Highest and Best Use
Most appraisers have a good understanding of highest and best use. USPAP Standards Rule 1-3(b) states; “when necessary for credible assignment results in developing a market value opinion, an appraiser must develop an opinion of the highest and best use of the real estate.”
The subject site as improved on the effective date of the appraisal must reflect the highest and best use for Fannie Mae to purchase or securitize the mortgage. The development of the highest and best use entails four important concepts:
· Legally permitted,
· Physically possible,
· Financially feasible, and
· Maximally productive use (most profitable).
Legally permitted entails that the subject’s use is a legal, conforming use. This would exclude uses that are not currently allowed or are unlikely to become allowed, including, but not limited to, uses that are not allowed per zoning or are restricted by the deed or a land covenant.
Issues, such as the size and shape of the site, could inhibit a possible use, thus the improvement must be physically possible.
The concept of financial feasibility entails that the cost to change the improvements cannot be greater than what the real estate would be worth after the change. For example, in some markets, a dwelling that was originally a two-family dwelling will be converted into a single- family. The appraiser researches market data and finds that the subject would be worth $400,000 as a single-family home. If it was converted back into a two-family dwelling, it would be worth $430,000. The appraiser then estimates the cost of the conversion to be $50,000. This would not pass the financial feasibility test as the cost of the conversion is greater than the increase in value to the subject. It would not be financially feasible to put $50,000 into the subject for the conversion, only to see the subject increase in value by $30,000.
The concept of maximally productive and most profitable use involves the analysis of what use is the most profitable use for the subject.
Appraisers sometimes struggle with the highest and best use of a site as improved when a neighborhood is changing. Examples include areas where properties are purchased and torn down to build newer and bigger improvements. Fannie Mae gives us guidance on this by stating, “If the use of comparable sales demonstrates that the improvements are reasonably typical and compatible with market demand for the neighborhood, and the present improvements contribute to the value of the subject property so that its value is greater than the estimated vacant site value, the appraiser should consider the existing use as reasonable and report it as the highest and best use”.
The highest and best use could still be its current interim use until such time that the market changes, making it more financially feasible to convert to another use or until such time that there becomes more demand for the alternative use.
One of the top USPAP compliancy issues with appraisal reports is in regards to the highest and best use analysis.
Standards Rule 2-2 (a)(x) states “an Appraisal Report must summarize the support and rationale for the highest and best use opinion which such an opinion was developed by the appraiser.”
The key word here is “summarize”. Most appraiser think he or she has met this USPAP requirement because YES has been checked in the site section, stating that the highest and best use of subject property as improved (or as proposed per plans and specifications) is its present use. A restricted appraisal report allows the appraiser to only state the highest and best use, but per USPAP, an appraisal report must summarize the rationale for the highest and best use opinion in the report.