Alternative Use Scenario Analysis

Tutorial 5: Most Fitting Use Analysis © JR DeLisle

Site in Search of Use:

Most Fitting Use Analysis

Preface

Real estate development decisions constitute irretrievable commitments of scarce resources of land, labor, materials and capital. As such, it is imperative that land use decisions focus on optimizing the utilization of resources within given sets of constraints. The objective of this tutorial is present a framework that can be used to determine the most appropriate use for a given subject property (i.e., site in search of use). This type of analysis can require a number of steps, depending on the scope of your study and the goals and objectives you are trying to satisfy.

In addition to the narrative, this tutorial includes a basic Excel model that can be modified to specific situations.They are a starting point with some basic equations that can be modified to create new templates to support your project analysis. Regardless of how you conduct alternative use analysis, you should document how you arrive at your recommended development scenario. If you have an existing building on your site, you should consider recycling or renovation of that facility along with demolition and new construction. You can run the numbers on such a decision as in this case or make the decision based on use other criteria (e.g., functional obsolescence, physical deterioration).

Overall Site in Search of Use Decision Framework

Exhibit 1 presents a summary of the overall process for deriving the most fitting use. Although it is laid out in something of a linear manner it should be noted that the process itself is iterative with a number of feedback loops.

Introduction

Overview

As noted in the flowchart, there are four major use decisions that can be applied to alternative use decisions. These include:

Most Suitable Use. This is the use that optimizes the “goodness-of-fit” between the real estate and the use. That is, it is the use that is most “valued” or appropriate for a site. This is determined by rating the static, environmental and linkage attributes objectively, applying the evaluative criteria, scaling and weights that would be applied by potential users.
Politically Palatable Use. This use is designed to quantify or identify the use options that are either explicitly permitted via zoning and cannot be challenged, or are likely to affect the entitlement process and project approvals. It address community benefits associated with market and neighborhood effects of alternative uses.
Highest and Best Use. This is the traditional usage standard which reflects the use that is identified after considering such factors as: the legality of the use, the physical possibility of the use, the marketability of the use, the financial feasibility of the use in terms of providing acceptable risk-adjusted returns, and finally the maximization of residual land value.
Most Fitting Use. This the use optimal use that provides the best overall, aggregate fit between a site and the most likely users (both direct and indirect), investors (both debt and equity), and community interests (economic, social, ethical, political). It is a conclusion in which competing interests and goals and objectives are “satisficed” to arrive at a mutually acceptable use.

Decision Model

An essential element of alternative use analysis is that the application of an objective, fact-based decision model which allows you to quantify the various elements of the decision. In addition, the goals and objectives of the decision makers, combined with the situational context and constraints within which the decision must be made helps develop the emphasis that is placed on the alternative approaches in arriving at the “Most Fitting Use.” This level of introspection involves determining the structure and weights applied to the relative use models including Most Suitable, Politically Palatable, and Highest and Best Use. At the same time, you must be able to specify the relative importance assigned to financial, market, and other criteria that affect the investment side of the equation, as well as the neighborhood and community side that affect the political palatability and market acceptance of the ultimate use. This is especially true where you place high importance on community acceptance and benefits, or where your use depends on rezoning or permitting that provides a platform or forum for opposing views to influence the decision.

Stage I: Exploration of Most Suitable Use

The notion of MSU is an input to both Highest & Best Use and Most Fitting Use analysis. This preliminary analysis is a critical input that looks at the suitability of the site from the respective perspectives of the potential uses. That is, each major land user will have different standards that affect how they rate a site in terms of its attractiveness for their particular use. This ranking will also affect the demand or “marketability” of a site for various users. In many cases, the scrutiny of a site through the eyes of potential users is essential to avoid a “field of dreams” dilemma (i.e., build it and they will come). For example, a developer may see a project that appears to be very successful and replicates that strategy on another site, which is not unacceptable unless the selected site and market context have similar attributes that contributed to the success of the initial project. If the components aren’t remarkably similar, then the replica may be doomed to failure, which can take the form of the inability to rent up the property to the targeted users, or the bankruptcy or failure of the user at the new site. Another example is provided by the planning agency that creates incentives to encourage certain land usage without an understanding of the drivers of value that determine the long-term success and viability of such a use. This market intervention can result in development that does not fit the business model of the intended users and is doomed to failure.

Exhibit 2: Static, Environmental and Linkages Analysis in MSU

Demographic/Demand Analysis: Potential User Profiles

In this case, the potential uses and sub-type uses and that might consider or be placed at a particular site should be identified. Once these potential uses/users are identified, the “spatial requirements” should be extracted, indicating the criteria and weighting they would likely apply to a locational decision. These spatial needs can be converted to a three-factor model including Static, Environmental and Linkage attributes. This analysis requires the ability to “empathize” with the potential users; to be able to extract their real estate requirements. Obviously, these requirements will vary from user to user, so a preliminary cut would require the application of market segmentation. That is, due to the nature of a site (e.g., size, ingress/egress, neighborhood attributes and transit/vehicular access), the potential pool of users could be narrowed down. As noted in Table 1 (a), the subject site is relatively small and suitable for neighborhood or community-based users rather than larger tenants. Given this qualitative assessment based on experience, research and judgment, the analyst can fill in the relative importance of the SEL attributes in qualitative or descriptive terms.

Table 1 (a): Qualitative Assessment of User-Based Spatial Requirements

Weightings: Static, Environmental and Linkages

Based on an understanding of the potential users and subtypes, the relative importance of the major factors should be established in the forms of weightings (see: Table 1 (b))

Table 1 (b): Weighting of User-based Spatial Requirements

Most Suitable Use Ratings

At this point, the SEL attributes and sub-attributes should be rated through the eyes or criteria of the potential market segments who might occupy the space. These attributes can be rated on a 1-10 scale and may include the following examples or other decision variables.

Table 1 (c): Rating of Site on SEL Attribute Factors

As noted in Table 1 (c), the “most suitable use” at this point is industrial which happens to be the current use. However, when the weights are applied, the preference shifts to apartment and office uses as noted in the summary table. It should be noted the “Linkages” factor which included 4 attributes had to be adjusted downward to reflect the fact the other factors of Static and Environmental included 3 attributes. At the same time, the analyst could add more attributes --or delete some-- without distorting the final weighted ratings by making a comparable adjustment. Indeed, when calculating the Most Fitting Use, the Most Suitable Use scores will have to be adjusted to reflect differences in the number and scaling of attributes to avoid biasing the results and distorting the weights.

Table 1 (d): Weighted Most Suitable Use

The values in Table 1 (d) are derived by multiplying the summary values for the SEL attributes by the weightings for them contained in Table 1 (b). Based on this analysis, apartment and office uses rise to the top.

StageII: Determination of Highest & Best or Most Fitting Use

Background

The Highest & Best Use model is the default for real estate appraisal and investment analysis. While the model is widely applied, the increasing emphasis on sustainable development and community fit has created the need for a more balanced approach to development decisions that consider the implications on current and future generations, seeking a sustainable solution that has an enduring demand that extends beyond the immediate users’/owners’ span of involvement. This is not to ignore the importance of the financial or investment side of the decision, but to temper it to ensure the use decision recognizes the importance of externalities.

Highest & Best Use (H&B Use)

The H&B Use criteria include standard factors including:

Legally permissible
Physically possible
Marketable
Financial feasible
Maximizes Land Value

Application I: Unweighted H&B Use Analysis

In this phase, the analyst rates the alternative use candidates on the traditional five feasibility criteria using a scale of 1-10. Since the Industrial Use is the current use, it is given the highest rating for being Marketable. On the other hand, the retail, apartment, hotel and office uses are something of a long shot, depending on the ability of the developer to reposition the site or over come its environs. For such uses, the decision to pursue such a use may be dependent on the ability to find an anchor tenant or to somehow establish confidence that a potential tenant(s) can be found. As noted, the current Industrial use ranks slightly behind Office and Apartment as the H&B Use due in large part to the “maximization of value” criterion.

Table 2 (a): Unweighted Highest & Best Use Ratings

It should be noted the ratings for the factors would be determined through market and financial analysis that would be conducted separately. Once completed, the results could be converted to a 1-10 scale. As noted, using unweighted H&B Use, the office option moves into the lead, followed by apartment, industrial and hotel.

Weighted H&B Use Analysis

At this point, the analyst can specify the weightings that are appropriate to the H&B decision, focusing on the relative importance of the 5 factors. The weighting will be somewhat subjective, although it should reflect the situational context within which the usage decision is being made. For example, if it is likely that zoning can be changed to a more intense use, then “legally permissible” may not be as important as the “marketability” of the use.

Table 2 (b): Weighted Highest & Best Use Analysis

In this case, after applying the weights, the apartment use moves to the head, followed closely by the office use.

Attribution Analysis

At this point, it might be helpful to look at why a particular use comes out the way it does in the rating. Table 2 (c) presents the “attribution analysis” of the weighted H&B Use ratings. In essence, this approach looks at the marginal contribution of the various factors to the final conclusion.

Table 2 (c): Attribution Analysis of H&B Use

As noted in the table, the apartment use got most of its weighted point totals from the “marketable” and “feasible” factors. On the other hand, office depended on “feasible” and “maximizing value,” retail won on “feasible” but lagged on others, industrial hung its rating on “marketable” since it was the current use, and hotels were split with no clear attribute dominance. This will give insight into the sensitivity or elasticity of the rankings to different ratings or weightings. This same approach can be applied to other types of use analysis.

Most Fitting Use (MFU)

In general, the MFU model blends the perspectives of the three major constituencies --space producer, space user, and community/neighborhood-- to arrive at a compromise use that represents the optimal use in light of competing goals and objectives. In general, MFU applies the same core criteria in H&B Use analysis, with the exception of “maximization of land value.” Rather, the MFU substitutes the “fit” criterion which incorporates the preferences and values of other constituencies outside of those directly involved in the ownership, development or usage of the property.

Legally permissible
Physically possible
Marketable
Financial feasible
Maximizes “Fit” for targeted users/constituencies

Rating of Product Attributes

One of the first stages in assessing MFU is to rate the site against the evaluative criteria of the potential users. In this case, the analysis adopts a generic user profile for the major property categories, and then compares those criteria against the full dimensionality of the subject property: static, environmental and linkage attributes. As noted in this exhibit, the actual profile of the site generated in previous analysis is evaluated against the standards for the potential uses. For example, a retailer will benefit from a shallow site with street frontage for visibility, rating a rectangular site an 8 (on a 10 scale with 5=neutral, 10=excellent), while an office user might prefer a square site to fit ideal floor plate sizes, rating it a 5 or neutral. Similarly, industrial users will enjoy other uses in the area for employment and to avoid complaints on noise and pollution rating it an 8, while other uses will downgrade an industrial zone, placing it in the 2-3 range.

Table 3(a): Aggregate Weighted Ratings

In looking at the weighted ratings, it should be noted the Most Suitable Use weighted ratings were converted to equivalent units by multiplying them by the number of attributes in them, compared to the number of attributes in the other use analyses. For example, the MSU had 100 total points, while Politically Palatable and H&B Use had 50; thus, the scores were cut in half to get them on the same 1-10 scale across uses. As noted, apartments come out ahead, followed by office.

Table 3 (b): Weighted Most Fitting Use

As noted in the exhibit, the weighted points are similar to the unweighted, with apartments leading followed by office. This suggests the system is fairly robust.

Table 3 (c): Attribution of MFU

As with H&B Use, attribution analysis could be conducted to see why apartments took the lead, and why retail lost ground.

Determination of Final Use Decision

Up to this point, the analysis of MSU, PP Use, H&B Use, and MFU have been conducted on an aggregate basis, helping provide general guidance among alternative scenarios. Once the analyst has progressed to this stage, the top uses can be accepted and subjected to more detailed scrutiny in the form of more advanced design, market analysis, and financial analysis including Discounted Cash Flows. Depending on the strength of the conclusion, the use decision may be revisited, although the analysis can move forward to more advanced stages of design/analysis. While the detailed analysis presented in this primer may seem extensive, in reality the calculations are relatively straightforward and the exercise can force the analyst to take an objective look at alternative scenarios with relatively limited demands on resources and time.

Updated: Fall 2008