the additional land, anticipated development costs and a reasonable profit.

Continuing with our example, the subdivision analysis indicated that a 30-lot scenario had a present value of $7,000,000. This number represents the total purchase price the developer is willing to pay to assemble the excess land and the resort. If the developer is able to purchase the adjacent land for assemblage for $4,000,000, the remaining budgeted $3,000,000 can be used to cover the cost of the main resort parcel. The original "as is" value of the main resort parcel was $1,100,000. Clearly, the developer identified a development opportunity which maximized the excess dock rights and, in doing so, created a financially feasible scenario for achieving the maximum productive use of the subject resort.

This article touches briefly on some of the techniques used in the market place for capturing the full value of unique assets. Identifying and applying ordinary methods of valuation to unusual properties may reveal the hidden value. This is especially true for lakeshore properties where the number of permitted docks/slips on a given lake far exceeds the number of residential homes allowed under current zoning ordinances. Developers are exploring creative ways to maximize the existing permitted uses of a site at a time when development standards are becoming more and more restrictive. Appraisers must identify all existing uses as well as all potential uses and how they impact the value of a property. Developers, land planners architects and contractors can all contribute to the process of providing creative solutions to complex development problems. The valuation of a land parcel is not always about what you see today, it may be that capturing its full value depends upon your vision for tomorrow.