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Highest and Best Use Analysis

Highest and best use is an integral step in most real estate appraisal and consulting assignments. Subsequent steps in the engagement are contingent upon the highest and best use conclusion. Highest and best use can be described informally as a probable and legal use that will result in the maximum value for a parcel of real estate. This is true whether the parcel is vacant land or an improved property. Criteria for highest and best use include physically possible, financially feasible, legally permissible and most productive from a financial perspective.

Highest and best use analysis can assist an owner in maximizing return. Modest variations in a property can lead to meaningful increases in value. For example, upgrading apartments built in the 1990s with contemporary features and level of finish can generate a substantial net increase in value. A highest and best use analysis should be performed routinely for improved properties. Preferences for aesthetics and amenities continually change. Properties that are not offering both an aesthetically pleasing appearance and contemporary amenities will not maximize their value. Highest and best use analysis can be performed for acreage, site development, and for improved properties. Research and planning can substantially increase investment returns. In some cases the change in use is modest. For example, should the owner of a class B apartment complex install separate HVAC units to replace a chilled water cooling system. In other cases, the analysis can contemplate demolishing the existing improvements.

A highest and best use analysis should consider all legally permissible uses. While it is often simple to exclude uses that are not physically possible, determining which use is financially feasible and generates the highest value for the property often requires obtaining voluminous data and performing extensive series of analyses. The final highest and best use conclusion should be both precise and detailed.If in a metropolitan area, highest and best use is likely a combination of uses including single-family, multifamily, and commercial. Evaluating the highest and best use of a large acreage tract is often considerably more complex than determining the highest and best use for a 1-2 acre suburban tract. Mixture of uses and timing of development are both critical factors. Commercial and multifamily land will yield a higher value, but artificially calling a use commercial will result in an excessive holding period. Ultimately the use may still be single-family.A popular misconception is that commercial land is automatically more valuable than single-family land. Single-family lots in the most prestigious areas of most cities rival the market value of land throughout the metropolitan area with the likely exception of prime land in the central business district. For example, lots in the River Oaks subdivision in Houston and the Highland Park subdivision in Dallas are similar to or exceed the market value per square foot of commercial land throughout most of the metropolitan area.

Highest and best use for a single site may seem intuitive. A variety of factors make highest and best use analyses one of the most difficult assignments for real estate appraisers. These include gentrification, material changes in construction costs, and the high level of detail necessary to properly define the highest and best use which maximizes the value for the property. For example: 1.) this is clearly an industrial site since it is in an industrial park or 2.) this is clearly a strip center site since it is on a major thoroughfare at the corner of a street which enters a subdivision. The precise characteristics of the proposed property can vary markedly. Is the industrial property a metal warehouse with 20 clear height and 5% office space or a flex/technical building with tilt wall construction and 75% office space? However, an appropriate highest and best use study will be detailed and precise. For the industrial property consider the following issues:

  • Tilt wall versus metallic;
  • Office warehouse versus warehouse versus flex;
  • Percentage of office build out;
  • Quality of office finish;
  • Depth of truck apron;
  • Eave height;
  • Truck wells versus grade level versus dock height;
  • Sprinkled;
  • Parking ratio;
  • Level of landscaping;
  • Quality of finish for front of building;
  • Type of elevation for front of building;
  • Cranes;
  • Stabilized yard.

For an existing building on two acres, the following should be addressed:

  • Is the current use the highest and best use or should improvements be demolished (explain if used as improved; land and demolition; highest and best use is demolition).
  • Should the existing use be revised or upgraded? What is the precise description of the proposed renovation? When should it occur? How much will it cost? How much will market rent increase and what is the net increase in market value?

Consider the following examples:

  • Old office building in central business district into lofts;
  • Old big box into self storage;
  • Apartments to condominiums;
  • Upgrade class C apartments in affluent area to class A-/B+;
  • Convert warehouse to flex;
  • Cure deferred maintenance and renovate class C office building into class B office building.

Research and analysis by seasoned real estate professionals can help identify highest and best use to maximize returns. The old bromide of measure twice and cut once fits highest and best use analysis.

O'Connor & Associates' staff complement of over 50 real estate professionals includes 12-15 senior staff member who can complete an expedited highest and best use analysis for your property. They can also handle other due diligence tasks. These professionals are supported by an experienced staff of over 100 who are accustomed to complex assignments. Our team has experience in all aspects of real estate including acquisitions, due diligence, ownership, appraisal, property tax appeals and dispositions. Reduce your risk and stress by utilizing O'Connor & Associates' breadth and depth of experience to evaluate real estate investments.

To obtain more information on O'Connor & Associates highest and best use analysis services, call or email Larry Brewster at 713-686-9955 or fill out our online form.

About Patrick O'Connor
Pat O'Connor, MAI is president of O'Connor & Associates, 180-person firm in business since 1974. O'Connor & Associates is the largest tax consultant in Texas, handled more than 70,000 administrative appeals in 100 counties in 2006 and is currently coordinating over 2,000 judicial appeals. O'Connor & Associates also provides real estate appraisal, cost segregation and market research services. For more information, visit www.poconnor.com or e-mail Patrick O'Connor at poconnor@poconnor.com.

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