Zoning: What it is, How it Works, and Categories in Real Estate

Key Takeaways

• Zoning refers to governance of the use of property in areas that are divided into “zones” by a municipality or other local government.

• Even if an individual owns the land on which they wish to build, they must still comply with area zoning laws.

• A property owner or developer may apply for what are called variances that would permit zoning exceptions.

Property investors and those interested in entering the market would do well to understand zoning and its considerations, regulations, and guidelines, as well as how such an understanding can optimize real estate investments. With that said, here is zoning: what it is, how it works, and what the categories are.

What is Zoning in Real Estate?

Zoning refers to governance of the use of property in areas that are divided into “zones” by a municipality or other local government. A zoning law or ordinance directs how land is used for property within zoning districts. So basically, zoning determines the property makeup of different areas of a city.

An example of zoning would be restrictions on the use of industrial or commercial land with the goal of preventing the establishment of businesses in industries such as oil or manufacturing in residential communities.

Note that if construction of a property would help an area economically, it is possible for zoning laws to be altered or suspended. Also, zoning laws are different from rules established by homeowners associations since the former are made by governments.

Common Types of Zoning Categories in Real Estate

There are several types of zoning distinctions in real estate, including:

Residential

To avoid an aesthetic patchwork of residential units throughout a municipality, a local government will often create some zones that lend themselves to cohesion. Such ordinances can address permission to possess animals on a property, encumbrances such as the number of structures permitted on a property, the allowance of manufactured homes, and permission to build multi-family homes.

In a residential zone, housing unit types can include single-family residences, suburban homesteads, trailer parks, apartments, condos, co-ops, and home-based businesses.

Commercial

These zoning laws will impact a city’s businesses, including shopping centers, office buildings, hotels, nightclubs, restaurants, and business development-ready vacant land.

While there will be variations among business types in a commercial zone, the city government will be able to establish rules that include:

• Maximum building heights
• Parking availability
• The proximity of specific business types to others

Industrial

These zoning regulations involve industrial-type businesses such as manufacturing and storage facilities, warehouses, and even airports.

The establishment of such zones are determined by factors such as air quality and the presence of loud noises. Such zones are usually situated far from a municipality’s residential sections.

Mixed Use

An area can be deemed residential as well as commercial, with zones typically divided into mixed-use or single-use properties.

Zoning Regulations and Guidelines

There is no federal entity that controls zoning in a given area. Thus, sometimes zoning is controlled at the county level, and sometimes the city. Such control commonly occurs in what is called a zoning office or a land use office.

Regulations and guidelines can include terms such as “lot coverage” – a building’s or structure’s footprint or size on a lot, divided by the parcel’s size, and expressed as a decimal number. Lot coverage is utilized in figuring out the intensity of use of a parcel for a development.

Zoning ordinances can include setback requirements, which usually refers to the distance that a house or other structure must be built from the property line. The precise property setback hinges on the shape of the building and lot, structure type, and other factors.

Setback requirements can influence neighborhood development and are different for main buildings and detached accessory structures. Note that special rules may apply when measuring setbacks for lots that are irregularly shaped, and the method must be cleared with the area permit office. For example, while a property’s front yard can have an irregularly shaped setback line that is consistent with the property line’s shape, the rear setback line can be based on the average lot depth.  

There also may be setback requirements regarding structure height. Restricting a building’s size on a property, for example, could promote sound insulation as well as the use of clear ventilation and natural lighting. Taller buildings will block out more sunlight from area homes and can look out of place in most residential communities.

It is important to note that because setbacks are not set in stone, it may be possible to apply for a setback variance. A possible scenario would be if there is an obstruction such as a pond or river that is deleteriously affecting one’s ability to utilize their property as their neighbors do.

The local government zoning board must approve such a variance, which it often does if the situation is unique to the applicant’s property. However, if most properties in the areas have a similar issue, then it is less likely that the board will approve a variance.

How Does Zoning Work?

Zoning can regulate residential versus commercial property usage, and real estate can sell at a premium, depending on zoning. In short, zoning is very influential in real estate, and vice versa.

Zoning sets forth the types of developments and operations that are permitted on a certain land area, commonly to foster economic development, manage noise levels, control traffic flow, shield certain resources, or save dwelling spaces for residents. At times, the promise of commercial activity is prioritized, leading to a prohibition on the use of residential property in a certain part of town, for instance.

Construction in specific neighborhoods can also be affected by zoning laws. Details such as the maximum height of buildings could be restricted in an area, ruling out, say, high-rise residences or office buildings. 

Even if a person owns the land on which they wish to build, they must still comply with area zoning laws.

Challenges and Considerations

There are some who contend that zoning establishes and furthers life quality chasms that exist among socioeconomic classes. For example, say a township’s zoning regulations limit heavy commercial and industrial development to land tracts near relatively low-income neighborhoods. The net result would be a sparing of the more affluent neighborhoods from such pollution and noise.

In another example, communities that refuse to permit construction of residential units in an area with low-density residential neighborhoods would be, in effect, contributing to homelessness, some would argue.

Others maintain that zoning too often separates residential and commercial areas, rendering or perpetuating an unnecessary dependency on vehicles. 

In any case, zoning is commonly a battle to balance property rights with community interests.

Note that a property owner or developer may apply for what are called variances that would permit zoning exceptions. It is incumbent upon the applicant to explain the variance’s necessity and how a modification would not significantly disrupt the area, and each county or municipality has its own variance process.

Investing in Real Estate: The Impact of Zoning

Once a thorough knowledge of zoning has been gained, investing in real estate can become a real option. After all, the asset class is consistently popular for its many potential benefits, including tax favorability, secondary income, fund leverage ability, steady cash flow, and a hedge of protection against inflation and public markets volatility.

The alternative investment platform Yieldstreet, which already offers the broadest variety of asset classes such as art and transportation, has been adding to its real estate offerings. The platform, on which nearly $4 billion has been invested to date, has highly vetted opportunities in private as well as commercial real estate. Yieldstreet features a Growth & Income real estate investment trust, a fund that makes equity and debt investments in commercial properties of various types, including industrial, multi-family rental, and hotels, in top U.S. markets.

Investing in real estate also provides another powerful advantage: holdings diversification. Establishing a portfolio composed of various investment types can reduce risk and is a key component of long-term successful investing.

Portfolio Diversification and Alternative Investments

Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $5000.

Summary

While zoning does have municipal benefits, implementation over the years has had some unintended consequences. However, understanding current regulations and guidelines can help investors in real estate make the best decisions. 

Learn more about the ways Yieldstreet can help diversify and grow portfolios.