Highest and Best Use Decisions Wayne Foss DBA
Highest and Best Use Decisions Wayne Foss, DBA, MAI, CRE, FRICS Foss Consulting Group Email: wfoss@fossconsult. com 1
Highest and Best Use àDefinition: The reasonably 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. The four criteria the highest and best use must meet are legal permissibility, physical possibility, financial feasibility, and maximum productivity. à(The Dictionary of Real Estate Appraisal, 4 th ed. , pg. 135) 2
Purpose of Highest and Best Use à Market Analysis provides information on physical, legal and economic issues à Analysis of alternative uses determines the Highest and Best Use à Provides an economic basis for the use finally chosen by addressing: àUtility àDesire àScarcity àEffective Purchasing Power 3
Purpose of Highest and Best Use for Real Estate Appraisals (부동산감정평가에서 최유효이용의 목적) à Establishes the criteria for selecting comparable sales à 거래사례를 선택하는 기준의 설정 à Establishes the elements of comparison à 비교요소를 설정 à Provides the basis for estimates of physical, functional and external obsolescence 물리적, 기능 및 외부 노후화의 추정을위한 기초를 제공 à Provides the basis forecasts required to apply the income capitalization approach 수익환원법을 적용하는데 필요한 예측의 기초를 제공 àOccupancy 점유 àTiming (absorption) 타이밍, 흡수 àAmount (capture) àRents 4
Two Major Parts of a Valuation Appraisal 1. Basis for Value (Highest and Best Use) 2. Application of the Three Approaches Note: The thorough study of market forces that affect use and value requires study time at least equivalent to the study time afforded to measuring that value by applying the appropriate techniques and procedures of the valuation approaches. 이용과 가치에 영향을 미치 는 시장 힘의 철저한 연구가 필요하다. 가치의 적어 도 동등한 가치평가접근의 기술과 절차 적절한 적 5 용되는 가치를 측정하는 기술
Application à Vacant Land 나지 à Improved Property 개량부동산 àLand as though vacant 나지상정토지 àProperty as improved 기존 건물의 용도전환 à Items Specified in Highest and Best Use Conclusions: àPhysical Use àTime (probable use date or occupancy forecast) àMarket Participants àTypical User of Space àMost Probable type of buyer 6
Discussion Questions à If the purpose of a highest and best use study is to establish the basis of value, are the following highest and best use conclusions adequate? àVacant Land: Develop for retail use when the demand warrants. àImproved Property: Continue use as a multi-tenant office building. à If the highest and best use statements are not adequate, what is missing? à What misunderstandings may lead to inadequacies in the highest and best use conclusions? 7
Land Use Alternatives àVacant Land àNature of Analysis àconsideration of probable alternative uses àExtent of the Analysis àUsually involves many highly competitive alternative uses 보통 경쟁적 대안용도를 포함. Requires the most detailed study (fundamental analysis). 보다 상세한 분석이 필요 (기초분석) 8
Land Use Alternatives àLand as though Vacant àNature of Analysis àImproved property will continue in its current use until the land as vacant, less demolition cost, is more valuable that the property as improved. àExtent of the Analysis àIf land value does not approach the value of the property as improved, a detailed study of alternative uses is less critical (inferred analysis). 9
Land Use Alternatives à Property As Improved àNature of Analysis àIf the improvements contribute to value such that the value of the improved property is equal to or greater than the value of the land as though vacant, the existing improvement(s) must be considered as contributing to the property’s current highest and best use. àExtent of the Analysis àHow long and at what level (occupancy and rents) will the current improvements perform? (timing issue) àHow long will the current improvements contribute to the property value? (timing issue) àCan the current improvements be remodeled, renovated or converted, or demolished in the future? àIf remodeling, renovation, conversion or demolition, what is the time frame? 10
Land Use Alternatives à Proposed Properties àNature of the Analysis àIf the assignment is to value the property at a proposed use, a detailed marketability study of that use is required. àExtent of the Analysis àEven when new, the proposed improvement may not be the highest and best use of the land as though vacant. àAlternative uses should be considered àA detailed marketability study of each alternative use may be required (fundamental analysis) 11
Testing Highest and Best Alternatives à Criteria àPhysically Possible àWhat uses can be constructed on the site? àWhat alterations are physically possible? àLegal Permissibility àExisting restrictions as vacant àExisting restrictions as improved àCan existing restrictions be changed to allow more intense use? àWill deed restrictions increase the property’s market appeal? àWhat legal attributes give the subject a market advantage? 12
Testing Highest and Best Alternatives à Criteria, continued. . . àFinancial Feasibility àConsidering Risk and all costs to create and maintain the use - àWhat uses, as though vacant, produce a positive return to land? àWhat uses, as improved, result in a positive present value? àMaximum Productivity àWhich use results in the highest present value? àFor Vacant Land: ideal development specified in terms of density and style àFor Improved Property: the improvement remains as-is, is added to, is remodeled or renovated, converted to another use or demolished. 13
Reasonably Probable and Adequately Supported Aspects of Highest and Best Use àTheory àTo select use alternatives that should be tested àTo judge the appropriateness of conclusions from the application of each of the highest and best use criteria àProblem àDetermining reasonable probability and adequate support is left to the analyst’s judgment àInitial Assessment àBased on market acceptability àOnly practical to investigate alternative uses for land or improvements when a reasonable probability exists for potential alternative uses 14
Reasonably Probable and Adequately Supported Aspects of Highest and Best Use àZoning àAt times, it is mandatory to investigate the reasonable probability of a zone change. àRelationship of Reasonable Probability and Adequate Support to the four highest and best use criteria àMust address the reasonable probability of market acceptance and demand for the alternative use àAdequate support for a reasonably probable, physically possible and legal use is the first issue addressed àMust apply sound judgment! 15
Test the Performance of a Property Use: Information and Measures àPhysical Possibility àdetermined by analysis of the property itself àItems considered in testing àSite characteristics àExisting improvement characteristics 16
Test the Performance of a Property Use: Information and Measures àLegal Permissibility àdetermined by analysis of the public and private restrictions àItems considered in testing àCurrent zoning and other land use restrictions àBuilding Codes àPrivate restrictions àProbability of modification or change of current restrictions (public and private) 17
Rate Factors for Possible Zone Change 18
Test the Performance of a Property Use: Information and Measures à Financial Feasibility àEstablishing adequate support for a use àdetailed marketability study is needed àCost of Alternative Uses àDevelopment Costs àLand acquisition and site development àCosts of obtaining necessary approvals and permits àBuilding Costs àConstruction and Indirects àEntrepreneurial incentive àHolding Costs àOperating expenses àComparison of alternative Uses 19
Test the Performance of a Property Use: Information and Measures à Maximum Productivity àThe financially feasible use that results in the highest present value àConfidence in the conclusion may require a form of reconciliation 20
Consideration of Alternative Uses àVacant Land àproperty productivity analysis (site, improvements, legal, and location attributes) usually eliminates most alternatives àImproved Properties àIf the property at its current use is forecast to lease up or stay leased up that insures a value at or above the values of the other alternatives - no further analysis is needed. Current use is selected as highest and best use. 21
Consideration of Alternative Uses àDemolition Alternative àIf the value of the property in its current use is significantly higher than the value of the land as though vacant, the demolition alternative is eliminated from further study. àInterim and/or Alternative Use of Improvements àmust consider alternative uses or the timing for demolition of existing improvements àVacant buildings or Properties operating with extremely low or negative NOI àalternative uses or alternative operation of the current improvements should be considered in detail 22
Mathematical Procedures àSelecting and financial decision model à Three characteristics must be realized by the model 1. The model must consider the amount and timing of all cash flows. 2. The model must consider the time value of money. 3. The model must consistently select the use that will produce the highest financial reward. 23
Mathematical Procedures àVacant land as though vacant àCurrent financial feasibility is not a requirement àUse must eventually be financially feasible to be considered àFeasibility Rent is the tool for determining financial feasibility àFeasibility rent is the rent necessary to justify new construction àIf market rent is at or above feasibility rent, construction is justified àIf market rent is less than feasibility rent, financial feasibility can only be achieved if market rent is growing faster than expenses and costs. 24
Mathematical Procedures àImproved Property àCurrent financial feasibility is a requirement àRequires that the property value as-is must be surpassed by the value of the property after conversion, renovation or alteration (CRA) less the costs of CRA. àAlteration can result from excess or surplus land àAlteration can mean demolition of improvements 25
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So That’s Highest and Best Use Decisions Wayne Foss, DBA, MAI, CRE, FRICS, Fullerton, CA USA Email: waynefoss@usa. net 27
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