Principle of Highest and Best Use

Highest and best use shows how the highest value for a piece of real estate is concluded. Highest and best use is based on the use that is going to bring the highest value for real estate; its actual current use is not relevant to the highest and best use. This would be done by conducting a site analysis. If the use is temporary, it would then be considered the interim use.

When determining what use would constitute the highest and best use, the appraiser needs to consider many possible uses of the property. A potential use cannot be considered to be the highest and best use unless it is all four of the following:

1. Legally allowable
2. Physically possible
3. Financially feasible
4. Maximum utility / Profitability

1. Legally allowable

A prospective use cannot be considered the highest and best use unless that use would be allowed under current building codes, zoning ordinances, environmental laws, and other government regulations. For example, if an area is zoned as residential, it would be hard for an appraiser to state that the highest and best use of that real estate would be as a commercial building.

Properties with a use that existed prior to current zoning laws or other regulations could be legally nonconforming. This is known as being grandfathered in. These uses are usually permissible even though they do not meet current regulations or zoning requirements. However, it is possible that some of these uses could not be reproduced if the legally nonconforming improvement is badly damaged or destroyed.

2. Physically possible

Not all properties can be developed to all uses. A potential use must be physically possible in order for it to be the highest and best use of that property. Potential uses can be limited by the size, shape, topography, and other characteristics of the site.

As an example, a 50,000-square-foot single-story warehouse would not fit on a 15,000-square-foot site; therefore, that use would not be physically possible.

3. Financially feasible

A property must be economically feasible. Suppose, for example, that a lot is physically, legally, and geographically suitable for an office building. If there already a ton of office space on the local market, this use is not currently economically feasible.

4. Maximum utility / Profitability

Finally, the use must generate the highest net return (profit) to the developer. All remaining uses which are legally allowed, physically, and economically possible must be tested to decide which use will provide the most profit.