This analytical technique estimates the most profitable, competitive use to which the property in focus can be put to use. It treats on the analysis of the market in respect to the local region rather than more broad terms.
The primary effects on the highest and best use are competitive forces among the participants within the given market. A thorough understanding of market behavior based on market analysis is critical to developing an accurate assessment of highest and best use.
In theory, the highest and best use analysis would focus on the potential uses of the property as if it vacant. However, in reality the value that is added to the land through existing improvements also weighs in determining the actual property value. In most cases, if the value of the land after improvements is a higher value than the vacant land, this value should be used in the highest and best use analysis.
Four primary tests are implemented when using the highest and best use analysis.
1) Legally acceptable
2) Physically possible
3) Financially reasonable
4) Highest productivity
What is legally acceptable is the first and primary determinant of highest and best use. Zoning is the first and most relevant factor in how a site can be developed. Zoning will eliminate a number of uses, making the physically possible analysis easier. Locational effects will affect the probable use while site size and frontage will further reduce the available development or use options.
After analyzing the legal and physical attributes, the development options should have been greatly reduced, making the financial analysis straightforward. With two or three reasonable development options, the financial analysis looks to find the option that creates the highest return that can be generated from these alternate uses.
The determination of whether a property use is reasonably probable is important in the initial assessment. For instance, market analysis might insist that a day care would be a usable use for a property, but, if the surrounding area is composed of mostly elderly individuals, this plan is not reasonably probable.
If there is a proper demand in a market area, and the property is appropriate for a certain use, the property is not necessarily the best land for the project. Another site might be more appropriate, and the appraiser must consider these alternate sites to ensure that the full market potential from competition has been accounted for. In highly competitive markets, demand must be accounted for in property valuation.
After these analyzes have been completed the appraiser must determine what use, among the options that remain, will be the best use for the site. In some uses, even those that may create the highest return may not be the best use because of the demographic composition of the neighborhood. Once the best use is estimated, the land must be value under that use.