Anytime you are looking at selling or buying a property you need to find out what the Highest and Best Use is of that particular property. What this means is that what type of use of the property is going to deliver the highest value. Now there are some criteria that needs to be fulfilled from an appraiser’s standpoint and these criteria should also be followed if you are an investor. Ask yourself the following questions and you will get to your answer.
The Highest and Best Use of a property may or may not be the current use of the property so keep that in mind. As appraisers we ask the following four questions to establish the Highest and Best Use. The first one (in no particular order), is it it legally permissible? In other words if the highest and best use for income points to the property having a guest studio, would that studio be legally permissible. This is especially important if the property is being looked at as an income property.
The second question is, ‘Is it legally possible?’. Sure the highest and best use of a property might be to add on a guest studio and you may find that it is legal to do so but if the property doesn’t have enough lot size to do it then it would eliminate the guest studio option as the highest and best use of that property. You want to use the questions to find the type of use that will produce the highest value and that often means you need to go through a process of elimination. The four questions are designed to do that.
The third question is, ‘Is it financially feasible’? What does it cost, is financing available, and will the cost to acquire the guest studio be worth the increase in value? If you end up spending $300,000 but you only increase your value by $10,000, it’s probably not worth it unless somehow it works out that you could recapture your initial cost in a reasonable time period through the rental income.
Finally, the last question is, ‘Is it maximally productive?’. Will the property produce the highest net return once it is converted to its highest and best use. Properties don’t always have to be converted into the highest and best use. In fact most properties are already at their highest and best use. But you should always ask the question if the property is returning the highest value back. This is a step that can often be overlooked because many properties will produce good recurring value back. Most people don’t ever realize that they might be leaving a lot of money on the table.
This is one of the reasons that you should consult an appraiser especially one who is good at doing cash flow analysis on income properties as well as one who is competent enough to do unit in place appraisals for new construction properties. The unit in place method breaks down the cost of each component of the property as well as the cost of installation/building of that particular component. It’s a very detailed cost approach method and can be the difference in determining whether a developer will feel comfortable with going forth with a project. The ROI can be very difficult to project on a property that has not been built yet.
So the next time you are looking at valuing a property and you want to get the most bang for your buck, make sure you run through the 4 steps so you can identify the highest and best use of that property. Always make sure to consult with a knowledgeable appraiser who is willing to do the due diligence necessary to uncover any hidden uses which might yield the best value for you.
Good luck and we hope that helps with your next investment.