Rezoning Risk and the 'Highest and Best Use' Question
A client owns a 4,000 m² site zoned 'Low Density Residential' (min 1,000 m² erven) in a municipality whose Spatial Development Framework (SDF) designates the node for 'medium-density mixed use.' The client wants you to value it on the basis that rezoning to allow 60 townhouse units (avg 180 m²) is a 'certainty' because 'the SDF says so.' A neighbouring site was rezoned 3 years ago after a 26-month process and an appeal. Current zoning permits 4 erven; comparable sales of low-density sites indicate R2,200/m² of site area. You are asked for a market value opinion for a bond application.
1. Should you value on the basis of the existing zoning or the rezoned potential? Justify using highest and best use principles.
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Highest and best use (HABU) requires the use to be: (1) legally permissible, (2) physically possible, (3) financially feasible, and (4) maximally productive. Crucially, it must be reasonably probable, not merely aspirational.
- Legally permissible now: existing low-density zoning. The SDF is a policy/vision document - it does not itself rezone land. Rezoning requires a formal application, public participation, council decision, and possible appeals.
- Probability: one comparable took 26 months and an appeal. That is a real risk, not a certainty. The SDF designation supports an application but does not guarantee approval, and density/height/coverage conditions may be imposed.
- Conclusion: For a mortgage security valuation, value on existing zoning as the primary basis, with a sensitivity/commentary on the upside if rezoning is achieved. Do not capitalise a 'certainty' that is not legally in place. A speculative rezoning value would overstate security and mislead the lender.
Test: If the rezoning were refused, would the value still support the loan? If not, the assumption is unsafe.
2. Outline how you would quantify and present the rezoning upside without overstating value.
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Approach - residual/development appraisal with risk adjustment:
- Gross development value (GDV): 60 units × achievable price per unit (from comparable new-build sales), escalated to completion.
- Costs: construction, professional fees, marketing, finance, contingency, and rezoning/planning costs (application, consultants, appeal, time).
- Time: allow the realistic 26+ month rezoning period plus construction; discount cash flows to present value. Time value materially reduces the residual.
- Developer's profit: required return (e.g. 15–20% of GDV) deducted.
- Residual land value = GDV − costs − profit − finance, discounted.
- Probability weighting: apply a risk-adjusted discount (or scenario weighting, e.g. 50–60% probability of approval) to the upside.
Presentation:
- State the primary value on existing zoning clearly.
- Present the rezoned scenario as a separate, clearly labelled 'subject to planning' figure with stated assumptions and probability caveat.
- Give a range, not a single optimistic number.
- Advise the lender which figure underpins the security and recommend a condition (e.g. revalue on approval).
This protects both the client's interest and the integrity of the valuation.