Highest and Best Use
“Highest and Best Use” is a concept in real estate appraisal and property economics. It refers to the most profitable, legally permissible, feasible, and physically possible use of a piece of property. The highest and best use often determines the property’s market value.
Here’s a breakdown of the four criteria involved:
- Legally Permissible: This refers to what can be built or done on the property within the current zoning and building codes, as well as any other legal restrictions.
- Physically Possible: This considers what can be physically built on the property given its size, shape, topography, and other characteristics like soil composition and availability of utilities.
- Financially Feasible: This looks at whether a potential use of the property can generate enough revenue to justify the costs of construction and maintenance, providing a reasonable return to the investor.
- Maximally Productive: Out of the uses that are legally permissible, physically possible, and financially feasible, this considers which use will result in the highest value for the property.
For example, consider a vacant lot in a busy downtown area. The highest and best use might be to build a multi-story commercial building if that’s legally permissible, physically possible, and likely to generate more revenue than any other feasible use of the property.
Keep in mind that a property’s highest and best use can change over time as market conditions, zoning laws, and local demographics evolve. Therefore, property owners and potential investors often need to reassess the highest and best use of a property periodically.
Example of Highest and Best Use
Let’s consider an example of a piece of property located in a city’s downtown area.
Initially, this property has been used as a parking lot. However, over the years, the area has grown significantly, with new offices, retail spaces, and residential apartments springing up. The increase in local businesses and population has led to higher demand for commercial and residential real estate in the area.
In this context, the property owner decides to conduct a “highest and best use” analysis to determine whether continuing to use the property as a parking lot is the best use of it. The analysis considers the following factors:
- Legally Permissible: The local zoning laws permit the construction of both commercial and residential buildings. Therefore, converting the parking lot into a building is legally permissible.
- Physically Possible: The size and shape of the lot, as well as the availability of utilities, allow for the construction of a multi-story building. It’s physically possible.
- Financially Feasible: A financial analysis shows that converting the parking lot into a mixed-use building (with retail spaces on the ground floor, offices on the middle floors, and residential apartments on the top floors) would generate more income than continuing to use the property as a parking lot, even after considering the construction costs.
- Maximally Productive: Comparing potential uses, the mixed-use building is the most profitable use of the property and would result in the highest value.
In this example, the “highest and best use” of the property would be to develop it into a mixed-use building rather than continuing to use it as a parking lot. Therefore, the property owner may decide to invest in this transformation to maximize the property’s value and profitability.
