In 2000, The Interagency Land Acquisition Conference developed, promulgated, and adopted the Uniform Appraisal Standards for Federal Land Acquisitions which is an excellent guide for real estate appraisers and government agencies to follow. The Standards were originally developed in 1971 and revised in 1992 to develop uniform appraisal standards among the various federal government agencies. Cities and States should adopt these guidelines for acquisition as well to improve the quality of appraisal reports and valuation conclusions and insure fairness for property owners. It is of paramount importance for appraisal reports to be objective, accurate and unbiased. Two sections are extremely important for a proper analysis – highest and best use and selection of comparable sales. In this blog, highest and best use will be discussed.
Highest And Best Use
Highest and best use has been defined as “The reasonably probable and legal use of vacant land or an improved property, which 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.” (The Dictionary of Real Estate Appraisal, 4th Edition). Economic feasibility is extremely important and cannot be ignored by real estate professionals. Land cannot be properly valued for condemnation if the net income that would be derived from new construction or the existing use of the property does not justify the proposed highest and best use. If income is derived from the property, even business income, it must be analyzed to properly develop the highest and best use conclusion.
The price that should be paid is the value to the seller, not the value that might be created by the buyer ( a government agency). The projected highest and best use must be based on an economic use of the property. Non-economic uses are not appropriate because market value is based on the net income that is derived from operating property to achieve maximum productivity. Just because land sales have occurred does not mean that they indicate the highest and best use of the subject property being appraised. The sales represent historical information that may be irrelevant as of the effective date of valuation based on changing market conditions. For example, in the current market, the highest and best use may be to hold a vacant site until market conditions warrant new construction. Demand may be non-existent which will negatively affect value. The sales occurred when new construction was justified. The sale prices of the comparables reflected that fact, while the value of the subject property might have to reflect holding costs and market uncertainty.
The highest and best use is a critical part of the appraisal process and provides the basis for the selection of comparable sales. Comparable sales should have a similar economic highest and best use. For example, vacant land that is zoned for office, retail and hotel use may have been acquired for one specific use, such as office. It may not have the same value if it was developed with a retail facility. A corridor that has a highest and best use for a pipeline is not comparable to a corridor that has a highest and best use for electrical transmission lines. The net income generated from each use is different and the residual income to the site may also be different. The highest and best use cannot be a conjectural and speculative use either.
The highest and best use requirement for financial feasibility requires that the appraiser show that the site can be adaptable to such use, and there must be effective demand for such use. Competitive demand is not proven by government acquisitions. Private enterprises must be acquiring properties for similar uses. The Appraisal of Real Estate states that “the benefit a real estate development produces for a community or the amenity contribution provided by a planned project (i.e., the public space in a park-like area) is not considered in the appraiser’s analysis of highest and best use. Highest and best use is driven by economic considerations and market forces, not by public interest.” Properties acquired by government agencies are generally for the benefit of the public and the acquisition price may not represent the price that would be paid by normal market participants based on the economic benefits that would be derived from the property.
For additional information on highest and best use, please see Part One – What Is The Highest & Best Use?