Appraisal / The Four Tests of Highest and Best Use
McKissock- November 17, 2020
- Appraisal, Appraisal Insights, appraisers, article, Buzz Feed, criteria, featured, highest and best use, real estate appraisal
Earlier this year, we asked our real estate appraisal community, “What’s the ONE thing that is most often overlooked by appraisers?” The top answer we received was “Highest and Best Use.” Highest and Best Use is the reasonable, probable, and legal use of vacant land or an improved property. Here’s a breakdown of the four criteria that Highest and Best Use must meet.
1. Physically possible
You must consider the size, shape, topography, and accessibility of the site when determining if it is physically possible.
Some questions to answer:
- Can the site support a new build or improvement?
- Is there access to utilities?
- Is the drainage sufficient?
- Is the property easily accessible? Is it on a one-way street or cul-de-sac, for example?
- Would the location, topography, or size dramatically increase the cost to build on the site? (If so, that may decrease the value.)
2. Legally permissible
You must consider whether any zoning issues or restrictions will prevent building on or improving the lot.
Some questions to answer:
- Do you have a current survey of the property? (If not, obtain one, specifically covering boundaries to learn if easem*nts or encroachments exist.)
- Are there any deed restrictions?
- Are there zoning issues, such as minimum lot size or maximum building height or size?
- Is there a maintenance easem*nt, such as with waterfront properties, that could affect existing or proposed structures?
- Are existing structures considered legal non-conforming use? (For example, the structure has been “grandfathered,” and can remain; however, it would not be allowed to be built under current zoning requirements.)
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3. Financially feasible
This pertains specifically to whether financial investments would be greater than the potential financial return.
Some questions to answer:
- How would the build or improvements compare to other local properties? (For example, extensive upgrades could over-improve a property to the point that it is over-priced for the market.)
- Would the cost to upgrade or construct the house exceed well beyond the cost to construct an average house in the immediate area?
- Could the unique, owner-specific design of the new build or improvement make the property hard to resell or bring down the value of the property?
4. Maximally productive
If you are applying this criteria to residential properties, the financially feasible use generally aligns with the most profitable use, so you can combine these two criteria. However, most profitable usually refers to commercial properties, and establishes the highest net income for a proposed structure.
Some questions to answer:
- Do you have a market analysis or a feasibility study? (You will likely want to conduct one to ensure you have enough information on which to base your opinion.)
- What type of commercial property (e.g., retail, restaurant, service station) would be most profitable given the location?
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Highest and Best Use (HBU) in real estate appraisal is a critical concept, often overlooked but fundamental in determining the most suitable and profitable use of a property. It involves evaluating four key criteria to ascertain the optimal use of a property—physically possible, legally permissible, financially feasible, and maximally productive. Let's break down each component:
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Physically Possible: This criterion involves assessing whether the land or property can physically accommodate the intended use. It considers factors such as size, shape, accessibility, topography, and utility access. For instance, determining if the site can support new construction, whether utilities are available, the adequacy of drainage, and accessibility to the property.
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Legally Permissible: This aspect involves examining the legal constraints and regulations that might affect the property's use. This includes zoning laws, deed restrictions, easem*nts, and existing structures that might not comply with current zoning requirements. Ensuring the property aligns with zoning regulations and doesn’t violate any legal constraints is crucial.
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Financially Feasible: Assessing the financial viability of the intended use is essential. This includes evaluating the potential return on investment versus the costs involved in development or improvements. Over-improving a property or investing significantly more than the potential return might negatively impact its value.
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Maximally Productive: For commercial properties, this criterion focuses on identifying the use that would generate the highest net income. It often requires conducting market analysis or feasibility studies to determine the most profitable use for the property.
By considering these four criteria, appraisers can accurately determine the highest and best use of a property, which significantly influences its value in the real estate market.
As for the article you mentioned from McKissock, it delves into these four criteria of Highest and Best Use and emphasizes their importance in real estate appraisal. It highlights the significance of evaluating the physical, legal, financial, and productive aspects when determining the optimal use of a property. This understanding is crucial for appraisers to provide accurate and comprehensive assessments in the real estate industry.
