As most residential appraisers know, secondary market lenders are not encouraging use of the cost approach. Are we then, actually determining the most profitable use of the land by developing an opinion of land value? Or are we simply auto checking the box ‘yes’ when asked ‘Is the highest and best use of the subject property as improved (or as proposed per plans and specification) the present use?’ This is not to say a precise land value opinion is needed in all market value appraisals, only that having no land value opinion is probably inadequate and could result in a repurchase demand by our investor friends. What? Secondary market investors developed that form! Ah yes, but we have experienced it, so appraisers beware.
Perhaps it’s worth reviewing the fundamentals. Highest and best use may be defined as follows:
The reasonably probable and legal use of vacant land or an improved property that is physically possible, appropriately supported, and financially feasible and that result in the highest value.
The concept of highest and best use applies to land alone because the value of the improvements is considered to be the value they contribute to the land. In practice, the contributory value of the existing improvements and any possible alteration of those improvements must be recognized, so the highest and best use of the property as improved is equally important. For most assignments, the improved use conforms to zoning regulations and is consistent with surrounding uses. Great; check the box ‘yes’ and move on. Time is money.
But what happens when we have to provide support for the analysis that occurs almost automatically in our heads? We can start by asking three basic questions. The first two apply to land as though vacant and the third takes any improvements into account.
1. Should the land be developed or left vacant?
2. What kind of improvement should be built?
3. Should the existing improvements on the property be maintained in their current state or should they be altered in some way to make them more valuable?
Appraisal theory holds that as long as the value of a property as improved is greater than the value of the land as though vacant, the highest and best use is the use of the property as improved. Now all we have to do is apply the testing criteria and we are off and running.
The highest and best use must be:
- Physically possible
- Legally permissible
- Financially feasible
- Maximally productive
These criteria should be considered sequentially. A use may be financially feasible and maximally productive, but if it is not legally permitted or will not physically fit on the given site, you’ve reached a dead end. The limitations of the land use should also invoke logic. Know your market! For example, a housing development for the elderly might be a permissible use of a site, but, if most residents of the area are under 40 years old, this use may be illogical and might not meet the criterion of financial feasibility. I realize this sounds absurd to most of us. Look around while driving to your next property inspection. I’ll bet you’ll come across at least one example of a building now vacant that was once a developer’s dream. The designs were drawn with detail and all the permits pulled properly. What’s missing? No one bothered to identify the target market and if there was in fact, a need for this use.
If improving the land is determined to be the highest and best use, the appraiser should be specific and describe the type and characteristics of the ideal improvement to be constructed. The appraiser compares any existing improvements on the site with the ideal improvement and the differences are analyzed to determine the depreciation suffered by the existing improvements. This process helps identify underimprovements and overimprovements and sets the foundation for comparable selection.
So, we’ve completed all the necessary analysis. Now what? Do we need to report it narratively or is it sufficient to check the ‘yes’ box now? In my opinion, all appraisal reports should disclose the appraiser’s analyses and conclusions pertaining to the highest and best use of the land as though vacant and improved. The highest and best use statements may be brief, but must summarize the results and include a review of the four tests. Consider inserting a simple three-column spreadsheet.