In the world of real estate appraisal, one of the key concepts to understand is the “highest and best use” of a property. This refers to the most profitable and optimal use of a property, which can significantly affect its appraisal value. In this blog post, we will explain the concept of highest and best use and how it is determined in real estate appraisals.
What is Highest and Best Use?
The highest and best use of a property refers to the most advantageous use of the property that is physically possible, legally permissible, financially feasible, and maximally productive. The concept of highest and best use is important because it directly affects the value of a property. In appraisal practice, the appraiser must identify the highest and best use of the property, and then determine its value based on that use.
How is Highest and Best Use Determined?
Determining the highest and best use of a property involves a four-step process:
- Physically Possible: The first step in determining the highest and best use of a property is to identify all possible uses that are physically possible on the property. This includes evaluating the size, shape, topography, location, and any natural or artificial features that may limit or enhance the potential use of the property.
- Legally Permissible: The second step is to determine which of the physically possible uses are legally permissible under the current zoning laws, land-use regulations, and other legal restrictions. For example, a piece of land may be suitable for building a high-rise, but zoning laws may limit the height of the building that can be constructed.
- Financially Feasible: The third step is to determine which of the legally permissible uses are financially feasible. This involves evaluating the potential income and expenses associated with each use, as well as the costs of development, construction, and ongoing maintenance. The appraiser must determine whether the potential income from a particular use will exceed the costs associated with it.
- Maximally Productive: The final step is to determine which of the financially feasible uses is maximally productive. This involves evaluating the potential returns and risks associated with each use and selecting the use that offers the highest return with the lowest risk.
Factors Affecting Highest and Best Use
Several factors can affect the determination of the highest and best use of a property. These factors include:
- Market Demand: The level of demand for a particular use can significantly affect the determination of the highest and best use of a property. For example, a property may be suitable for building a shopping center, but if there is no demand for retail space in that area, then the highest and best use may be something else.
- Economic Conditions: Economic conditions can also affect the determination of the highest and best use of a property. For example, if the economy is in a downturn, it may not be financially feasible to develop a property for a particular use.
- Location: The location of a property can also affect the determination of the highest and best use. For example, a property located in a residential neighborhood may be suitable for building a commercial property, but if it is not zoned for commercial use, then it may not be the highest and best use.
Determining the highest and best use of a property is a complex process that requires a thorough understanding of the physical, legal, financial, and market conditions that affect the property. It is a critical step in the real estate appraisal process, as it directly affects the value of the property. By understanding the concept of highest and best use, property owners and investors can make informed decisions about the use and development of their properties.