How do you reconcile conflicting highest and best use scenarios for a commercial property?

1 The four criteria of HBU

To determine the HBU of a property, appraisers use four criteria: legally permissible, physically possible, financially feasible, and maximally productive. Legally permissible means the use must comply with zoning, building codes, environmental regulations, and other legal restrictions. Physically possible means the use must fit the size, shape, topography, and soil conditions of the site. Financially feasible means the use must generate enough income or value to cover the costs of development and operation. Maximally productive means the use must yield the highest net present value or return on investment among all feasible alternatives.

3 The sources of conflict between HBU and market value

Sometimes, the HBU of a property may not match its market value, creating a conflict for valuation purposes. This can occur when the property is underutilized or overimproved, subject to external obsolescence, or transitioning in use. For example, market changes, environmental issues, or social trends can negatively affect the value of the property. Additionally, shifts in demand, supply, or regulations may cause the HBU to change but the market has yet to recognize and adjust to these changes.

4 The methods of reconciling HBU and market value

In order to reconcile conflicting HBU and market value scenarios, appraisers can use different methods depending on the situation and purpose of the appraisal. The interim use method assumes that the property will continue to operate in its current use until it is converted to its HBU, and discounts the future value of the HBU to the present. Alternatively, the prospective use method assumes that the property will be converted to its HBU in the near future and adds the cost of conversion and risk premium to the current value. Lastly, the alternative use method compares values of different feasible uses of the property and selects the one that is most likely to occur or most consistent with the market.

5 The implications of HBU and market value for decision making

Understanding the relationship between HBU and market value is essential for commercial real estate decision making. Investors, developers, and lenders can use this information to evaluate the potential and risks of a property, as well as plan their strategies. For instance, they can identify opportunities to acquire discounted properties, assess the impact of external obsolescence on the value and performance of a property, or compare the costs and benefits of different uses of a property. Ultimately, this allows them to select the option that maximizes their return on investment or meets their objectives.