Highest And Best Use Only

[GWC]

Has anyone done an Highest and Best Use only report for a client? I've done stand alone market studies, sales comparison only and similar "single approach" appraisals, as well as appraisals with in-depth market studies, but not a stand alone H&BU report with no appraisal. If anyone has, please let me know as I had a couple questions. Thanks.

 

[RebelNYC]

Yes, many times. Highest and Best Use studies are one of the few opportunities most appraisers get these days to truly use our skills to help clients make decisions we can actually see the results of. To do this properly, I recommend the Appraisal Institute Book Market Analysis for Real Estate.

There are 2 kinds of studies, a site in search of a use, and a use in search of a site. I'm actually working on the latter right now, but that is less common. I will assume you are doing the former.

You really have to discuss with your client the scope of work, as the level of detail you put into such a report can vary considerably.

The short answer is rather than structure your report as a traditional appraisal, it is structured as the highest and best use analysis. You first look at the site, determine what can legally be done with it, and perform a productivity analysis (all of the positives and negatives of a site). You then determine what is financially feasible, based on what is both physically possible and legally permissible.

The market analysis for each use should follow the AI standards for levels A, B, C, and D. If you don't know what those are, you need the book I cited above. Most appraisers have little experience doing high level market analyses, but depending on the project, the seemingly difficult Level D analysis can be a lot of fun. It involves a lot of interviewing, and if your client has the cash, you can hire all kinds of third parties.

Once you determine what is financially feasible by looking at supply and demand factors in our market analysis, you perform an appraisal for each of the uses.

Generally, these are all residual analyses. You perform an income approach as if hypothetically complete, and deduct out construction costs, lease-up costs, etc. Whatever yields the highest residual land value is the highest and best use.

Alternatively, you can perform a discounted cash flow and impute the IRR for each scenario. The scenario with the highest IRR wins.

 

[GWC]

Thank you for your help! I'll use my Capstone H&BU section as a rough template. I really appreciate your input RebelNYC!

 

[DWiley]

Yes, many times. Highest and Best Use studies are one of the few opportunities most appraisers get these days to truly use our skills to help clients make decisions we can actually see the results of. To do this properly, I recommend the Appraisal Institute Book Market Analysis for Real Estate.

There are 2 kinds of studies, a site in search of a use, and a use in search of a site. I'm actually working on the latter right now, but that is less common. I will assume you are doing the former.

You really have to discuss with your client the scope of work, as the level of detail you put into such a report can vary considerably.

The short answer is rather than structure your report as a traditional appraisal, it is structured as the highest and best use analysis. You first look at the site, determine what can legally be done with it, and perform a productivity analysis (all of the positives and negatives of a site). You then determine what is financially feasible, based on what is both physically possible and legally permissible.

The market analysis for each use should follow the AI standards for levels A, B, C, and D. If you don't know what those are, you need the book I cited above. Most appraisers have little experience doing high level market analyses, but depending on the project, the seemingly difficult Level D analysis can be a lot of fun. It involves a lot of interviewing, and if your client has the cash, you can hire all kinds of third parties.

Once you determine what is financially feasible by looking at supply and demand factors in our market analysis, you perform an appraisal for each of the uses.

Generally, these are all residual analyses. You perform an income approach as if hypothetically complete, and deduct out construction costs, lease-up costs, etc. Whatever yields the highest residual land value is the highest and best use.

Alternatively, you can perform a discounted cash flow and impute the IRR for each scenario. The scenario with the highest IRR wins.

Great reply!!

One challenge I see is client education. It is sometimes hard to get a client to understand that a true HBU study will still require an appraisal (more than one, actually)

 

[RebelNYC]

Thank you for your help! I'll use my Capstone H&BU section as a rough template. I really appreciate your input RebelNYC!

Good luck! Do talk to the client, as you could easily get bogged down and lose a lot of time and money on an assignment like this. You very likely are not going to have all the data at your disposal like in the Capstone. Caveat!

 

[GWC]

Great reply!!

One challenge I see is client education. It is sometimes hard to get a client to understand that a true HBU study will still require an appraisal (more than one, actually)

Smart. They actually had an appraisal done recently, but the H&BU study was bare bones. He probably does need an updated appraisal though....haha

 

[GWC]

A follow up question. In the demo, I went through the feasibility analysis and and ended up with a site value (that was negative). In the case of my subject, the H&BU of the property will be an owner/user industrial building. Since the income approach is typically much lower than the Sales Comparison approach in this area, would you suggest I tweak the feasibility study a bit to analyze the site vale + estimate construction cost vs the the sales price of recent sales that were built in the last 2 years? Almost like a hybrid of a Cost & Sales Approach.

 

[RebelNYC]

A follow up question. In the demo, I went through the feasibility analysis and and ended up with a site value (that was negative). In the case of my subject, the H&BU of the property will be an owner/user industrial building. Since the income approach is typically much lower than the Sales Comparison approach in this area, would you suggest I tweak the feasibility study a bit to analyze the site vale + estimate construction cost vs the the sales price of recent sales that were built in the last 2 years? Almost like a hybrid of a Cost & Sales Approach.

If you're going to say the highest and best use is owner-user occupancy, then the analysis is really not terribly different from single-family homes. Ok, I lied. It's conceptually similar but a lot more complex.

You need to look at the proposed business, forecast the income they can generate, estimate how that relates to the price of the property. This is hard to do if you are not familiar with the business, but specialists who focus on say car washes or gas stations often can do this kind of analysis fairly easily.

 

[leasedfee]

feasibility analysis and and ended up with a site value (that was negative)

What's going on with that? If it was scraped today, what'd the value and the use be, a la land sales?

 

[Gobears81]

You need to look at the proposed business, forecast the income they can generate, estimate how that relates to the price of the property. This is hard to do if you are not familiar with the business, but specialists who focus on say car washes or gas stations often can do this kind of analysis fairly easily.

If a potential HBU is a car wash, c-store, hotel, etc., I would agree with you. But an owner-occupied industrial HBU could encompass a range of potential businesses, particularly if it is warehouse, rather than manufacturing. Same issue for an office building - you could look at the business income needed to justify new construction, but I don't foresee a multiplier of an occupant's business income as producing a reliable valuation metric, and that is ignoring the supply demand issues for the existing office space in the market. Take an appraiser's office - even if the business is a goldmine, many appraisers tend to occupy Class C offices, assuming they don't work from home.