Breaking Down The Four Tests of Highest and Best Use (HBU)

Traditionally, commercial appraisers have followed a four-step process to determine a subject property’s HBU. Each of these steps can also be considered a test, and each test can be expressed as a question the appraiser sets out to answer.?In the article below, we will illustrate how these “tests” are employed and the possible implications in determining value.

Test #1: What Is Physically Possible?

HBU is contingent on what is “physically possible.” Location, topographic features (e.g., exposure to flood risk), access to infrastructure, and a building’s own condition and dimensions all impose constraints within which the appraiser must operate when assessing what a property’s highest value might be — and how it might realize that value.??

Test #2: What Is Legally Permissible?

Appraisers typically research five areas when verifying the legality of a potential property use. Those areas are:?

1. Land use regulations.?
2. Zoning.?
3. Building codes.?
4. Restrictive covenants.?
5. Easements.???

Test #3: What Is Financially Feasible?

Ultimately, a property’s highest and best use must meet two criteria:?

1. It must generate enough revenue to cover the costs of construction and/or property improvements.?
2. It must generate enough revenue to turn a profit.?

Test #4:nbsp;What Is Maximally Productive?

Recall that a property’s highest and best use must meet two criteria:?

1. It must generate enough revenue to cover the costs of construction and/or property improvements.?
2. It must generate enough revenue to turn a profit.?

The final test appraisers apply in establishing HBU pertains to this second question.?

By this stage of the process, the appraiser will have narrowed the field of possible property uses to a handful of top candidates. They then rank these proposed uses and identify which qualifies as the HBU based on its productivity, typically measured in terms of the revenue generated by rent changed to building occupants.?

All that being said, HBU cannot be reduced to a number. HBU is both quantitative and qualitative. HBU is dependent upon the stakeholders involved, the actions they take, and the timing of those actions. So, although there is often little overlap between the property buyer and the tenants occupying that property, both parties are major characters in the HBU narrative.?

Windows of opportunity can open and close unpredictably in today’s commercial real estate market. Whether you’re a buyer, seller, lender, or investor, the most accurate and up-to-date data is more valuable than ever.??

That’s why LPA’s valuation experts, including the members of our?dedicated research team, always stay proactive, taking extraordinary measures to ensure their reports contain credible — and actionable — business intelligence.?

Contact us today?to learn how we use our tech-enabled innovative tools, analytical acumen, and dedication to excellence to help clients make the most informed and timely decisions about their real property assets.??