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Analyzing the ‘Highest, Best Use’ of Property Taken by Eminent Domain

New York Law Journal

April 9, 2012

A basic principle of condemnation law is that the condemnee is entitled to have its property valued at its highest and best use on the date of condemnation. However, even when there is agreement by both sides on the highest and best use of the property, there can sometimes be breathtaking differences between the values put forth by the parties’ appraisers. This article will discuss several relatively recent cases where highest and best use was a central issue, in all but one of which the different approaches resulted in appraisals that differed by tens of millions of dollars.

“Highest and best use” is first and foremost an appraisal concept, and means “the reasonably probable and legal use of vacant land or an improved property, which is physically possible, appropriately supported, and financially feasible and that results in the highest value.”[1] In developing support for the appraiser’s highest and best use opinion, the appraiser considers four criteria: The use must be (1) legally permissible, (2) physically possible, (3) financially feasible, and (4) maximally productive.[2]

A condemnee may assert that its property should be valued based on some use other than the one in effect on the date of condemnation. However, it bears the burden of proving that the proposed alternate use is the appropriate basis for valuation.[3]

It is not necessary that the proposed use be a legal use at the time of condemnation. If the proposed highest and best use would require a change in zoning,[4] or if a property is burdened with a legal restriction,[5] and the condemnee can show that there is a reasonable probability that the rezoning would occur or that the legal restriction would be judicially overturned, then the condemnee is entitled to an additional increment of value based on that probability.

It is worth emphasizing here the word “increment.” The courts are very clear that the fact that there might be a reasonable probability of, say, a rezoning, does not mean that property should be valued as if such rezoning were an accomplished fact. The objective is always to determine the fair market value of the condemned property on the vesting date. The fact that a property has the potential to be rezoned means that a purchaser in an arm’s length transaction would pay some additional amount above the value of the property if it did not have the potential to be rezoned. A knowledgeable purchaser would not pay for the property the same amount it would pay for an otherwise identical piece of property with the rezoning and all other approvals in place.[6]

Often there is disagreement over “reasonably probable and legal use” and, occasionally, “financially feasible.” What is sufficient for showing that a proposed use is “reasonably probable and legal”? The rule has been succinctly stated by the New York State Court of Appeals:

While it is not essential to demonstrate either that the property had been used as its projected highest and best use or that there had been an ante litem plan for such use…, it is, of course, necessary to show that there is a reasonable probability that its asserted use could or would have been made within the reasonably near future…; and a “use which is no more than a speculative or hypothetical arrangement in the mind of the claimant may not be accepted as the basis for an award.”[7]

There have been a number of recent cases involving a range of issues relating to highest and best use.

‘East Side Access’

A relatively straightforward case arose in connection with the Metropolitan Transportation Authority’s (MTA) East Side Access Project.[8]  The case concerned two similar, adjacent properties, owned by unrelated owners, but tried together because the same question arose with respect to each property. The properties contained approximately 28,000 and 30,000 square feet, respectively. They were located in an M1-1 zoning district and both were used for warehouse/storage, accessory parking and some office use. Each was leased to tenants for income-generation purposes. MTA’s appraiser determined that the highest and best use was continued use as a multi-tenant property and used the income approach to valuation. The claimants’ appraiser determined that the highest and best use was for occupancy by a single owner-occupant, and used the sales comparison approach.

The primary issue in the case was whether to value the property as income-producing property or property suited for owner-occupancy. MTA’s appraiser noted that the properties were already divided into multiple units and were too large for owner occupancy. He thought that owner-occupied industrial properties were typically 3,000 to 8,000 square feet, and that properties the size of the subjects were typically purchased for investment. Because of the recession, he thought that financing for owner-occupancy would be more difficult for owner-occupants than for investors, whose lenders could more readily evaluate a property generating income. Finally, he thought that there would be significant renovation costs to convert the properties for use by owners.

The claimants’ appraiser said there was a decreasing supply of industrial buildings suitable for owner occupants, and that such properties therefore commanded a premium in the market. He testified that the subject properties were well-suited to owner occupancy and that the costs of renovation were not significant. He found eight comparable sales of owner-occupied buildings and testified that there was a market for owner-occupied properties in excess of 8,000 square feet.

The court seemed to focus on the “maximally productive” part of the test. The court felt that owner-occupancy resulted in the greatest value and found that the claimants met their burden of proving that was the highest and best use.

‘Fallsite’

Cases also arise where the claimant seeks to have its property valued as it has been used, while the condemnor sees the property differently. In Matter of New York State Urban Development Corporation (Fallsite, LLC) (Sup. Ct. Niagara Cty., Index No. 126578, April 5, 2010), the court was faced with a condemnor claiming the highest and best use of the condemned property was as vacant land, while the condemnee sought to have it valued based on water park use, as that it was on the date of vesting. The issue in the case was financial feasibility.

The court recited what it called a “gloomy history of the park,” from its inception in 1987 until vesting in 2006. It was developed with large amounts of municipal development grants and loans. It closed in 1991, having never turned a profit. The city of Niagara Falls operated it from 1992 until 1998, and it was closed and inactive from 1998 through 2005. When it reopened in 2005, there were more free admissions than paid attendees, and property taxes exceeded revenues by a factor of four. The court found that the water park operation was infeasible, and suggested that the reopening in 2005 “was nothing more than a feigned attempt to create the appearance of a feasible operation. Its goal was apparently to solely service this valuation process.”

There is little in the decision to indicate what evidence the claimant submitted in support of its highest and best use, but it was clearly unconvincing to the court. This case makes clear that highest and best use requires a convincing showing of financial feasibility, even for an existing use.

‘Fulton Street’

A case in which the claimants achieved a significant victory involved five contiguous properties located just a few blocks from the World Trade Center site, acquired by the MTA for its Fulton Street Transit Center Project.

The properties were owned by three parties. One party, Collegiate Church, owned the northernmost, southernmost (a historic building) and middle parcels. A major operator of chain restaurants, Riese, owned the parcel just north of the historic building. The remaining parcel was owned by a joint venture of Collegiate Church and a major developer, Brookfield Properties.

The properties were a diverse collection. North to south, they consisted of a two-story retail and office building, a one-story retail building, a 12-story office building, a three-story retail building, and a nine-story office building.

The MTA’s approach was to value each building individually. The claimants sought to have their properties valued as an assemblage, with a residential condominium building to be constructed on the three northern properties, using air rights from the two southern properties. The difference in valuations was approximately $70 million.

A significant issue in the case was whether the properties, which were not in common ownership, nor had they been the subject of a zoning lot merger,[9] could nonetheless be valued as an assemblage. The First Department, affirming the trial court, said that it could:

Contrary to the MTA’s contention, courts in New York have recognized that the reasonable probability standard applies to potential assemblages…. Whether there was a reasonable probability of an assemblage is a question of fact.[10]

While the condemnation occurred in 2006, the claimants presented considerable evidence that the parties had had serious intentions regarding development of the Broadway blockfront going back many years. Collegiate began exploring the assemblage of the blockfront as early as 1998. Brookfield had engaged a brokerage “to prepare a strategy for acquiring and developing the entire square block.”[11]  Brookfield had shared that report with Collegiate in 2001 and “had exchanged draft letters of intent outlining the terms of a proposed joint venture to develop the block.”[12]  Collegiate had also commenced discussions with Riese as early as 2001, either to acquire the entire property or just the air rights.

Brookfield, which did not yet own any of the blockfront, purchased its parcel in 2003, the one-story retail parcel. This was significant to the trial court, to whom it was “inconceivable” that an entity such as Brookfield, with over 19 million square feet of property under management in New York City alone, would have acquired such a small property without a major development in mind. This property was conveyed in 2004 to the joint venture between Brookfield and Collegiate. For the trial court, it was clear that the three northern parcels would have been merged. The closer question was whether Riese would have sold its fee interest or its air rights. This would have been essential in order for Collegiate and Brookfield to take advantage of the air rights associated with the southernmost parcel, owned by Collegiate.

The trial court noted that “negotiations began in earnest in November of 2004.” However, there were only negotiations for the purchase of air rights. Collegiate tendered an offer of $60 per square foot for Riese’s air rights. Riese countered that they were worth $300.

The parties met in December of 2004 without an agreement…and, there is no evidence of subsequent negotiations between the parties through March of [2006]…. Notwithstanding the lack of negotiations, this Court is of the opinion that there was in fact a reasonable probability that the Riese Organization would have transferred all of the rights including the developmental rights to 196 Broadway as there was simply too much at stake for the Church and Brookfield Properties.[13]

This justification for accepting the assemblage argument with respect to the Riese property is startlingly sparse. It was buttressed somewhat by the Appellate Division, which cited testimony from Riese that “he believed the parties were ‘closer than ever,’” and the testimony of Collegiate’s negotiator with Riese, who “also believed a deal would be reached because it made ‘economic sense to both parties.’” The court also referred to similar testimony by Brookfield’s executive vice president, and noted that “even the MTA appraiser testified that it was in the economic interest of Collegiate to reach an agreement with Riese.”[14]

Ultimately, “[t]he trial court’s conclusion that a deal was reasonably probable necessarily reflected a finding that these witnesses were credible. Such credibility determinations are entitled to deference.”[15]

We do not read this opinion as endorsement of the concept that it is sufficient for the purposes of determining “reasonably probable” that an action be in the claimant’s economic interest. At best, it is something for the judge’s consideration in making a factual determination with respect to reasonable probability.

One other item of note is that the MTA argued to the Appellate Division that if the trial court were going to accept that there was a reasonable probability of assemblage, it should have taken a discount to reflect the possibility that an assemblage might not have occurred. However, the court dismissed that argument, stating that “there is no evidence in the record as to what, if any, that discount factor should have been.”[16]

‘John Jay College’

Representing the other side of the coin, the next case is one in which the condemnor prevailed in a very lengthy trial where, again, tens of millions of dollars were riding on the outcome. The condemnor valued the property at $82,185,000 and the claimant’s appraiser gave the subject a value of $227,000,000.

The case involved the 2001 condemnation of three lots improved by a three-story warehouse building with a rooftop parking garage. The property was acquired by claimant three years prior to vesting, for $49,525,712.

Originally zoned M1-5 and M1-6, the lots were rezoned as commercial, in response to actions taken by claimant, and claimant obtained large scale development and other special permits. There was no disagreement over the highest and best use. Both appraisers agreed that mixed use/commercial development was the highest and best use.

The court started by noting that the burden of proof is on the claimant, and that it would have to “submit proof to support its claim that the 1998 contract price of $49,525,712 is unrelated to the subject’s fair market value.”[17]

The claimant had architectural renderings prepared showing five different components, each of which was valued separately by claimant’s appraiser, “based on the notion that the subject was ‘a development project in progress’ with development plans ‘well underway’ at the time of condemnation.”[18]  The court rejected that assessment for several reasons. No building plans had been filed. No construction financing had been obtained, nor a construction manager engaged. There was no agreement for demolition of the building. In fact, tenants occupied approximately 80 percent of the building.

Citing Arlen of Nanuet v. State, 26 N.Y.2d 346, 354 (1970), the court noted that it was obligated to “look to the situation existing on the day of the taking” and noted that in City of New York v. Chestnut Properties, 39 A.D.2d 573 (1972), aff’d, 34 N.Y.2d 800 (1974), “it was held error to predicate a condemnation award upon the value of a nonexisting income stream from land as if it were improved by building which had not been constructed at the time title vested.”[19]

There were other problems with the claimant’s appraisal. In addition, there was testimony that the architectural drawings were not consistent with the site’s special permit.

The court was left with the condemnor’s appraisal, which it found generally persuasive. It did, however, add $15 million to take into account enhanced value by reason of the zoning change obtained by claimant and the borings and foundation studies conducted by the claimant. That victory was short-lived, however, since, on appeal, the First Department eliminated that part of the award as “duplicative, since it was already factored into the condemnor’s appraisal that was accepted by the court; in addition, the costs were not documented.”[20]

‘Gyrodyne’

The careful reader will have noticed that, while the first four cases discussed involved differing views regarding the use of the properties in question, in none of them was a change in zoning required. This last case is of the “classic” variety, in that a zoning change would be required in order to realize the claimant’s proposed highest and best use.

At issue was the valuation of an approximately 308-acre parcel located partially in Brookhaven and partially in Smithtown, 245 acres of which were acquired by the state. The state’s appraiser found the property’s highest and best use to be“to create a light industrial/business park, as permitted under current zoning”…. Conversely, claimant’s appraiser finds the highest and best use of the subject property is “for a change of zoning to Planned Development District…and development with a multiple residence family residential community.”[21]

The court, in a lengthy opinion, went into great detail discussing the testimony of each side’s experts. The opinion makes clear that the claimant made a compelling case that a change in zoning was reasonably probable.

Space does not allow a detailed discussion of the evidence. In summary, the evidence presented by the claimant showed that the surrounding area was primarily residential, with a farm and SUNY Stony Brook being the only non-residential properties in the neighborhood. The subject itself was originally residential, having been changed to industrial at the claimant’s request many years earlier.

The subject had never been fully developed as industrial property. Claimant’s traffic expert noted the remoteness of the subject from major highways, and the major traffic problems that would result if the property were to be fully developed as an industrial property. Much less traffic would have been generated by residential development. There had been previous attempts by the claimant to change the zoning back to residential, one of which, for a senior living facility, had been withdrawn despite favorable review by Brookhaven when claimant’s partner, Marriott, got out of the assisted living business.

The court clearly was more impressed with the claimant’s experts than the state’s.

In establishing its case, claimant presented the Court with: the background and history of the subject property (Pitsiokos); a businessman willing to invest time and money toward developing the subject property (Barton); a traffic study to compare and contrast the impact of traffic in an industrial scenario and a residential scenario (King); an expert in rezoning (Gulizio); and a real estate appraiser (Taylor). Each of claimant’s experts were either local to Long Island or had experience on Long Island and had extensive backgrounds in their field….

The majority of experts presented by defendant were not local. They had no familiarity with the local areas or the processes on the local level in regard to acquiring a change of zone. Defendant’s planner, Grover, lists himself as an environmental scientist on his resume, but testified as a planner. During his cross-examination, Grover testified his resume was incomplete/inaccurate because it should reflect he is an environmental planner. It is inconceivable a witness being hired to provide expert testimony as a planner would not list himself as a planner in his curriculum vitae.[22]

When theories of valuation differ so markedly, the court is faced with an either/or situation. There is really no middle ground. Consequently, it is essential for each side to present rebuttal evidence. If a party’s theory is not accepted, then the court will not simply be left with the other side’s appraisal. What is most remarkable about this case is that the state put all its eggs in one basket, and lost. The result was a valuation of $125,000,000, almost $100,000,000 higher than the state’s appraisal.

Conclusion

Differing views of the highest and best use of a property taken in condemnation can result in highly divergent values. The burden is on the claimant to prove to the court that its proposed use is reasonably probable in the reasonably near future—a use that is merely speculative will not be accepted. A claimant must submit convincing evidence backed up by credible expert testimony in order to prevail. The burden, however, is not all on the claimant. A condemnor must be aware of the risk that its theory of valuation will not be accepted, and present credible rebuttal evidence that can be used to reduce the award in the event that the court accepts the claimant’s highest and best use.

 

John R. Casolaro is a partner and Lee A. Ohliger is counsel at Carter Ledyard & Milburn, where they practice in the condemnation practice group.

 

Reprinted with permission from the April 9, 2012 edition of the New York Law Journal © 2012 ALM media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382, reprints@alm.com or visit www.almreprints.com.

 
Endnotes


[1]The Appraisal of Real Estate, 13th Ed. (Appraisal Institute, 2008,), at 277-78.

[2] Id. at 279.

[4]Masten v. State of New York, 11 A.D.2d 370 (3d Dept. 1960), aff’d, 9 N.Y.2d 796 (1961).

[5]Matter of Town of Islip (Mascioli), 49 N.Y.2d 354 (1980); Chase Manhattan Bank v. State of New York, 103 AD 211 (2d Dept. 1984).

[6] See, generally, Mascioli, 49 N.Y.2d at 360-61; Masten, 11 A.D.2d at 371-72.

[7]Matter of City of New York (Broadway Cary Corp.), 34 N.Y.2d 535, 536 (1974) (citations omitted).

[8]Matter of MTA, 34 Misc. 3d 1213(A) (Sup. Ct. Queens County).

[9] A zoning lot merger would have allowed unused development rights, sometimes referred to as “air rights,” to be transferred from the two southernmost properties to the three northernmost properties.

[10]Matter of Metropolitan Transportation Authority, 86 A.D.2d 314, 320 (1st Dept. 2011) (citations omitted).

[11] Id. at 321.

[12] Id.

[13] Matter of Metropolitan Transportation Authority Fulton Street Transit Center Project Phase 2, at 9 (Index No. 400464/06, Aug. 23, 2009).

[14] Matter of Metropolitan Transportation Authority, 86 A.D.2d at 324-25. While a purchase of the Riese air rights was essential to the assemblage claim of Collegiate and Brookfield, it did not follow that the court should value the Riese property on the same basis as the other three. Nonetheless, it did, even though Riese’s appraiser concluded that the highest and best use of the Riese property was to retain the three-story improvement and transfer the air rights.

[15] Id. at 325.

[16] Id. at 326.

[17] Matter of Dormitory Authority of the State of New York (John Jay College), Index No. 102934/01, April 16, 2008, p.4.

[18] Id. at.8.

[19] Id. at 9.

[21]Gyrodyne Company of America Inc. v. State of New York, 28 Misc.3d 1202(A), 2010 NY Slip Op. 51129U at 5, aff’d 89 A.D.3d 988 (2d Dept. 2011).

[22] Id. at 12.


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