There has been much made of the County Appraisers employing “highest and best use” as the basis for valuation for tax purposes. This resulted in cases such as “working waterfront” properties that argue that not every parcel is a site for a waterfront condominium and that the present less “valuable” use should apply. Many have rallied behind the idea including another group severely affected by the run-up in prices, the small motel and hotel properties which are often family owned and marginally profitable before any potential tax burden.

It is tempting and emotionally appealing to consider this change in the law but in principle, it is the wrong thing. We must drill deeper to unearth the root problem and consider how there may be other potential remedies. There are four classic tests of highest and best use that must be considered and while each is important they require total consideration to arrive at an informed decision.

• The proposed use must be legally permissible
• The proposed use must be physically possible
• The proposed use must be financially feasible
• The proposed use must be maximally productive.

The classic (and only partially true) statement often heard is “that use which results in the highest net return to the land”. It is a highest and best use as if vacant concept which is then considered in terms of the highest and best use as currently improved. The contemporary statement which most applies to the definition is “that use which results in the highest net return to the land in consideration of USE, USERS and TIMING (risk).” It is more than a subtle difference and one which is widely ignored by fee appraisers and county appraisers who fail to consider properly all of the four tests which in turn are supported by market analysis which is the “plasma” that sustains the organism.

Here are some examples based on recent cases with location and some details purposely omitted. In a local incorporated island community all land parcels west of the single service arterial are zoned for commercial use which among its permitted uses allows condominiums under certain physical guidelines. In this community are a number of locally owned or seasonal beach cottages much like the scenes I remember growing up in Sarasota. The lots are small and in many cases substandard in size allowing only conditional rebuilding if the structures are destroyed or severely damaged by an act of God. The property appraiser holds the view that since the land is zoned for commercial use now, even if the site is not large enough to support a multi-family structure, it may be combined with either contiguous parcels or worse, non-contiguous parcels to create a condo site.

This is an extraordinary set of assumptions under any conditions but in light of recent, current and likely continuing conditions the act strains credulity! First “assemblage” of land and/or improved parcels with attendant price influences is not a properly supported highest and best use. The only reason to assemble is when there is a market for the product that will ultimately be placed on the assembled site. This is such a key issue and it cannot be underscored enough, it’s about the TIMING requirement we discussed earlier.

The property appraiser used some sales of small residential properties that were “flips” and others where the implicit assumption on the appraiser’s part was that they were potential condo sites. More to the point at the time of the valuation there were (and more now) hundreds of unsold condominiums and even available vacant sites. Why would there be a market for the land when there is clearly no present market for the condos? This is the point where the issues become timing and risk as there needs to be a forecast of when there will be a market for the potential development and as always timing and risk are intertwined. The longer the holding period required to build the more risk that the outcome may not be as planned. Simply, the present worth of assumed future benefits.

The second example is similar in that as before, it’s a highest and best use problem (but then all of them are!). There is a slice of time in a rapidly escalating residential market, especially at the beginning stages, where there is unsatisfied demand because supply to match demand takes time, there is a lag. In that interim period there are “low hanging fruit” in the form of rental apartment projects that may for a time have a highest and best use as converted condos where they can be sold quickly. In my experience this has happened every time there has been a market surge and every time there have been unintended consequences. When the supply side catches up to current demand there exists a significant product differentiation. If you are a “user” or intended resident there may be better products with more features that are newer. If you are an investor there may be nobody to flip the speculative purchase to. If all sales are not consummated and closed there is the danger of becoming “fractured”, partly sold, partly not and among those two, partly rented.

In this case the appraiser has a “loophole”, once an apartment project is “declared” as a condominium the assessor in the next cycle can assess each unit separately as a “condo” unit. Let’s consider the aforementioned four tests; the use may certainly be legally permissible and physically possible (as improved) since it is basically the same as a rental project. There is just an aggregate change of ownership. The real problem is when the market never materializes or just disappears mid-stream! It is very likely in the case of a project never marketed that it is operated just as before, as a rental. Logically under highest and best use tests that is the highest and best use. In the case of the fractured or partially sold project it is a bigger mess to clean up. It should be valued both as a rental and as an unsold condo with market analysis of the product, timing and supply and demand required. This will be the present worth of future benefits as well.

Highest and best use cannot be determined without appropriate market analysis and value cannot be estimated without an appropriately supported highest and best use.

First, any recovery however that is measured, will not be uniform and across the board at the same time. Second, prices (not values) will not “return to their peak” anytime soon given that the peak was investor driven and not user driven. In addition to the hopefully soon to be flowing credit availability there is a single troubling wild card that cuts across every region and every property type. It’s fundamental that jobs are the key to all of the other systems. The alarming rise in unemployment will not change overnight and in spite of assurances to the contrary may not respond positively to stimulus attempts in the near term. Think about it, jobs create income which evolves into disposable income. Without adequate ability to repay from income there can be no housing mortgages, retail space becomes vacant (save for necessities) and office space exhibits shrinking occupancy.

I tend to agree with St. Pete Times columnist James Thorner in his May 1st column, “Rah-rah housing talk is wishful”. He provides an estimate that there are 35,000 unsold homes which for some period of time will be fed by further foreclosures. We in the Tampa Bay area and most of coastal Florida have been dependent upon in-migration of retirees and relocation of families coming primarily from the Midwest and Northeast. If that migration pattern is to continue (and there are signs that is dramatically changing) those folks need to sell their homes “up north” first. Almost every day the optimists (and some with rose colored glasses) point to the increase in home sales which has closely followed the slow to change price declines. It appears that there are certainly bargains, especially if you intend to live in what you purchase, but once again there are pockets of equity rich investors counting on the market being at or near the bottom in prices and are preparing for a renewal of flipping. However, once again the fundamental lack of credit and mortgages for many precludes fueling the cycle and at the end of the day it’s still about jobs, especially if you don’t have one!

As an appraiser and market analyst the project of course intrigues me on several levels. I have recently worked on assignments in Lee County to the south of the acreage and it is widely thought there are tens of thousands of unsold lots and homes with ground zero being the long enduring Lehigh Acres east of Ft. Myers. The first thing that must happen is that an overwhelming excess supply of both lots and homes must be absorbed in order to provide any opportunity for a new project. I do not, nor does anyone else know exactly how much time that will take or if the worst is over and the bottom reached.

I agree the energy efficiency aspect is an intruiging one as Floridians watch their cost of living soar at a time when joblessness is rising and many cannot sell their homes. The recognition that addressing the critical issues of energy cost and water is long overdue and may well eventually even provide a marketing advantage over other opportunities. What bothers me is the optimisim that the developers apparently feel that things will go back to where they were before the downturn, that just as many people will retire and migrate to Florida as ever. There is already documented study that suggests that while in-migration is positive a substantial number of households are leaving. There are many reasons that this was happening even before the resounding economic upheavals of the last 9-12 months, primary among these is the reality that the quality of Florida living “ain’t what it used to be”.

At the end of the day as they say, it is a gamble to acquire and hold the land and likely incredibly expensive to create infrastructure even without the consideration of a fully solar community. It is possible that the ability to hold on to “Boardwalk” and “Park Place” can provide a tremendous upside but substantial market analysis and due diligence is required to support that confidence.

 In the case of downtown St. Pete, I was wondering what the pilings being pounded along 1st Avenue South were for? This represents the foundation building step of a project located at 1560 Central Avenue which will when complete function as a market rate rental aprtment project of 300+ units. The location places the project due north of Tropicana field and as a neighbor of the nearby sports bar. I would assume that the project demand forecast was based upon a very thorough market study and if so I would love to see it. As a market analyst and appraiser for 35 years I have heard most of the stories, plans and dreams that precede the development of a project, I am a natural skeptic of hype and a practical believer in sound market data and indicators.

The compelling question is why now and why rental apartments at market rate? There are a few related threads of reason that warrant further discussion. During the early stages of the recent burst-bubble there were a number of conventional rental projects converted to condos throughout the Tampa Bay area and Florida. It is the “low hanging fruit” available for a short window of opportunity while the supply side struggles to catch up with demand. Like fruit, the opportunity is highly perishable with a short shelf life. The aftermath of the conversions produced a predictable result, the successful conversions went up and out quickly but as of this writing there are thousands of units in hundreds of projects all over the state that are now “fractured” (part condos sold-part rental units). Many units were purchased as “investments” to be rented and some amount by the former apartment tenants. The ownership structure changed but the market metrics indicate that the fractured projects are still rental competition. Add to that the the “shadow market” of built but not fully sold or occupied condominiums dotting the landscape from I-175 to 1-375 and from 34th Street to Tampa Bay.

So first “supply” must be absorbed through sales or full rental occupancy which has been and will continue to be slow for a year or two and possibly more. Secondly, the recent condominium developments were not based on any definable demand but on the “Field of dreams” theory, “if you build it they will come”; they didn’t, at least in sufficient numbers. In any community there is a dynamic ratio between the propensity of household occupants to rent or buy; the typical range is from 30-60% rental and of course has results rooted in jobs and household income, both of which are currently in trouble. This project should come to market in 2010 and we will just have to wait and see if the location and the product ignites a lateral move as high density Pinellas is nearly at capacity without demolition and replacement. I just wonder, “Is now the right time” and is this the right place?

So, where is the light? Any decision made regarding commercial real estate or for that matter the residential development sector must be made on more than hope and desperation. Smart marketing always plays a role but this is more about relying on realistic timing forecasts built as solidly as possible on good market analysis study and the use of the six-steps of market analysis detailed on my websites. So much depends (and it always has) on properly defining the product at the outset and coldly assessing the competitive attributes. The product or project that most closely possesses and maximizes efficienctly  market standards will emerge sooner from these troubled times and market turmoil. It is a fact that during this crazy run-up in price superior products sold or rented first, and as always the second and third tiers followed. As the market demonstrated an appetite for more and more, the secondary location and product became a pseudo-primary property and each level in turn moved up. As the tide goes out, and gathers to return, the pecking order is reordered and “the last shall be last”. It is also important to know the competitive market area and a realistic assessment of the estimated market share. From within that market area (and it’s different for most different properties and variations) demand can be forcast and competitive supply can be counted.

It’s not complicated in concept, absorption of supply will eventually and gradually result in a renewal of reasonable demand, the burning question is when!

A recent Tampa Tribune article detailed the current problems associated with a “late-in-the-market” apartment-to-condo conversion. While not rising to the level of an “I told you so” moment this type of project problem has happened before in our market. Unfortunately there are some very difficult situations that can occur as a result of a stalled or failed conversion and it seems as if this project has, is or will experience most of them. The developer already knows that they likely paid too much, too late for the property and were forced to set a price based on investment cost and not necessarily on market price or value. The advantage of conversions is usually timing in that filing condominium documents, making cosmetic changes and putting a marketing team in place is much less time consuming than finding land, getting approvals and building from scratch. As long as the price fits, the market is not oversupplied and the investor-flipper buyers are still there, it works!

It’s a simple but often overlooked process that can be employed; instead of paying “whatever it takes” to buy land or in this case an apartment building, and then building all costs and profit on top to create a price there is a moe sensible alternative. If the developer calculates the selling price of units first and then deducts, all costs including profit and marketing, it becomes apparent what can be paid for the underlying property (land or apartments).
The issues are that if the conversion stalls anytime before sellout and especially early on with just a portion sold when the market flattens or declines the developer and the unit buyers both have a dilemma which will extend to the lender at some point. Once conversion takes place there are ongoing shared expenses, condo fees, indicidual taxes per unit as well as insurance. Marketing and carrying costs continue and any significant delay can eat up all of the potential anticipated profits. At some point when the flipper-investor can’t get their price and the developer can’t sell anymore there is an ugly stalemate. By that time the lender may be involved and will be concerned but not excited about taking over the problems and letting the developer off the hook. The few unit owners are stuck without assurance of services promised and the effects of having overpaid now that their unit cannot sell for wha tthey paid. This could drag on until “someone” comes along and is able through market conditions convince all parties to sell out and move on. The “price” paid is likely to make enough sense that the project can once again function in its intended role until there is once again an apprent “demand” for conversion.

As a market analyst engaged in market studies, highest and best use studies and feasibility analysis this project has all of the ingredients to make an interesting and compelling study. In my field the lexicon identifies “Linkages” which are primarily thought of as being roadways linking people and jobs and services. Linkages can also include public transportation, utilities and communication corridors as well.

The last article in May provided an overview of the project and news that the proposal was met with opposition and disinterest on the part of the new governor of Florida. To be sure the St. Petersburg Times stories leading up to the latest article not very subtly attempt to attach a “stink” to the project due the fact that there are large landowners who would benefit from the project. It all sounds very “John D. McDonald-ish” when you paint a picture of the rich land baron creating ill-gotten gains. In spite of the slant of the articles and using my own consulting practice as a resource as well as first-hand knowledge of previous successful projects the whole story has not been told. This area of Florida is where the great ranches, farms and landholdings of the past formed a vital part of our economy for many years. The plan seems to call for a conscious and overt effort to provide both the necessary linkages to control growth as well as accumulate public interest lands for conservation purposes.

Governor Crist calls the roadway “a road to nowhere”; precisely governor and that’s the sensibility of it. As a life-long Florida resident I have seen many of the traditional growth areas attempt to control growth by not providing services and then finally when growth pressure occurs anyway a much steeper price is paid to provide the same services after the fact. Even more importantly is the question “Where else would you put a corridor”? Although Florida’s traditional growth volume and patterns are changing we will continue to grow. We will grow where there is land and “Linkages” from where people live to where they shop and work and go to school. Building the road ahead of time is not a radical concept, look at the Veteran’s Expressway in Tampa and the controlled community planning that followed and closer to the Heartland, the Polk Parkway. In both instances these are toll roads paying for their own cost impact and at the same time providing a much needed linkage in already congested areas (especially in the case of the Veteran’s Expressway). The Polk Parkway provided me with a consulting assignment for the FDOT several years ago when they were attempting to negotiate the acquisition of sufficient land to widen an existing roadway at the Parkway and were met by reluctance on the part of the landowner. My assignment was to provide a marketability study of the larger parcel from which the acquisition would be made and determine the (at the time) highest and best use.

The study revealed that although the road had initially been controversial it accomplished the goals set for the project in opening up new lands in south Lakeland and Polk County for new and much needed family housing and new schools and services. The road provides access to the two main work centers for Polk residents, Tampa and Orlando. Central Lakeland at or near I-4 was (and is) congested and there were few parcels of land left to build on in northerly Polk due to environmental reasons.

Florida historically has too few north-south linkages and arteries but an abundance of east-west corridors crossing the peninsula. The call for additional widening of I-75 as well as I-95 and the congestion on the aging Florida Turnpike point to a need for relief by providing new growth centers and corridors instead of throwing money at a losing battle to stay abreast of traffic needs to already overcrowded areas of urban sprawl.