Real Estate Analysis and Commentary in Victorville

There are basic economic principles that every valuation is based on. One of the more important one for real estate valuation is Highest and Best Use (HABU). The following is a brief discussion of this principle. In future blogs, I will discuss where to find an appraiser's finding in the Uniform Residential Appraisal Report and the various levels of analysis that an appraiser can provide. 

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Principle of Highest and Best Use (HABU)

This is a cornerstone principle and incorporates other principles such as:

 

1. Demand and supply.
2. Increasing/Decreasing returns.

 

Proper use of this principles helps to identify the single use that produces the greatest value as of a specific date for a parcel of land.

 

There are four specific tests that must be considered prior to the use conclusion. These are:

 

1. Legal Permissibility.
2. Physical Possibility.
3. Financial Feasibility.
4. Maximum Productivity (value maximization).

 

Each of these tests are applicable to the land and to the existing improvements (if any).

 

Key considerations for these tests:

 

Site size.	Shape of the site.	Availability of utilities.	Market demand.
Topography.	Access.	Development costs.	Absorption rate
Expected return	Zoning.	Political risk.	Social risk.

 

Clarifying questions to answer:

 

1. Is the property (as improved) underused?
2. Is the site larger or smaller than community standards?
3. What is the likelihood of zoning changes or variances?
4. What are the demolition and construction costs for this community?

 

Legal permissibility determines the permitted uses and maximum building size.

Physical permissibility determines the limits of what can be built on the site.

Financial feasibility measures the costs versus the returns and helps in demonstrating the feasibility of building.

Maximum productivity the final determination of the use that yields the highest value. (sales comps and income models).

 

How appraisers apply HABU:

 

1. Market analysis:
   1. Identify demand and supply.
      1. Volume of sales and active listings. Results in an absorption rate that may be used to determine the current level of supply and timing.
   2. Who is the likely buyer for the property
      1. Price levels are an important consideration. A buyer for a $1,000,000 property is going to be different than a buyer for an entry level home.
      2. The buyer for a property with an alternative use is likely to be different than a buyer for an existing use that does not require time and expense.

          

2. Site Analysis:
   1. What are the physical constraints to development?
   2. What are the levels of utilities? If they need to be brought to the site, what is the distance and level of cost? Are private utilities typical and if so, what are the costs and timing for development?
   3. What alternative uses are available for the site?
   4. What is the current path of development and the level of current development?
   5. New development in the subject’s area. Location and type are important.

       

3. Legal Review:
   1. Zoning – What are the legal uses for the site?
   2. Potential for re-zoning or variances? Examples found in the area help to identify this potential. Consideration needs to be given to the timing, political and social risk to this potential project.

       

4. Feasibility modeling: Proforma cash flows (including timing) or cost replacement analysis are used to test financial feasibility.

 

Risks, limitations and practical cautions to this analysis: 

1. Changes in zoning and granting of variances are speculative. The basis of how this was determined should be clearly delineated in the report with examples cites (if possible).
   1. A discussion regarding the political risk, social risk and time for this change should be discussed.

       

2. Timing and carrying costs estimates may change after the estimate is made.

    

3. Data gaps – a weak market (limited sales, etc.) increases the uncertainty of estimates for the project viability.

    

4. Conflict with current use. The owner may resist change, legal or community barriers may block redevelopment despite the economic logic to do so.