It is axiomatic that “you can’t get the value right if you get the highest and best use wrong.”1 There may be no more fundamental concept in the valuation of property under the Fifth Amendment’s just compensation clause than that fair market value is determined in light of a property’s highest and best use.2 It is well-established that market value and highest and best use are connected—the market value of a property is the value of the property at its highest and best use.3
This article will explore highest and best use, its analytical definitions, both legal and appraisal, and the evidentiary application to assist in preparing the expert witness for trial.
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APPRAISAL AND LEGAL DEFINITIONS
Appraisal Definitions
The Uniform Standards of Professional Appraisal Practice (USPAP) Rule 1-3 provides:
When necessary for credible assignment results in development a market value opinion, an appraiser must … (b) develop an opinion of the highest and best use of the real estate. Comment: An appraiser must analyze the relevant legal physical and economic factors to the extent necessary to support the appraiser’s highest and best use conclusion(s).4
The Appraisal of Real Estate defines highest and best use as “[t]he reasonable probable use of property that results in the highest value.”5
The Dictionary of Real Estate Appraisal has a similar definition:
The reasonably probable and legal use of property that results in the highest value. The four criteria that the highest and best use must meet are legal permissibility, physical possibility, financial feasibility, and maximum productivity.6
A thorough analysis of highest and best use issues provides a firm foundation for the appraiser’s opinions and helps the appraiser identify the most likely purchaser for the property in the open market.7 Highest and best use is that reasonable and probable use that supports the highest present value, as defined, as of the effective date of the appraisal.8
The four criteria to determine highest and best use are:
- Legal permissibility: Is the proposed use legal under existing zoning or other applicable rules, regulations, and bylaws as of the date of value? If not, is there a reasonable probability of securing legal entitlements (e.g., permits, zoning variances)?
- Physical possibility: Can the land physically (size, shape, frontage, access, wetlands) support, sustain, promote, and accommodate the proposed use?
- Financial feasibility: Can the land be developed to the use proposed in a financially sound manner? Is the cost associated with achieving the proposed future use (e.g., demolition, site preparation, environmental remediation) reasonably related to the return generated in terms of value (and profit)?
- Maximum profitability: Will the proposed use produce the highest economic land value and generate both a return of and a return on the capital invested?9
The tests of physical possibility and legal permissibility must be applied before the tests of financial feasibility and maximum profitability as “[t]here is little to be learned from analyzing the financial feasibility of an illegal, or physically impossible, use.”10
These four tests have the following three essential components: (i) a property’s physical, legal, and locational attributes; (ii) the economic demand for the potential alternative uses of the property; (iii) estimates of the financial rewards for each alternative use.11
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Legal Definitions
Legal definitions should be, and are, aligned with appraisal standards. The US Supreme Court has stated the rule as follows: An owner of lands sought to be condemned is entitled to their “market value fairly determined.”12 That value may reflect not only the use to which the property is presently devoted but also that use to which it may be readily converted.13
According to the prevailing holdings in the states, highest and best use is that use of the property, among all those reasonably probable uses, that impacts the reckonings of the willing buyer and seller when arriving at the most probable selling price for a property in a free and open market. Highest and best use is that alternative from among all reasonable alternatives that will bring the highest value return to the owner, taking into consideration site capacity, infrastructure, neighborhood conditions, zoning trends, and data dealing with costs and values. Highest and best use is not restricted to the existing use of the property by the owner at the time of the taking (date of valuation), nor necessarily only those uses allowed as a matter of law (e.g., by zoning). In determining market value, a factfinder may consider all uses to which the property is reasonably adaptable and for which it is (or in all reasonable probability will become) available within the foreseeable future. The probability of a property’s use for all purposes, present and prospective, for which it is either presently adapted and/or to which it might in reason be applied, must be considered. It is the legal, possible, and probable employment that will give the greatest present value to land or realty while preserving its utility. With discounts for likelihood of being realized and for futurity, the values of potential uses of land taken are elements that should be considered in fixing just compensation.14
CLICK HERE to read the full article, which was originally published in ALI CLE’s The Practical Real Estate Lawyer.
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