Highest and Best Use
Presented inBulgaria by Walter Winius, Jr., MAI, CRE
(circa 1997)
(Instructor’s Note: This was about a one and a half day presentation developed for presentation in both Ukraine and Bulgaria to classes assumed to have some basic real property appraisal training, though we found this was not the case, for the most part. Except for some reference to the Uniform Standards of Professional Appraisal Practice, the course could almost be given today as set forth in the outline. The course could be even more productive since the Bulgarians and others now have the Appraisal of Real Estate text book-- a translation of the Appraisal Institute's text-- available to them. This was not the case at the time the course was presented.)
1. Introduction and Class Warm-up
1.How many of you speak English (or, better yet, American?)
2.How many of you have been to the United States?
3.Did anyone get as far west as the state of Arizona where the Grand Canyon is located? Our state has various climates - high mountains with a lot of snow in the winter to desert areas where little grows and the temperature is often very hot. Only 13% of all the land is privately owned. The remainder is controlled by the state and national governments with a major portion consisting of Indian Reservations. I have brought with me a copy of a magazine published by the State of Arizona which you might like to look at when we break.
4.Before coming to Bulgaria, I read two books that told me a little bit about property ownership and that Bulgaria is unlike the Ukraine from where I just came. While most all of the land in Ukraine is under long ground (land) leases, much of your
land is privately owned. Is that the situation in the cities as well as in the country?
5.How many of you here own real property? How many own property in a partnership with others? If you own a flat, who owns the land beneath it? If the land is leased, do you know when the lease began, or when it ends?
6.How many here also sell real. property? Do you sell the property for cash? Do you sell the property with the payments being made over several years? Does the property sell for the same price for cash as it does if it is paid out over several years? Why?
7.What I have been doing is to establish a foundation for the lecture outline that you have been given, translated from American (or English) into Bulgarian, I hope. Since I am not always certain that our words have the same meaning as yours, if the lecture gets confusing, please stop me. In fact anytime you have a question, raise your hand. Don't wait until later. I find it better to deal with questions when you have them.
8.Now, assume for the moment the city block across fromwhere we are meeting is entirely vacant and that you own that city block, what would be some of the reasons it has value?
Answer:
A. Location
B. Size and Utility
C. Zoning
D.Availability of Utilities
E. Soils
F.Topography
9.Assume instead of owning the vacant land you had to appraise it and tell me, as your client, how much I should pay for it. What would you do?
10.Would the vacant city block have a higher value if you divided it into several smaller parcels?
(Answer: Maybe or Maybe Not
Would you first consider what you might build on that vacant parcel that would bring the highest amount when you sold it? In other words, if it is a well located, in town vacant parcel it is unlikely that you would build houses on the land, rather you would probably build apartments, retail stores, or both, maybe an office building on the first two or three floors with flats above, maybe a hotel with retail stores. The facts are you have many choices.)
So, what we are going to be discussing is putting land to its highest and best use and looking at the land as though vacant and with any improvements (building structures) that may be on the land at the time we appraise the property.
I now will be following the lecture outline provided to you.
2. Terms
Neighborhood Trends
Investment
Speculation
Retail: Stores, Shopping Centers
Leases: Short Versus Long Term
Gross Revenues - Net Income
Contributory Value
3.HIGHEST AND BEST USE
I. Definition
A.Highest and best use - the reasonably probable and legal use of vacant land or an improved property, which is physically possible, appropriately supported, financially feasible, and that results in the highest value.
B. The definition indicates two types of highest and best use.
1.Highest and best use of land or a site as though vacant
2.Highest and best use of a property as improved
C. Analysis of highest and best use takes into account the motivations of probably purchasers, who may use the property for the following reasons:
1 .Personal use or occupancy
2. Investment
3. Speculation
D. Competitive forces, i.e. retail, office, apartments, residential, in the market where the property is located shape highest and best use. Analysis of these competitive forces helps the appraiser identify highest and best use in terms of the following:
1. Physical use - retail, office, single family, continued use for farming
2. Timing for use (probable use date or occupancy forecasts)
3.. Market participants for use
a. Typical user space
b. Most probable type of buyer
E.. As long as the value of the property as improved is greater than the value of the site as unimproved, the highest and best use is the use of the property as improved. Once the value of the vacant land exceeds the value of the improved property, the highest and best use becomes the use of the land as though vacant. Example - residential to retail; or industrial
(Note: The cost to demolish existing improvements must be considered in the analysis.)
II.Highest and best use of land or a site as though vacant
A.Highest and best use of land or a site as though vacant assumes that a parcel is vacant and available to be put to its highest and best use - the use that creates the highest residual land value.
B.When a reasonable forecast of a property's highest and best use indicates a change in the near future, the present highest and best use is considered an interim use.
C.Highest and best use of land or a site as though vacant is required for subdivision and assemblage, and when land value is estimated separately in an appraisal. Assemblage is joining two or more parcels together to provide a better use.
D.Highest and best use of land or a site as though vacant specifies the type of improvement when an improvement is required for highest and best use. The appraiser must determine the type and characteristics of the improvement. Check zoning, neighborhood trends.
E.This type of highest and best use recognizes that the current use might not be the highest and best use. The highest and best use may be to hold the property for speculation until development is justified by market demand.
III.Highest and best use of property as improved
A. When a site contains improvements, the highest and best use of the land as though vacant may be different from the existing use. Example, apartment buildings in Kiev old and vacant.
B. Highest and best use of property as improved compares the existing improvements with the ideal improvement. Old apartment having few occupants compared to new apartment buildings being fully occupied.
C. The use that maximizes the value of an investment property, consistent with the long-term rate of return and associated risk, is its highest and best use as improved.
D. Highest and best use of property as improved considers whether the existing improvement should be
1. Remodeled - conversion of several flats into office space
2. Demolished - torn down as cost to build improvement would be less than cost to remodel
3. Maintained - repair
IV. Purposes of highest and best use analysis
A. Highest and best use of land as though vacant is the basis for
1. A land value estimate when required.
2. Selecting comparable land sales. How do you do that here?
B.Highest and best use of property as improved is the basis for
l. Identification of the property use. This property use will produce the highest overall return for each dollar of invested capital.
2.Identification of comparable properties - apartment to apartment; retail to retail; how does it compete?
V. Criteria in highest and best use analysis - vacant or improved
A. Legally permissible
l. ZoningAppraisers must investigate the following questions:
a. Is the use currently permitted?
b. Is it legally nonconforming? What would happen if the existing building was removed ?
c. Does it require a special permit? How is the permit acquired?
2. Private restrictions. Appraisers must investigate the following questions:
a. Are there deed restrictions that prohibit uses?
b.Are the restrictions being enforced?
c.Can the restrictions be overturned - legally or otherwise?
If private restrictions conflict with zoning laws, the most restrictive rules usually apply.
3. Building codes. Building codes can prevent development of land to its highest and best use by increasing the costs of construction to prohibitive levels.
4.Historic districts. Historic districts may control changes or remodeling that would lead to a higher and better use. Do you have these?
5. Environmental regulations. Environmental regulations may preclude more intensive development or any development at all, particularly as it relates to industrial use.
6. Long-term leases - 3 to 5; 5 to 25 years. Long-term leases may also interfere with changes in use. May dictate whether modifications are undertaken.
B. Physically possible
1. Site
a. Size
b. Shape and utility, frontage and depth - illustrate
c .Topography - changes in elevation
d.Access - illustrate
e.Availability and capacity of public utilities - water lines, sewer lines large enough?
f.Soil and subsoil conditions
2. Improvements
a. Size - too small, too large
b.Design - new, old, functional
c.Condition - roof, painting
d.Costs of conversion
C. Financially feasible
l.A property must be able to produce a return greater than the amount needed to satisfy operating expenses, financial obligations and capital amortization.
2.All physically possible legal uses that are expected to produce a positive return after consideration of risk and all costs to create and maintain the uses are regarded as financially feasible.
D.Maximally productive. Of all the financially feasible uses, the use that produces the highest present value consistent with the rate of return that the market warrants for that use is the highest and best use. Highest residual land value is the measure of maximum productivity in the analysis of land as though vacant.
VI.Test of highest and best use
A. To test the highest and best use, the / appraiser analyzes / all reasonable usealternatives. See examples / to follow.
Apartment
Building / Office
Building_ / Retail
Building
Cost of Construct / $1,200,000 / $950,000 / $800,000
NOI / $162,000 / $135,000 / $110,000
Income to Improvements Q 12% / -144L000 / -114,000 / -96.000
Income to Land / $18,000 / $21,000 / $14,000
Residual Value to Land Cap Q 10% / $180,000 / $210,000 / $140,000
Highest and best use is office building.
Retail / OfficeNOI / $55,000 / $60,000
OAR / 11% / 10%
Cap / $500,000 / $600,000
Dev. Cost / 300s000_ / 450.000
ResidualLand / $200,000 / $150,000
Value
B. The appraiser usually tests highest and best use in sequence. Tests of legal permissibility and physical possibility must he applied before the remaining tests of financial feasibility and maximal productivity. A financially feasible use is irrelevant if the use is physically impossible or legally prohibited.
C. Five examples of tests for highest and best use on various properties appear beginning on page 283 of The Appraisal of Real Estate.
VII. Highest and best use statements
A. All appraisal reports should contain summary statements that describe the appraiser's analyses and conclusions pertaining to the highest and best use of the land or site as though vacant or of the property as improved.
B. Standards Rules 2-2i of the Uniform Standards of Professional Appraisal Practice state that each written appraisal report must set forth the appraiser's opinion of the highest and best use of the real estate.
C. When the highest and best use conclusion is the primary objective of an evaluation report, the appraiser should include the income and return calculations and the reasoning employed in reaching the conclusion. See Standards Rules 4-6 and 5-2g for further explanation.
D. If an appraiser concludes that the highest and best use of an improved property is different from its existing use, the report should include justification for this conclusion.
E. Five examples of highest and best use statements appear in The Appraisal of Real Estate, beginning on page 287.
VIII. Special situations in highest and best use analysis
A.Single use. A property's highest and best use may be unusual or a demand might exist for only one property with this use, for example, printing plant, hotel, school.
B. Interim use - the temporary use to which a site or improved property is put until it is ready to be put to its future highest and best use.
1. A property's highest and best use may change in the foreseeable future, for example, farming to residential.
2.An interim use may or may not contribute to the value of the site or improved property.
a.If improvements do not contribute to value, then the appraiser must consider costs of demolition.
b.Certain interim uses such as farming, parking lots, and golf courses contribute to the value of the land. The appraiser must consider their income in making comparisons to other properties.
C. Legally nonconforming use - a use that was lawfully established and maintained, but no longer conforms to the current use regulations of the zone in which it is located.
1. Zoning changes may create under improved or over improved properties.Example: apartment densities.
2. In most cases, the preexisting use can continue, but expansion or major alterations are prohibited. These restrictions depend on the individual zoning ordinance.
3. The property value estimate reflects the nonconforming use in most situations. This estimate may include a bonus for the nonconforming use.
4. Depending on the zoning ordinance, the nonconforming use may or may not be resumed after a property loss like a fire.
5. Depending on the zoning ordinance, the nonconforming use may expire if the building is unoccupied for a certain period of time.
D. Uses that are not the highest and best use
1.Many existing buildings do not represent the highest and best use of their sites as though vacant, but the highest and best use is generally in the same category as the existing use. The ideal use might be for a similar building that is newer, larger or more modern.
2.In cases where the general category of highest and best use may have changed, such as from residential to commercial use, the improvements on these sites suffer from external obsolescence. However, the concept of consistent use affirms that land cannot be valued on the basis of one use while the improvements are valued on the basis of another. For an example, see The Appraisal of Real Estate, beginning on page 292.
E. Multiple uses. Highest and best use may include more than one use for a parcel of land or a building.
1. One parcel of land may serve many functions.For example, individuals may use wooded land for gathering timber, hunting or exploring for minerals.
2.A building can have multiple uses. Examples include a skyscraper with offices, apartments and stores.
3.Appraisers can often estimate the contributory value of each use. However, appraisers must take care to ensure that the sum of the separate use values does not exceed the value of the total property. See Standards Rules 1-4e for further explanation.
F. Special-purpose units
1. Because special-purpose properties are appropriate for a single use, or very limited uses, probably the highest and best use as improved is the continuation of its current use, for example, cement plant.
2. If the current use is physically or functionally obsolete, and no alternative uses are feasible, the appraiser might determine that the
highest and best use of the property as improved is demolition of the structure and sale for scrap or salvage value.
3.Sometimes the appraiser must analyze the highest and best use of the special-purpose property under continuation of the existing use and with consideration of conversion to an alternative use.
G. Speculative uses. Appraisers might regard land that is held primarily for future sale as a speculative investment. The appraiser should discuss its potential future highest and best use and logical alternative uses.
H. Excess land - give example of small building on large lot
1. Vacant land may contain land that is not necessary to accommodate the primary highest and best use of the site. In some cases, the highest and best use of excess land is for future expansion or for future development as a separate entity.