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Highest and Best Use

DEFINITION

The highest and best use is a term commonly used in real estate to describe the most likely and legally acceptable use of a property with improvements, or a piece of land, which can be physically implemented, with the requisite support, and is financially viable in order to generate its highest value.

EXPLANATION

The term highest and best use is basically a principle that advocates for a real property to be used for maximum productivity and in a legal manner that is financially rewarding. This concept is typically applied in the process of real estate appraisal to determine the highest value of a real property.

However, the highest value of a property is a subjective figure because it largely depends on the expertise of the appraiser especially their analytical skills, hence, it is not a statement of fact. This concept also largely ignores the current use of a property as its sole objective is to determine how the property can generate the highest value for its owners and the surrounding community in future.

The highest and best use of a property can also be referred to as its most probable use and is commonly used to determine the approximate selling price of a property.

The criteria for the highest and best use

The highest and best use of a property must meet a strict criteria as described in the definition, which includes:

–             Being legally permissible

–             Being physically possible

–             Being financially feasible

–             Must lead to maximum productivity

Firstly, the highest and best use of a piece of land or a property with improvements must be allowed by law, which means that it must comply with the applicable building and zoning regulations in the area. It must also be legal at both the Federal and state level, which means that you cannot use the land for illegal activities, such as growing banned substances, regardless of whether this will generate the highest value for the land.

The highest and best use for a property must also be physically possible, which means that whatever you want to use the property for, must be practical. For example, you cannot build a private airstrip on a small piece of land because it is not physically possible. In such a case, you might be best served building a helicopter landing pad (a helipad) due to the limited space.

The financial feasibility of how a real property is developed and used is critical for everyone involved as it will determine whether the project becomes profitable, or turns into a loss-making venture. The highest and best use of a property must be the use that generates the most profit for the property at present, and remains profitable over the long-term.

For an improved real property or an empty lot, its highest and best use must be the use that generates the maximum returns for the developer, owner, or investors. The returns are measured in terms of potential profits, but are more accurately represented by the net present value and the internal rate of return.

A word of caution

In many cases, sellers, buyers, investors and developers of real estate tend to be very optimistic about the properties they are buying, developing, or selling in terms of the highest and best use. However, it is best to be realistic and to ensure that an accurate appraisal of the property is done before buying it, selling it, or investing in such property in order to ensure that you do not lose your investment capital based on a lofty unrealistic appraisal.

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