Residential Highest & Best Use Issues

Residential Highest & Best Use Issues Bill King President, Chief Valuation Officer http://www.real-info.com 206.409.5017 cell bill.king@real-info.com

Residential Highest & Best Use Issues Highest and Best Use is an economic concept: It is the study of value and what creates value Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues Highest and Best Use was originally focused on land as though vacant In the early days of appraisal as its own discipline the focus was primarily on the Cost Approach Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues The label Highest and Best Use suggests a superlative degree of use. Highest and Best Use is really about the interaction of ALL factors that affect how individuals and groups decide to utilize a parcel of land. Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues How has the definition of Highest & Best Use evolved over time? • In “The Appraisal of Real Estate” second edition, published in 1952, highest and best use is discussed under the header “Highest and Most Profitable Use”. • Fundamental to the concept of value is the idea of highest and best use. This can be defined as follows: “highest and most profitable use is that use which is most likely to produce the greatest net return over a given period of time.” Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues “The Appraisal of Real Estate” second edition: This section goes on to discuss time as a factor; “a given period of time” is presented as a foundation factor in the equation determining highest and best use. That is, the question always has to be asked, “what period of time about which are you thinking?” Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues On page 71 in the second edition we find the following: If the highest and best use is not immediately apparent and clear at this time, the appraiser may select two or more tentative highest and best uses, his final selection to be made when he has collected sufficient conclusive data to indicate the desirability of one of the tentative uses over the others. Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues The following is from “The Appraisal of Real Estate” fifth edition, published in 1967: Fundamental to the concept of value is the theory of highest and best (or most profitable) use. Briefly it can be defined as that use which at the time of appraisal is most likely to produce the greatest net return to the land and/or building over a given period of time. The key phrase in this definition is “net return,” which means whatever is left from gross yield after all costs are met. Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues “The Appraisal of Real Estate” fifth edition, 1967, Chapter Summary: Highest and best use is that use which at the time of appraisal is most likely to produce the greatest net return. The greatest net return is the surplus productivity resulting from the proper apportionment or balance of the agents in production. Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues The Appraisal of Real Estate, fourteenth edition: “The reasonably probable use of property that results in the highest value” Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues Appraisal Institute course General Appraiser Market Analysis and Highest & Best Use (2008): The reasonably probable use that produces the most benefits and highest land value at any given time. Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues From the Dictionary of Real Estate Appraisal, fifth edition: 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 • maximum productivity Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues Alternatively, the probable use of land or improved property—specific with respect to the userand timing of the use—that is adequately supported and results in the highest present value Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues “Probable” means probable among alternatives. Probable does NOT mean a poorly done or incomplete study, but a situation that is not fully predictable, and that there are other possible uses. Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues Most Probable Use Focuses on the interaction of the factors determining use and recognizes that determining use rests on conflict resolution, compromise and feasibility. The reality of determining use lies in actual human behavior, prediction of people, actions and probability. Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues “There seems to be little doubt that most investors optimize or satisfy and that few of them rely on the single classical criterion of maximizing net income. To the extent this is true, the “highest and best use” determined by the maximization of net income is an unrealistic concept because it does not reflect actual human behavior.” Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues “Actual decisions are complex with the primary skill of the appraiser to predict human behavior in terms of the probable outcome. The “highest and best use” thus becomes the “most probable use” and the prediction of market behavior in general, for whatever purpose, must be founded on the manner in which real people arrive at decisions rather than the unreal assumption of the single maximization test.” ~ Richard Ratcliff, Valuation for Real Estate Decisions, 1972, Page 69. Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues There is a big difference between the most probable and likely uses versus that use which totally satisfies all groups but is very unlikely. The use of a given parcel may not be set by the most profitable use, but by something as fickle as which local developers are busy and which are not. Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues Most Probable Use • The use to which a property will most likely be put based on market analysis and the highest and best use conclusion. The most probable use is the basis for the most probable selling price of the property. • Highest and best use in the context of market value. (The Dictionary of Real Estate Appraisal, 5th ed.) Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues Most Profitable Use Highest and best use in the context of investment value. (Real Estate Appraisal Terminology, rev. ed.) Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues Legally Permissible: • Zoning • Building Codes (height, setbacks, etc.) • Historic District • Environmental Laws • Deed Restrictions, CCRs • Existing leases • Pending Litigation Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues Physically Possible: • Existing Improvements • Size, Shape, Slopes • Soil Conditions • Access, Street Frontage • Utility Connections • Adjacent Uses (impede construction?) Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues Financially Feasible: • Create New Improvements • Modify Existing Improvements • Curable vs. Incurable Obsolescence • Which Option Has Greater Demand? Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues Maximally Productive: • The maximally productive use is the use that produces the highest residual land value over time (future). • Total improved value minus cost of improvements • Alternative: capitalize residual income to the land Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues Interim Use • In some cases, it may be clear that the highest and best use is likely to change in the foreseeable future. However, due to economic factors, the market may not yet be ready for the property's ultimate highest and best use. The use to which a property is put until the market is ready for the new highest and best use is known as an interim use. • Examples of interim uses are parking lots, temporary buildings, "Christmas tree" farms and old buildings rented on a short term basis. A residence situated on a commercially-zoned site may be an interim use. Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues Legal Non-Conforming • This is a use that was lawfully established and maintained, but no longer conforms to use regulations of the zone in which it is located. This is often called a "grandfathered" use. • A nonconforming use can be either an under-improvement or an over-improvement. An example of an under-improvement is a single family residence in commercially zoned location. An over-improvement example is a duplex that does not meet minimum lot size or parking requirements on a site now zoned for one unit. Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues • In the case of nonconforming properties, land and improvements must be valued under the same ultimate highest and best use. • The land is valued as if vacant under the current zoning. The contributory value of the improvements can be estimated by subtracting the land value from the total value of land and improvements. • Highest and best use as if vacant is determined first; then the Theory of Consistent Use is applied - not the other way around. Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues • The Theory of Consistent Use means the land cannot be valued on the basis of one use while the improvements are valued on the basis of another use.* • With nonconforming properties, the current use is usually different than the highest and best use as if vacant. • *The Dictionary of Real Estate Appraisal, Third Edition, page 72 Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues • The Appraiser must include the highest and best use analysis in the appraisal report to support the Appraiser’s conclusion of the existence of Excess Land. • The Appraiser must include Surplus Land in the valuation. Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues • If the subject of an appraisal contains two or more legally conforming platted lots under one legal description and ownership, and the second vacant lot is capable of being divided and/or developed as a separate parcel where such a division will not result in a non-conformity in zoning regulations for the remaining improved lot, the second vacant lot is Excess Land. Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues • The value of the second lot must be excluded from the final value conclusion of the appraisal and the Appraiser must provide a value of only the principal site and improvements under a hypothetical condition. Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues Non-residentialUse of Property: ensuring that mixed-use properties comply with zoning. Cost and Income Approach for Value: ALL appropriate approaches must be utilized when applicable. Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues Special Purpose Property “When I ask an audience or my students for their opinion of the most specialized property I rarely hear what I believe is the proper answer, namely a one family home with highly restricted zoning. It can only be used for that single purpose. It is therefore the most highly specialized of all properties and truly a single purpose property.” Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues “Most of our other so-called special-purpose properties have substitute uses that can be applied to them functionally and legally. However the one family home in a strongly zoned area can only be used for a single dwelling residence. What we really mean we talk about special-purpose property is a property with few types of uses and a limited demand. This is in contrast to the one family home which has a very strong demand.” ~ Dr. Sanders Kahn, “Down to Earth”, selected writings by Sanders Kahn, PhD, 1985 Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues Examples: Excess Land or Surplus Land? Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues Surplus or Excess Land? Example 1: Site Size: 15,720 square feet Zoning: SF 7200 Topography: Level Utilities: Water, sewer, power at site Existing House: 1922, 1.5 story w/ basement, 1420 sq.ft. Seattle Chapter Appraisal Institute

Residential Highest & Best Use IssuesExample 1: Excess or Surplus? Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues Surplus or Excess Land? Example 2: Site Size: 17,520 square feet Zoning: SF 5000 Topography: Level Utilities: Water, sewer, power at site Existing House: 1954, 1 story w/ basement, 2380 sq.ft. Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues Surplus or Excess Land? Example 3: Site Size: 11,460 square feet Zoning: SF 5000 Topography: Level Utilities: Water, sewer, power at site Existing House: 1943, one story, 1430 square feet Seattle Chapter Appraisal Institute

Residential Highest & Best Use Issues