First of all, if there is one thing Highest and Best Use is not, that is exact. But we’ll get to that later. Briefly, in the context of professional valuation, Highest and Best Use is the use that results in the highest return to the land value. Simple enough, right? Not really.
But let’s get the foundation laid first. The appraisal process can be broken down into three parts. The first part is a site visit and conducting a survey for information about the subject property. The second part is the consideration of Highest and Best Use. The third part is the research and analysis that goes into the formation of an opinion of value. The Highest and Best Use considers the information gathered about the subject property and results in a conclusion that establishes the basis for the valuation. It is sometimes referred to as the bridge between the first part and the third part of the process.
In order to be considered the highest and best use of a property, that use must be legally permissible, physically possible, financially feasible, and resultant in the maximally productive use for the site. These are the “tests” for Highest and Best Use. They also serve as an outline for the Highest and Best Use analysis.
For a use to be legally permissible, it must conform to zoning and building codes. For example, a commercially zoned parcel might be developed as retail or office or restaurant or housing or – increasingly – a combination, a mixed use. All of these uses must be considered. Further, the use must be consistent with building codes and any other governmental guidelines and restrictions. Design criteria outlined in the El Pueblo Viejo District that encompasses most of downtown Santa Barbara would be an example of government guidelines that must be considered.
For a use to be considered physically possible, it must be a use that can be accommodated by the site. Constraints on that use could include the size and shape of the site, the topography of the site, drainage, soils, and more. An example of a physical characteristic that could impact use is shape. A rectangular or square shaped parcel can accommodate most uses. On the other hand, a long narrow parcel, or a triangular parcel, could result in significant limitations on use.
For a use to be financially feasible, the cost to develop the property to the use must be at least offset by the value. For example, assume a site has a value of $500,000 and the cost to build a 2,000 square foot home on the site is $1,000,000. The value of the property after development must be at least $1,500,000 for the use to be deemed financially feasible. On the other hand, assume the site had irregular topography which caused the construction cost to increase to $1,200,000. With no change in value, the use becomes not feasible.
Finally, for a use to be maximally productive, it must be the use that generates the highest return to land value. Each of the tests discussed above narrow the list of potential uses. None the less, there are still alternatives. The fourth test is intended to narrow the list to one use. For an example, let’s build on the above-mentioned scenario. Let’s say the value generated by the total of the above site value and construction cost is $1,700,000. This would suggest a return to the
land value of $200,000. Further, let’s assume that an alternative development scheme would be to build a 3,000 square foot house at a cost of $1,500,000. And, let’s say the resultant value would be $2,100,000. This would suggest a return to the land value of $100,000. In this example, the most productive use of the site, the “Highest and Best Use”, would be the more modest development scenario. See the chart below for clarification.
Land Value | Improvement Costs | Total Costs? | Value | Feasible? (Return to the Land) |
$500,000 | $1,000,000 (2,000 SF home) | $500,000 + $1,000,000 = $1,500,000 | $1,700,000 | $200,000 |
$500,000 | $1,200,000 (2,000 SF home with irregular topography) | $500,000 + $1,200,000 = $1,700,000 | $1,700,000 | $0 |
$500,000 | $1,500,000 (3,000 SF home) | $500,000 + $1,500,000 = $2,000,000 | $2,100,000 | $100,000 |
Of course, the above is an oversimplification. Highest and Best Use might be exact in concept but in practice, it is more nuanced. There are many elements that are not allowed for in the above examples. It could be that the cost to build the larger home would be somewhat lower on a price per square foot basis due to the economy of scale. It also could be that there would be a third alternative that might generate an even higher return.
And finally, in a general sense, it is just not reasonable to presume that an appraiser, without an extensive investigation and analysis, could pick the single most productive use for the site. For all the above reasons, some appraisers prefer to use the term “Reasonably Productive Use” for
the site. And that use is assumed to be equivalent to the Highest and Best Use or the purpose of the valuation.
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