The next big thing in real estate investing could be air rights, but how?

As you examine the trends dominating real estate, urbanization efforts in major cities is hard to ignore. Especially in downtown areas, urbanization leads to more crowded regions.

When a city’s density goes up, space becomes limited. This can benefit real estate investors as a supply choke can help raise real estate prices.

But looking at it from another perspective, urbanization can create fantastic investment opportunities. Consider air rights and real estate investing; all you need to do is look up!

WHAT ARE AIR RIGHTS?

What does it mean when someone refers to ‘air rights’? Air rights are defined as the ‘right to control, occupy, or use the vertical space (air space) above a property, subject to necessary and reasonable use by neighbors and others (such as aircraft).’

Generally, owning property includes the right to use and develop that space above ground without interference. Similar to mineral and surface rights, air rights can be purchased, leased, sold, or transferred.

As you can probably guess, the origin of air rights comes from New York where the real estate market is hot and land is scarce. Lower Manhattan was largely developed in the 1960’s due to air rights allowing developers to build upward.

As demonstrated in New York, air rights have the potential to help foster urban development and shape a city. On the other hand, they can be used as a defensive tactic to keep adjacent properties from developing their real estate higher. This can help protect views and/or access to natural light.

HOW DO AIR RIGHTS ADD VALUE?

Now that we understand the fundamentals of air rights, how can they add value for real estate investors?

Air rights can have enormous value as they potentially lead to future development on the property. Future developments can generate rent and income and lead to future cash flows.

Think about a one-story building that is sold, but also has air rights to develop five stories. There are four stories of future development and revenue to take into account when valuing the air rights.

Knowing the potential value of air rights, they can be a price kicker when a property is sold. As a property owner, this is something to take into account when acquiring or selling property.

When acquiring, you want to analyze the development potential of the existing air rights. When selling, you want to make sure the value of the air rights is priced in.

Investors of air rights have a hard time securing a mortgage due to the lack of collateral. In the event of foreclosure, banks don’t have a tangible asset to receive in return.

That makes it tough to determine a value for air rights. It’s difficult to value something that doesn’t yet exist.

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AIR RIGHTS EXAMPLE

IRR discusses an appraisal they performed on a skyscraper in the Chicago Central Business District. They emphasized how air rights were taken into account during the appraisal and must be accounted for when determining real estate value.

In the layout of the skyscraper, the first couple of floors were retail space, the next dozen were home to the parking garage, and the floors at the top were office space. IRR was tasked with finding the value of the upper floors of office space.

They noted using the income versus sales approach to value the property. The sales approach incorporated air rights into the equation, along with several other property owner rights. IRR found the value of the land itself, and subtracted that from the comparables’ sales value. This led to an adjustment range of 10-22 percent.

In this example, they found the air rights were 78-90 percent of the total value. With Chicago’s Central Business District so dense, this valuation is supported (and notably supported by the U.S. Supreme Court). In the case of an empty lot of land, most of the value would come from the developer’s ability to build multiple floors.

HOW TO TAKE ADVANTAGE OF AIR RIGHTS

We see the potential value of air rights for property owners. We know air rights have more value in highly dense and urbanized areas. To take full advantage, you should look for areas engaged in urbanization efforts that will make the value of air rights increase as space becomes more scarce.

One area to focus on is downtown San Diego. The downtown area has been engaged in urbanization efforts for several years.

Horton Plaza was built and led a transformation in the Gaslamp District. Tourists and locals flock to the area when visiting downtown. The nightlife has flourished, along with restaurant and retail space in the area.

The development of Petco Park helped transform most of East Village. Along with the expansion of the convention center, that project helped spur economic growth with thousands of new jobs and increased living space.

Now, developments are leading the way to revitalizing the C Street Corridor. An area that has struggled to secure economic investment is finally starting to see some momentum.

A project received approval this year to redevelop the old California Theatre into a new mixed-use residential building. On top of that, the Civic Center is expected to receive major overhauls as well.

There are also talks to close off the major street (C Street) to traffic. This could lead to an underground trolley to create a similar pedestrian-style mall to that of Santa Monica’s 3rd Street Promenade. As you can guess, that all might be financed with the sale of air rights in the area.

The various urbanization efforts in downtown San Diego make it an intriguing place for real estate investments. When factoring in air rights, real property values could see healthy increases as new projects materialize and mature.

KEY TAKEAWAYS

Air rights are going to increasingly play a major factor in real estate investing. With the increase in urbanization efforts in the U.S. and around the globe, air rights could carry lots of value going forward.

Air rights can be seen as a bet of the future. Investors can expect air right values to increase in areas where urbanization efforts are taking place.

San Diego real estate is well-positioned to help property owners take full advantage of their air rights. The air rights in downtown San Diego make the region a great place for real estate investments.