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.