What is the highest best use in real estate development?
Highest Best Use
The highest and best use is determined by an assessment of a property’s potential to generate income, development profit and it’s permissible use based on its zoning.
Definition: Highest best use
It refers to the most profitable and efficient use of a piece of land or property, taking into account all potential uses and market conditions.
This concept is used by developers, investors, and appraisers to determine the most profitable and sustainable use for a piece of real estate.
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Highest best use is determined by answering 4 critical questions
Is it possible?
In a nutshell, all we are trying to do is determine whether or not, what we are planning on developing on the proposed site is a possibility.
Is it permissible?
Permissibility is nothing but legal compliance. Is what we are planning to develop legally permissible to do based on zoning laws applicable to that site.
Is it financially viable?
Do the numbers stack up? What if I can build a 10-storey building on the proposed site, but is building 10 stores going to be financially viable? In order to answer this question, developers often conduct a property development feasibility using a software.
Highest yield / Maximum profit
Every developer must determine the path of least resistance. We all want the lowest risk and maximum reward. Developers are 10 times more in-tuned to the risk-reward equation and ensure that their projects are designed and optimised to deliver the maximum profit or yield with the lowest possible risk.
Residual Value of Land
Residual value of land is different from profit margin. We address all 4 of the above questions in order to determine the value of the land the developer should pay based on its development potential.
Here is a video explaining the Highest best use in real estate using One Minute Feaso.
Example: Highest best use
For example, if a piece of land is located in a highly desirable area with a lot of foot traffic and good access to public transportation, based on its zoning and permissible use, the highest and best use may be to develop a retail space or a mixed-use building with both residential and commercial units.
On the other hand, if the land is located in a more rural area with little foot traffic, the highest and best use may be to develop a single-family home or a small apartment complex.
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Zoning
It is important to understand the role of allowed zoning, covenants and restrictions and various planning overlays. Even though you can technically build a highrise on a piece of land, it doesn’t constitute its highest best use as long as…
- The sites’ zoning and overlays allow doing so and
- There is an actual demand for you to build on that block.
How to determine highest best use of a site?
To determine the highest and best use, developers and investors will typically conduct a thorough analysis of the local market, including an examination of the area’s demographics, zoning laws, and economic conditions.
They consider various potential uses for the property and the costs associated with each use, including construction and ongoing operating costs. This is where the financial modelling of various proposed schemes helps developers model the financial viability of their highest best-use proposal to make an informed decision.
Overall, the highest and best-use analysis is an important tool that helps developers and investors make informed decisions about how to use a piece of real estate in the most profitable and sustainable way possible based on its market demand.