The importance of air rights in today's development.

Zoning regulations are of great significance to realtors and developers--especially in a place like Manhattan where there is finite space on which to build. Of equal and increasing importance is the concept of "air rights," or "excess development rights." When a building occupies less floor area than which is allowed on that site under the zoning regulations, the owner obtains air rights. The value of air rights are based on whether they are used to develop the existing property or whether they are transferred to another property--called transferable development rights, or TDRs.

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And, it is with TDRs that developers should acquaint themselves. These sellable air rights are usually transferred by merging adjoining lots that have at least ten linear feet in common. The market for TDRs using this method of merging is limited, from both the viewpoint of the owner of the granting site and the owner of the receiving site.

The only possible receiving and granting sites for development are contiguous lots that have excess development rights available (except for landmarked sites, whose air rights may be transferred to a property across a street by special permit). My introduction to air rights came during a deal to build bridges over the Major Deegan and Penn Central RR (now MTA) leading to the North River Park and Sewer Treatment Plant in Manhattan. Their value was based on land sales located next to the Major Deegan and RR (across the fence value). Back then--over three decades ago--there were very few fee sales of air rights.

In 1976, Grand Central Terminal [GCT] had 2.5 million square feet of air rights, above which the then-owners Penn Central planned to construct an office tower. The Landmarks Commission rejected this based on appearance. Penn Central sued, arguing Landmarks law is unconstitutional and a confiscation of property.

On behalf of Landmarks, I proved that GCT could make a reasonable return on investment by selling or leasing the above-terminal TDRs. The U.S. Supreme Court heard the case and not only validated Landmark law but also the premise that air rights have considerable value.

Penn Central eventually sold air rights for the construction of the Philip Morris building on 42nd Street and Park Avenue and the Bear Stems building on Madison Avenue. Another important TDR example involved City Center. The City of New York sold TDRs for construction of City Spire, a 74-story mixed-use building built in the early 1980s.

The City of New York, which owned City Center, was approached by a developer to sell the air rights, and we analyzed sales of fee land and sales of adjoining air rights to establish a ratio between fee land prices and TDR prices (which was 60%). We also determined the additional value and profits generated from using the City Center air rights to add 10 to 15 stories to the planned building.

Several midtown buildings were also built using air rights from adjoining property: The Lyceum Theater leased the air rights to the developer of 1540 Broadway to add to a 44-story office building at West 45th Street, and Harry Macklowe used the air rights from the adjoining Hudson Theater to build the Macklowe hotel.

The landmarked Rockefeller Center Complex has 2.5 million square feet of TDRs. Landmarked buildings such as Rockefeller Center can transfer TDRs across the street with a special permit. In 1986, stockholders sued the sellers of Rockefeller Center saying the price for an anticipated sale was too low and neglected the added air rights value. We were able to demonstrate in a Delaware court that the number of available and viable receiving sites was practically nil, and that valuing air rights without a specific receiving site is speculative. The court ruled that the TDRs did not have value at that time.

Air rights are in the news now, as well. The City of New York and the MTA are interested in selling for development TDRs over access streets leading to the Manhattan entrances to the Queens Midtown Tunnel and the Brooklyn Battery Tunnel. The Port Authority is interested in building a platform over the streets leading from the Manhattan entrance of the Lincoln Tunnel and leasing the TDRs.

These transferable air rights will only be more important as developmental land shrinks. That's why it's critical for anyone dealing in real estate be acquainted with the ins and outs of air rights--especially their value and how they are priced.

The value of TDRs is related to the fee value of the underlying land of the receiving lot. Fee land is nothing more than development rights. The only difference between fee land and TDRs is that TDRs have no ready market (they require a legal receiving site) and they don't include ground level and below-ground development rights.

The two differences suggest that TDRs are worth less than fee land, but this lower value is tempered by the fact that TDRs typically permit a receiving site to be developed with a taller building. Higher floors of a building typically are worth more than lower floors because of superior views, light and air.

There is also the consideration of greater flexibility in building design, use of lot line windows as legal windows and light or view protectors, and other attractive features. The developer who does not take air rights into consideration or proper valuation does so at his own peril. After all, in real estate, the sky is the limit.

BY ROBERT VON ANCKEN, EXECUTIVE MANAGING DIRECTOR, GRUBB & ELLIS