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Property in the Course of Development

From time to time a property is in the course of development finds itself the subject of a proposed condemnation proceeding. It may be in the beginning of the process, where planning is merely taking place or at various stages, up to where construction is very near completion. It inevitably raises the question of what the developer should then do, go forward with the project or stop all activity until the condemnation actually takes place?

It is not an easy decision. Often the decision is complicated by the fact that various levels of governmental approval are required, from variances or rezoning to securing approval of building plans, and the question arises whether the decision of the governmental body involved will be influenced by the pending condemnation, a more than likely proposition, and what the developer should do about it. What cannot be lost sight of is that in valuing the property in the condemnation proceeding the award would probably be negatively affected if an application for a variance or zone change were turned down and it could not be proved it was because a condemnation was pending. Then there are questions relating to losing a favorable market if he waited and the project did not go forward and to losing time-limited financing commitments.

We start with the basic proposition that despite a property being designated for a proposed condemnation proceeding, as long as the owner continues in title, he has an absolute legal right to continue to use and develop his property. In fact, we find a decision that holds that just because a condemnation proceeding is proposed is no basis for a tenant being relieved of the obligation under a lease to substantially renovate a building (2814 Food Corp. v. Hub Bar Building Corp., 35 AD2d 277, 315 NYS2d 969 [1st Dept., 1970]). Further, history tells us that, short of actual condemnation, there is no certainty that a project will go forward. The proposed Lower Manhattan Expressway and Westway are glaring examples in a long list of projects that reached various stages of approval and then were dropped. We have a client who did not build on a part of his lot on which the State Department of Transportation told him they were planning to construct a highway. When the highway was built, the lines had been changed and it was never taken, with his having lost gainful use of that part of the property, without compensation.

Stopping the Developer

We also find, on the other side of the process, that, at least with some condemnors, the temptation to stop the developer from going forward with his project by extralegal means has been too great to resist. It happens far more often than most realize. Thus, it has happened that where an application for a variance or rezoning or even a building permit was pending, an unpublicized letter or conversation between agencies or bodies has led to either the governmental body involved just sitting on the application without action or unjustifiably denying it. In the latter instance, the developer at least has a chance, by an Article 78 proceeding, in doing something about it, while with the former, unless there are statutory or regulatory time limits by which the government body must act, he is helpless.

Sometimes a paper trail has been left when it occurs, but most times it has not. When there is such a trail we find the courts act in terms of forcing permits and variances, disregarding inappropriate zoning and in providing compensation in the ultimate condemnation award for the resulting loss (See In re Public School No. 223, City of New York (Nelkin), 71 AD2d 1021, 420 NYS2d 501, aff’d. 51 NY2d 921, 434 NYS2d 981 (1980); In re City of New York (Jomar Real Estate Corporation) 71 AD2d 1020, 420, NYS2d 501 aff’d 51 NYS2d 921; In re Fifth Avenue Coach Lines Inc., 18 NY2d 212, 273 NYS2d 52 (1966); Keystone Assoc. v. Moerdler, 19 NY2d 78; Bowne v. Town of Hamptonburgh, 76 AD2d 848, 428, NYS2d 526 (2d Dept., 1980); Corrado v. Wolf, 37 Misc2d 89, 235 NYS2d 336 (Meyer J. Sup. Ct. Nassau Co., 1962); Winpol v. Town of Hempstead, 59 Misc2d 768, 300 NYS2d 197 (Sup. Ct. Nassau Co., Meyer, J.); In re Public Place, Borough of Manhattan, 54 Misc. 69, aff’d and remanded 24 AD2d 243, 265 NYS2d 150, on remand __ Misc2d __ , 281 NYS2d 414 rev’d on other grounds 31 AD2d 530; Chase v. City of Glen Cove, 246 NYS2d 975 (Sup. Ct. Nassau Co., Meyer J. 1964); Matter of City of New York (John F. Kennedy H.S.), New York Law Journal, July 24, 1967, p.10 col.3 (Sup. Ct. Bronx Co., Brust, J.); Zogby v. State of New York, 53 Misc2d. 740, 279 NYS2d 665 (Ct of Cl., Lengyel, J., 1967): Oakwood Island Yacht Club v. City of New Rochelle, 59 Misc2d 355, 298 NYS2d 807, aff’d __ AD2d __, 320 NYS2d 505 (2d Dept., 1969); Conway v. Kerr, 51 AD2d 758, 380 NYS2d 44 (2d Dept., 1976); Mt. Morris Assoc. v. McMorran, 35 AD2d. 843, 318 NYS2d 120 (2d Dept., 1970).

Paying Lip Service

Suppose the developer wishes to go forward with his construction in the face of a planned condemnation, the other side of the above coin. While we find the courts paying lip service to his right to do so, unless the developer has the most compelling reason for continuing with the development their decisions, in the valuation of the property in the condemnation proceeding, say something different in the result. We believe this is the real explanation for the decisions in Matter of City of New York (Atlantic Improvement Corp.), 28 NY2d 465, 322 NYS2d 708 and Matter of City of New York (G & C Amusements), 55 NY2d 353, 449 NYS2d 671 (1982), reversing 82 AD2d 829, 439 NYS2d 677.

In the latter case, the amusement rides and ancillary property in dispute, for which compensation were sought as “trade fixtures,” were held non-compensable “personalty” by the trial court because, when he installed them, the owner “gambled” that the property would not be condemned, he having installed them on land leased from the City, allegedly in the face of a planned project. They were then deemed compensable trade fixtures in the Appellate Division, which reversed the trial court. Then they were held to be part of the real estate, pursuant to a very strictly construed lease clause, and thus not compensable to the tenant, in the Court of Appeals.

On oral argument in the Court of Appeals, a year or so later, in the Jomar case, supra, a case where a building permit was revoked as to the tenant in the middle of construction of indoor tennis courts because of a newly planned condemnation proceeding (restored after a nine-month delay), with the balance of the development put on hold because of the project, the other side of the G & C Amusements coin, the then Chief Judge tacitly acknowledged the reason for its lease construction in G & C.

It is by reason of these latter decisions and others like them that we generally advise clients that if they are not so well along in their development that they have no realistic chance to halt the process they should put their project on “hold” until they know whether the condemnation is going forward. There is a down side to doing so, however. Usually, there has been a substantial amount of money already invested in planning, engineering and architect’s fees, while interest on mortgages as well as taxes, insurance and other costs continue to accumulate while the property remains unproductive.

There may be time-limited mortgage commitments that will expire either before the property is condemned or before one can be sure the project has been abandoned. Then there is the condemnor that will attempt to attribute the stoppage of the proposed development to causes other than the planned condemnation. Sometimes the development is so well along that it cannot realistically be halted. Sometimes the developer believes that because his project is so well along and beneficial he can persuade the potential condemnor to abandon the taking, usually more a hope than a reality. Sometimes he believes he can complete the development before a condemnation can be started.

Favorable Treatment

The upside in halting the work is that the courts appear to treat those who do so more favorable than those who do not. The dissenting opinion in the Appellate Division describing what the trial court included in its award in In re Public School No. 223 (Nelkin)supra, gives an indication of what that reaction is:

The total award — included $68,022 for real estate taxes for the period Jan. 1, 1962, to March 9, 1971, $137,712 for mortgage interest for the same period, $71,071 in architect’s fees, $29,000 in legal fees, and approximately $10,000 in other fees expended in claimant’s attempt to obtain financing for the projected development of the site.

The underlying facts of the case were that to develop the project the developer was seeking not only a Federal Housing Administration mortgage commitment, but a zoning change to increase density and a real estate tax exemption, which involved three different agencies. After years of effort, an agreement was reached to secure all of them. Before it could be implemented, condemnation of the property was proposed and a letter sent to the FHA by a City agency asking that it withhold the FHA mortgage commitment because of the pending condemnation proceeding. It was complied with.

Nothing happened for more than two years, despite the developer’s efforts, until the property was condemned. Fortunately, the letter was discovered in the FHA files and put before the court. While the dissent did not mention this, it appears that the result in fully compensating the developer for his out-of-pocket costs was attributed to it. But, we know of other instances where it is clear something similar happened but there was no smoking gun.

In Matter of City of New York (New Detention Facility) (China Plaza Inc.), __ AD2d __ (1989) the Appellate Division affirmed an award that included the costs of development of a project that had been halted upon the announcement of a planned condemnation of the property before it had reached the actual construction stage but after a package of complete planning and financing had been completed. While the trial court never spelled out the exact amount allowed for any particular item, it indicated it added to the award $3.2 million for “development costs.”

The question then is what the legal justification is for granting the costs expended in development, besides the moral and equitable one. The basis alleged has been that the project, in its then state of development, is saleable as a package with a buyer securing the advantage of not having to repeat what has already been accomplished, with its attendant costs, i.e., it is a project in the course of development (see Arlen of Naunet v. State of New York, 26 NY2d 465, 322 NYS2d 708; Matter of City of New York (Chestnut Properties Co.), 39 AD2d 573, 332 NYS2d 19 (2d Dept.); Matter of City of New York (New Detention Facility) (China Plaza Inc.), supra; Matter of City of New York (P.S. 223) (Nelkin), supra.

Added Value

While there is always an issue of “reasonableness,” the actual cost of the work is the best evidence of the value that the work added to the property. The courts have held that the cost of construction of a building, “well suited to its site is some evidence of value, at least as to the tax years soon after construction” (Joseph E. Seagram & Sons Ltd. V. Tax Commission, 14 NY2d 314, 251 NYS2d 460 (1st Dept., 1964); Dune Alpine Farm Corp. v. Assessor of Town of East Hampton, 125 AD2d 672, 509 NYS2d 861 (2d Dept., 1987) and cases cited therein.) This view is consistent with other aspects of real property valuation law and recognizes that while the quest is market value, which may or may not be coincident with the actual cost of construction, it is similar to using an actual recent lease of the subject premises as strong evidence of rental value (Matter of the City of New York (Clinton Urban Renewal-Franklin Record Center Inc.), 59 NY2d 57, 463 NYS2d 168 (1983); Matter of the City of New York (Maxwell), 15 AD2d 153, 162, 222 NYS2d 786; c.f.Ettlinger v. Weil, 1184 N.Y. 179, 183; Mater of the City of New York (Marshall), 16 AD2d 570, 229 NYS2d 947 (1962)); a recent sale of the subject property as strong evidence of its market value, (Matter of Woolworth Co. v. Tax Commission, 20 NYC 561, 565; Matter of City of New York (Maxwell), supra); Matter of the City of New York (Marshall), supra; recent cost of alteration as strong evidence of added value for a changed use (In re Madison Houses, 17 AD2d 317, 234 NYS2d 789; In re P.S. 79, Manhattan, 19 AD2d 239, 241, NYS2d 575); and actual use as evidence of highest and best use (Matter of City of New York (Jomar Real Estate Corp.), 61 NY2d 843, 473 NYS2d 963 [1984]). In each instance the actuality, and otherwise unexplained, is evidence of the first rank. As the cases make clear, existence does not make it conclusive but shifts the burden of proof to the side contending differently.

While this is an over simplification of a larger subject, it is clear from a synthesis of case law that there is a basic presumption in law of the reasonableness of an actual transaction. While it is specifically stated and recognized that no single transaction bespeaks and entire market, and the fact of actuality as to the subject property does not preclude other evidence inconsistent with that fact to prove the market to be otherwise, the fact itself, unless otherwise explained, is evidence of the first rank in determining market value of the subject property. This being so, if the cost of a building recently completed is evidence of the first rank, then the cost of development of a building in the process of development is also evidence of the first rank of the value.

Since actual cost is evidence of the first rank as to value, what then is included as part of the cost. As was stated in Matter of City of New York (Harlem-East Harlem Neighborhood Development Area-Salvation Army Inc.), 43 NY2d 512, 516, 402 NYS2d 804, 805 (1978):

Implementation of the summation method requires the inclusion not only of payments for material, equipment, labor and other obvious physical ingredients which go directly into construction, but also of those charges which may be termed indirect or less direct, such as architect’s fees, contractor’s profits, interest and taxes on land during the period of construction, cost of procuring necessary licenses and the miscellany of other essential overhead or incidental expenses. For a fair and realistic appraisal of reproduction costs must embrace in its reckoning all expenditure that reasonable and necessarily are to be expected in the re-creation of a structure so idiosyncratic as to leave no alternative method by which to measure fair compensation. (Cases cited)

Financing costs are such an expenditure (citation). — Thus, whether an owner uses its own or borrowed funds, the calculation of true cost would, wither way, require inclusion of costs of financing.

See also D’Amico v. State of New York, 37 AD2d 681, 323 NYS2d 224 (4th Dept., 1971); Richards “Of Course” Inc. V. State of New York, 36 AD2d 572, 317 NYS2d 827 (4th Dept., 1971); Lapides v. State of New York, 37 AD2d 755, 323 NYS2d 179 (4th Dept., 1979); Ryan v. State of New York, 39 AD2d 830, 333 NYS2d 158 (4th Dept., 1972); Rustcon Developers v. State of New York, 33 Ad2d 582, 3304 NYS2d 287 (3d Dept. 1969); Salamone & Company v. State of New York, 40 AD2d 916, 337 NYS2d 846 (3d Dept., 1972); Specialty Foods Corp. v. State of New York, 46 AD2d 989, 362 NYS2d 266 (3d Dept., 1974); In re City of New York (North Central Brooklyn High School-Chestnut Properties Co.), 39 AD2d 573, 332 NYS2d 19 (2d Dept., 1972), aff’d, 34 NY2d 800, 359 NYS2d 40); (See also Internal Revenue Code, §189, which provides that interest and taxes for purposes of acquiring, constructing and carrying real property during the construction period is not deductible as an expense but must be capitalized).

In Banner Milling Co. v. State of New York, 240 N.Y., 533 the court, while referring to “fair value of architect’s and engineer’s fees upon the construction and equipment of said plant, insurance premiums and interest on investment during construction period, railway franchises, legal expenses, sundry items correcting errors in construction expenses incurred in operating the mill at a loss up to a time when machinery is synchronized and coordinated so as to produce a satisfactory result” stated, at page 545, that while claimant was not entitled as a matter of law to recover for those expenses they were entitled to have them considered. As the court said (P. 546):

Each case necessarily involves different facts and must be considered by itself. Only a few general rules apply on the question of valuation in condemnation proceedings, and even these may yield to exceptional circumstances.

The rule in condemnation proceedings is “just compensation.” Fair market value is only a means of getting to it. But exceptional facts require exceptional handling.

Before we leave this subject, we mention one other aspect of this problem that the courts are yet to address and that the appraisal texts have just begun to recognize. That is compensation for earned “entrepreneurial profit.” It is a subject that is inherent in the compensation to be awarded for property in the course of development. Developers build for profit. That being so, the project, when completed, should be worth more than merely the land value plus the actual costs of construction, both hard and soft costs and builder’s overhead and profit. That difference is the entrepreneurial profit. As was stated in Levin v. State of New York, 13 NY2d 87, 242 193 (1963):

— Nor would one expect the prospective purchaser to pay for the vacant land in suit an amount equal to the worth of the conjectured net rental income, deducting of course, construction and other costs necessary to complete the building — for, then, he would be paying an amount which would precluded any profit. What the purchaser would pay would undoubtedly be influenced by the extent to which the property had been exploited.

If the project had been completed it would have included within its value that entrepreneurial profit. The question then is why should not a project in the course of development, which is only partially completed, have included as part of its value more than just the land and money expended, but a proportionate part of the entrepreneurial profit that condemnation has deprived him from realizing. For the same reason, one cannot come to a land value by contemplating the value upon completion and only deduct the costs of development without deducting for “entrepreneurial profit,” (the so called “residual” approach to land value), one should not merely be limited to land value plus development costs where there is a property in the process of development without including an amount for that part of the entrepreneurial profit earned to that stage of the development.

Reprinted with permission from the March 18, 1992 edition of the New York Law Journal © 2010 Incisive Media Properties, Inc. All rights reserved. Further duplication without permission is prohibited.