As stated in each article in this series, the sales comparison approach is only as good as the comparables used to arrive at the value for the subject property. One of the key aspects of determining the best comps is the use of Highest and Best Use (HBU) principles. In earlier articles in this series we covered other topics that you may be interested in:
- Part 1: Using property characteristic similarity and assessing such similarity in a completed appraisal
- Part 2: Validating the adjustments for comparables
- Part 3: Ensuring objectivity and detecting bias in the choice of comparables
In this part, we will explore how we can validate the highest and best use of each comp against the subject property.
Understanding Highest and Best Use (HBU)
HBU represents the most profitable, legally permissible, and physically possible use of a property, resulting in the highest value. This concept is fundamental in real estate appraisal and is guided by factors such as zoning regulations, market demand, physical characteristics of the property, and legal constraints. The applicability of these rules widely vary for different types of properties (commercial, industrial, mixed use, land, residential, etc.) and different stages of the property development process (improved, unimproved, permitted, rezoned, etc.).
We will limit our discussion here to the use of HBU in appraising residential properties.
Importance of HBU in Comparable Selection
When appraising a property, selecting comparable properties that align closely with the subject property’s highest and best use is imperative for accurate valuation. Using comps that reflect similar potential uses ensures a more reliable estimate of the subject property’s value. As a result the first step in the process is to adequately determine the subject property’s highest and best use for the HBU criteria. This would form the basis for the research and analysis of the comparables considering factors such as the following:
Zoning Regulations: Zoning ordinances dictate how land can be used within specific geographic areas. Understanding zoning regulations is crucial in identifying the allowable uses for a property and selecting comps that comply with these regulations. For example, if the subject property is zoned for residential purposes, selecting comps zoned for mixed use would not accurately reflect its HBU.
Market Demand: Assessing the demand for various property types in the market is essential for determining HBU. Factors such as population growth, employment trends, and demographic shifts influence market demand. Selecting comps that cater to similar market demands ensures comparability and accuracy in appraisal. For example, in a neighborhood adjacent to a university where most of the housing is for students, a luxurious single family home would not have similar demand as the other single family homes that attract student tenants.
Physical Characteristics: The physical attributes of a property, such as size, location, amenities, and condition, play a significant role in determining its highest and best use. Comparable properties should share similar physical characteristics to the subject property to provide a reliable basis for valuation. Having said that, certain physical characteristics of the comparable may not contribute to its highest and best use as compared to the subject and if so that must be considered for purposes of variation adjustments. For example, if the subject is a single family home and the comparable is a single family home on a large farm land, the land area of the farm may not be used toward an adjustment.
Legal Constraints: Legal restrictions, such as easements, environmental regulations, and historical preservation requirements, can impact a property’s highest and best use. Appraisers must consider these constraints when selecting comps to ensure they accurately reflect the subject property’s potential uses within legal boundaries.
Key Takeaway
The selection of comparable properties is a critical step in determining the fair market value of a property. Leveraging the Highest and Best Use (HBU) criteria ensures that comps accurately reflect the subject property’s potential uses and market value. Reviewers must validate the zoning regulations, market demand, physical characteristics of use, and legal constraints of the comparables to ensure the best comps have been selected.