Highest and Best Use Issue

[Deleted member 128537]

First time I've run across this:
1) Home is in the middle of area zoned C-2 (commercial). It was previously zoned C-2.
2) Home was rezoned at request of owner to C-5 (mixed commercial residential). It is the only property on the block zoned C-5. Some properties behind it are zoned residential.
3) All properties across the street, same side of street, and up the street are commercial businesses zoned C-2.
4) As vacant: Property use as residential is legally permissible and physically possible. Now the question is economic feasibility as vacant. There are ample other properties that are zoned purely residential that could be acquired. Why would someone build a house in a commercial area? So I am thinking that economically feasible is out the window. A reasonable person would buy this property vacant for commercial use.
5) Finally there is maximally productive. The fact that the property is in a commercial zoned area seems highly unlikely that residential is maximally productive. Especially when it is clear that everything else is moving toward commercial.

So in my opinion the highest and best use vacant would be commercial.

This now brings about the case of highest and best use "as improved."
There is an older house on it (1930's). The improvements do add value to the site. At this point it would not be economically feasible or maximally productive to tear the house down and build a purely commercial building.

But it also seems to me that the more likely future use of the improvements is not residential, but rather commercial. Especially since that is the direction of all the properties around it. Many of the commercial properties around it are homes that have been remodeled for commercial use (offices, shops, etc.).

Yet one can still argue the highest and best use is also residential because of the way it is zoned. Residential is legally permissible. All the other properties CANNOT be used as residential because they are zoned C-2. Also I cannot argue that the property is worth more as a commercial property than as a residential property since the present improvements are a residential structure.

Therefore I am going to say in the report:
1) Highest and best use as vacant is commercial.
2) Highest and best use as improved is present use.

Although here is the caveat: Although they want a residential SFR loan on it. The lady is using it to run her sewing business out of it. So in effect they are not using it as a residential property, but as a commercial property. And the pictures clearly show this.

Does this make sense? What do the rest of you think?

 

[Michigan CG]

What the current owner is using it as has little to no bearing on the Highest and Best Use at this time. It might be an indicator although you have identified that the Highest and Best Use at the CURRENT TIME is for continued use as a residential property as the improvements contribute value.

It appears that you have a property that has a possible INTERIM Highest and Best Use as a residential property and the indicated future Highest and Best Use will be commercial at some tome in the future and that Highest and Best Use MIGHT be to convert the current improvements for commercial use or might even be to tear down the improvements and have it as vacant land.

I am not at all insinuating that the license level is in question as you have identified the situation. However is the risk worth the reward for this assignment? I have a fee for these properties that is 4 figures. A lot of them are turned down. Fine, give it to the out of town guy who has given less than 10% of the thought you have given it.

 

[Mike Kennedy]

Refer it to a trusted G.C. colleague. What goes 'round comes 'round.

 

[Deleted member 128537]

I definitely agree that it's an interim use and how the property is being used now isn't the key. I AM going to turn this one down. For one thing not only is there a highest and best use issue, but there are no comparable residential sales with similar zoning and surroundings. So I have no way to determine market reaction to this type of property. It is as we say an "odd ball." Certainly not worth the headache for a $400.

 

[incognito]

Unpermitted addition

1234567890

 

[George Hatch]

Put aside the semantics and approach the question from the perspective of the market. The reason we develop HBU is in order to identify the probable buyers for the property in the condition it's being appraised (usually "as is") and the attributes that drive the values for those users.

You've got an old house on a commercially zoned parcel that's surrounded by commercial uses. As a residence it doesn't fit in well with its environment and that will most likely detract from what it's value would be if located in a more conforming residential neighborhood.

A potential buyer for this property has several options:

- Continue the existing use, either in as is condition or after repairs/rehab

- Convert the existing improvements to a different form of use than strictly residential, like converting a portion of the existing building to a non-res use or adding another use to the site. An example of this would be converting the property to a permissible commercial use like an office or a contractor's yard or a car sales lot of a mixed use.

- and lastly, scraping the existing improvements for redevelopment, in which case your "as is" value to one of those buyers will actually be a little lower than the underlying site value as if vacant due to the cost to cure of removing the existing improvements.

There is a school of thought among appraisers that "value as if vacant" isn't really all that relevant to a property with existing improvement except for use as a comparison against the "as is" value as a test for the contributory value of the improvements. In other words, so long as the "as is" value exceeds the site value then what the site's potential is beyond that isn't really all that relevant. That's an oversimplification of that theory but I'm sure you get my meaning/

In this case - and assuming this is for a mortgage transaction - if you think the property is worth more in it's existing use then the next question that will arise is "for how long?". Sure, it's worth more now, but what's the remaining economic life of those improvements in this use?

The answer to that question goes beyond the physical condition of the property because within reason most any structure can be rehabbed for a cost. This is where the proximate trends and the long term economic trends come into play. Regardless of physical condition if you see signs that there was a lot of redevelopment in this neighborhood during the last bull run and you think it might continue in the next cycle then the site value could possibly outpace the SFR value and render those improvements worthless in a relatively short period of time.

Regardless of the HBU right now, if you tell a lender you think that based on past trends the remaining economic life may be limited to 5-10 years that will likely have a huge effect on their decision. The way you would prove such an assertion is to go back into the sales history for this neighborhood and others like it and show prior sales involving underimproved properties with SFRs being converted or redeveloped into non-res uses. If the prior sales history doesn't demonstrate such a trend then that's something worth reporting, too.

More than likely, your existing use is far more valuable than the underlying site value, and even though the house is old you may come to the conclusion that it will continue to be more valuable for a long time to come. If so, that's also something very relevant to express in your report.

Obviously you're going to have a tough time tracking commercial sales data unless you have access to it so that will often be the big barrier to most appraisers engaged in residential practice. But if you have access to the data and the willingness to pull on that thread until you can develop an informed opinion there's no reason you can't get there. It ain't voodoo - it just takes time and effort.

 

[Deleted member 128537]

The trend is definitely commercial. Any structures similar to the subject that still exist have been changed to shops and offices. Right beside the property is a commerical office building. Across the street is a commercial building. Up the street for at least a block, and down the street for blocks are all commercial uses of similar previous residential structures or other commercial buildings. Doesn't take a genius to figure out the trend. (I took pictures of all of it.) And because the zoning all around is C-2 (small commercial) I don't see the trend changing. These people want a 30year fixed residential loan. Doesn't make sense from the client's perspective to do that. When I went inside I asked, "Have you had trouble getting a loan on this property?" Owner said, "yes." I told them they may end up going to a bank in-house loan, because I figured there may be problems. I have been doing this for 16 years, and I know lenders hate that word 'commercial' in a zoning description with SFR. Anyway thanks all for the advise. I have informed the AMC of the problem. It will be interesting to see what the lender says.

 

[Tim The Enchanter]

It sounds like it could make a live / work type property.
Shop or store downstairs, and apartment upstairs.
I bet the lenders AMC says cancel.

 

[George Hatch]

One thing to watch out for is the difference between prior development trends vs future development trends. If most of the office buildings nearby are older and they haven't been doing a lot of development during this last economic cycle then they may not be doing much development in the next cycle, either. one indication of demand is the looking at the current trends for rents and vacancy. If rents have been stable and vacancy has been low then that might indicate to some room for growth, but if rents are in decline and vacancies are way up then that's a market that's overbuilt and new development may not be feasible in the near term.

One big difference between residential uses vs commercial uses in the urban/suburban areas is that there is always a natural tenant for a residential unit - all you have to do is drop the rent and you'll attract tenants, guaranteed. Not so for commercial properties, which is how in some markets you can see buildings that have sat vacant, and unproductive, for months and years at a time. Commercial properties are subject to different external factors than residential properties. There's some overlap but not necessarily as much as you might think.

Land use trends among non-res properties are subject to changes in commerce, particularly as it relates to technology.

In this region the little "Main Street" business districts are mostly in decline as retail patterns move away from small storefronts to larger discounters and now, on to e-commerce patterns. Nobody goes down to the shoe store on Main Street to buy shoes anymore. They go to the mall or the big box sporting goods store to try their shoes on for size and then seek out the best deal from one of the online retailers. That leaves these shopping mall shops little more than dressing rooms and social centers for teenagers. Sooner or later these cities will release portions of these Main Street business districts to go back to multi-family residential due to lack of demand for more retail in those areas. Office districts can get especially tricky because unlike retail districts, office buildings are commonly built in the transition areas located between the main drag and the residential districts located a couple blocks in.

 

[Mark K]

Sounds to me that, at BEST, its residential application would be limited to a rental property; tenants will rent anything.

I can't imagine anyone buying it for owner-occupied residential use unless they want to also have an on-site business and these buyers are relatively few-far between.

I hate transitional properties because you essentially have to do a commercial appraisal and a residential appraisal to determine the HBU. When I do them I charge the equivalent of two appraisals.

Most of these properties seem to fall into one of three categories: Residential rental, commercial rental, or commercial use by the owner. And when all is said and done, the values are often very similar. In any case its probably no-go with AMC/secondary market loans.