When
it comes to land acquisition – one of the most important factors in getting this
number reasonably accurate is to understand the “highest and best use” for a
property.
The
question of a property's highest and best use is something all appraisers aim
to address – and the issue is particularly relevant to appraisers and investors
who are working with vacant land.
When
a vacant lot doesn't have any pre-existing improvements on it, there can be
many potential uses for the property (depending on how the owner wants to use
it, and what the local zoning regulations will allow), but even when there are
several possibilities, there is only ONE highest and best use.
Highest
and best use is always the use that would produce the highest value for a
property, regardless of its current use.
The
reasonably probable and legal use of vacant land or an improved property that
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. Alternatively, the probable use of land or improved property
– specific with respect to the user and timing of the use – that is adequately
supported and results in the highest present value.
In
some situations, it's easy for a professional appraiser to get lost in the
weeds when determining what the highest and best use actually is.
The
Four Criteria
To
keep things simple, let's assume we're looking at one acre of rural land with
no improvements and no history of environmental contamination.
According
to the Appraisal Institute, the four standard criteria points we'd be looking
at are:
Legal
Permissibility
Physical
Possibility
Financial
Feasibility
Maximum
Productivity
Legal
Permissibility
According
to the local and planning department, what are you allowed to do with this property?
Furthermore,
are there any particular uses that are disallowed by government regulations
and/or prohibited by deed restrictions or other issues covered in
the property's title history?
Physical
Possibility
When
considering what can be done with a property, it's important to recognize what
is physically possible – taking into account the physical attributes of the
property (its size, shape, location, terrain, legal easements, and a lot more).
For
example, if you've got one acre of land located in a swamp, you shouldn't
assume the property is buildable. Likewise, if you've got one acre of land in
the middle of the desert, you shouldn't assume the property can be used as a
marina… because it's just not physically possible.
Of
course, both are ridiculous examples – but they illustrate the point of taking
the property's physical attributes into account when determining what the
property may be used for.
Financial
Feasibility
When
taking any kind of construction or improvements into account (whether you plan
to build a house or a skyscraper), it's important to ensure that the intended
use can either:
- Generate enough revenue to justify the cost of the improvements (in the case of a commercial project or business endeavor).
- Create enough additional value to justify the cost of construction for the homeowner and/or make a profit for the investor.
- To use another ludicrous example, you wouldn't spend N10 million to buy a high-end parcel of land in downtown Ibeju lekki, only to run a lemonade stand that earns N2000 a day – right?
If
you're going to pay this kind of cash (and even more to develop it), you need
to be confident it will create enough value or generate enough revenue for this
kind of investment to actually make sense.
Maximum
Productivity
To
determine a property's maximum productivity, it's important to know which use
is likely to generate the highest return on investment (ROI) for the investor.
Another
important factor to consider is the local supply and demand for such buildings
and businesses. It may not make sense to build a self-storage facility right
next to another pre-existing self-storage facility, or a movie theater complex
two doors down from another movie theater complex. If the presence of similar
buildings in the area interferes with the feasibility of the property use, this
also needs to be considered.
When
Improvements Already Exist
Of
course, in many cases, we aren't dealing with a simple, vacant parcel of land.
If
you're trying to determine the highest and best use for a property that already
has a designated use (because it already has an existing structure on it),
there are three scenarios you'll have to think through:
What
would it cost to tear down the existing structure and redevelop the site? Do
the ends justify the means?
What
are the opportunities and limitations of renovating or adding a new addition to
the existing building?
What
are the opportunities and limitations of using the existing building in the
exact same way it was before?
Each
scenario comes with inherent costs, opportunities, risks, and rewards.
Depending on your access to funding and what you stand to gain (and what you'll
have to sacrifice) for each option on the table, these factors should play a
role in guiding your decision on what the highest and best use of the property
actually is.
In
any event, don't forget to adhere to the four criteria listed above when
determining the highest and best use of the property in question.
Assessing
Your Property
So
what does all of this mean for the property YOU are trying to appraise?
If
you'd rather avoid losing yourself in hours of detailed and complicated
analysis, a faster way to run this assessment is to start by asking yourself an
abbreviated version of the four criteria…
Question
1: According to the local zoning laws and deed restrictions (if any), what am I
allowed to do on this property?
Question
2: How many of these allowed uses are physically possible on this property?
Question
3: Of the uses that ARE allowed, AND physically possible, which of them are
actually worth the investment (which ones would be most likely to increase the
value of the property beyond the cost of improving it)?
Question
4: If my plan was to develop the property and sell it at market value, which
plan would generate the highest return on my investment?
As
you're asking yourself these questions, ALWAYS REMEMBER THAT TIME IS OF MAJOR ESSENCE.
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