By Collin W. Brown, Associate, K&L Gates

As the commercial real estate market continues to gain strength, investors and lenders should bear in mind the importance of proper land use due diligence. In a commercial real estate transaction, it often is surprising to see how little attention is paid to a property’s (or portfolio’s) land use entitlement status. In complex transactions, sophisticated parties will retain top-notch real estate counsel to handle the financing and closing. Licensed surveyors, engineers and environmental consultants may be retained to analyze certain issues. But more often than not, when it comes to an analysis of applicable land use regulations, buyers and lenders simply outsource this task to a company that will provide them with a “form” zoning report.

Increasingly, local government land use controls govern every aspect of the use and operation of commercial real estate. They may regulate: uses, hours of operation, signage, appearance, renovations, expansions, landscaping, tree pruning, parking, treatment of storm water runoff, and a myriad of other issues. But the most mind-boggling aspect is not the scope of land use regulations, but their variety. Unlike financial or environmental regulations, which usually are standardized on a national or state level, as a general rule, land use regulations are adopted and enforced locally, meaning that they vary wildly from one local jurisdiction to another and are subject to change at the whim of local elected officials. Therefore, it is difficult for real estate investors to understand and appreciate the land use regulations affecting a property. With so much at stake, purchasers and lenders should ensure that they understand land use issues and the nuance of their application.

Unfortunately, too many investors rely on simple zoning verification letters obtained from local governments or cursory zoning reports provided by companies that do not fully appreciate how a property is impacted by land use controls. Most land use due diligence analyses focus on one question: “Is the current use of the property legal?” That question can be answered by a government staffer, and the person preparing the zoning report can check the box on his due diligence checklist. However, this level of analysis provides very little information about a property’s land use entitlements and may paint an inaccurate picture of a property’s value.

Perhaps the most important single word that is overlooked in a typical zoning analysis is “non-conformity.” Sometimes referred to as “grandfathering,” non-conformities are instances where a project or structure was developed or built in compliance with the regulations in place at the time of construction, but over time, new regulations were adopted and the project or structure does not comply with current regulations. Almost all local ordinances include some type of provision related to grandfathering or non-conformities. These provisions typically recognize that projects or structures that met local ordinances when they were built may continue to operate and are not considered to be in violation of local ordinances, even though they do not comply with current regulations. However, most local regulations also impose some limitations on the use of these non-conforming properties. For example, a property may lose its non-conforming status if it is renovated or if certain changes are made, while other jurisdictions may prohibit any changes to a non-conforming property.

In today’s difficult market with stringent underwriting standards, it behooves prudent investors and lenders to pursue these lines of inquiry during the land use evaluation that accompanies the due diligence performed in connection with the purchase and financing of real estate projects.

About the Author: Collin Brown is Land Use and Zoning attorney at K&L Gates in Charlotte. K&L Gates advises clients with regard to the entire spectrum of real estate legal needs and offers legal counsel from more than 40 fully integrated offices across four continents. Learn more at klgates.com.