What’s the Highest and Best Use for My Property?
Professionally, I call myself many things – commercial appraiser, businessman, real estate consultant, but what I really am is an economist. I have yet to find anything in business that I cannot apply an economic principle to. And the intriguing thing about real estate is the economic concepts that hide in the shadows. There is no need to understand the mathematics of optimization or understand the micro economic theory of utility maximization. One only needs to understand four basic concepts – legally permissible, physically possible, financially feasible and maximally productive.
This brings me to the Highest and Best Use Analysis. It is based on the economic concepts of utility and substitutions. The highest and best use of a property determines the utility for a buyer. A buyer will compare the purchase of a potential property to the purchase of another property with similar utilities. The buyer will ultimately purchase the property with attributes that provide the greatest utility. As well, the seller of a property will expect to sell his/her property for a price no less than that of properties of similar utility.
The four tests of highest and best use are: (1) legally permissible (2) physically possible (3) financially feasible and (4) maximally productive.
“The reasonable, 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.” Appraisal Institute
Legally permissible primarily pertains to zoning and deed restrictions on a property, taking into consideration whether the existing property is a legal non-conforming use. For example, FRG completed a highest and best use analysis for a local Ohio school district’s administrative building which was formerly a middle school. The subject was in an area zoned for single family houses. The prospective buyer of the property planned to re-develop the administrative building site into multi-family townhomes. To do so would require a re-zoning. And the re-zoning required approval from the City Planning and Zoning committee and final approval from the residents of the city. FRG evaluated the site as improved, assuming the new zoning would be approved, but advised the client to quickly begin the re-zoning process.
FRG has also come across legally non-conforming properties. Another example of this test is when FRG was tasked with completing an ‘as vacant’ and ‘as improved’ highest and best use analysis before and after the taking of a multi-family housing property for a Michigan County Road Commission. The commission was seeking to determine the appropriate compensation for their acquisition of the site. The property was found to sit in an Agricultural and Rural Residential District (AAR) zoning area. The subject’s use of multi-family housing was not permitted in the ARR zoning district, as both the lot size and minimum buildable area was not in compliance with the ARR zoning. As a result, the property was considered grandfathered in legal non-conforming, meaning the property was okay to remain as is but would not be allowed to be built today, under current ARR zoning requirements.
The next test is to determine what is physically possible. FRG takes into consideration the size, shape, topography and accessibility of the site. FRG completed an appraisal for a subject property in an office/retail zone. The overall lot size could accommodate the proposed office development, however, due to an extreme topography, a downward slope, the usable lot was not sufficient in size to build on. The owner could engineer a solution but that would have been cost prohibitive over selecting a new site for development. In the end, the owner remained on the site in a temporarily building until he could find a place to relocate.
The determination of financial feasibility involves examination of the economic environment within the primary and secondary sub-markets. FRG completed a test for financial feasibility of a subject sitting on ten (10) acres of land and consisting of six (6) townhomes in various stages of completion. The development options for the site were demolition and redevelopment, modify existing use or continued use. The improvement in its current configuration as a multi-family development did not provide the greatest value to the site. The partially finished condominium townhomes had sat unfinished for seven (7) years. Completing development of the site would require additional capital investment and with an absorption rate in the market approaching five (5) years, FRG determined that the cost to complete the project was greater than the projected present value of the stabilized project. The FRG team advised the client that demand did not exist for a middle density development.
The next test completed for the site was on the ten (10) acres of land to determine the maximally productive use of the property that would produce the highest return. In determining the maximal productive use, FRG analyzed land use options such as demolition (of the unfinished townhomes), remodeling, renovation, conversion and continued use. It was determined that the structure did not add value to the land, however, a potential developer, if willing, could absorb the cost into a new use for the site. Thus, the use that would produce the highest return to the subject was to hold for future development when the market conditions made it viable to build.
Even though economic concepts hide in the shadows of real estate, you don’t have to be an economist to understand the highest and best use for your property. Keep it simple. For example, if you want to take your vacant land and build a 25-unit multi-family housing complex on it, ask yourself:
- Will my local government allow me to build multi-family housing on my site?
- Will a 25-unit housing complex fit on the land?
- Will I make money if I build the housing complex?
- Could I make more money building something else on my land?
If you can answer these questions, you are on the road to finding the highest and best use for your property.