Tests For Highest and Best Use Of A Commercial Property


Any commercial property is assessed for its potential value with various alternative uses, other than its current use for deriving the fair value and the best use. This is especially done at the time of buying and selling of the property so that the right price is arrived at. The fair value can be higher than the present associated value if the same property is used for some other purpose and hence can fetch a higher rate at the time of buying and selling. There are usually four determinants for highest and best use of a commercial property which are listed below:

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1 Is Any Other Use Physically Possible: This is one of the most basic determinants and involves the physical aspects of any alternative use. It does not deal with legal limitations but only looks at whether any alternative use can be derived from the property or the property can be put to any other use or not.  The soil type present at the site, topography, size and shape of the plot or land, water presence on the surface or under the surface and weather conditions prevalent in the area at the tests that can be looked at for any alternative use of the property. A tall or marble building will not be physically possible on a piece of land if the soil of the land is soft clay type. Similarly, there are certain types of construction which are not possible in places where it rains almost throughout the year.

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Another aspect of the physical possibility is that of improvements. A property may not be completely pulled own in order to put it to another use to make it more valuable but may require improvements to make it more attractive from investment point of view. What improvements can be carried out will again depend on the physical attributes of the property, apart from other determinates.

2 Is Any Other Use Legally Possible: A building or a property can be put to many different uses physically but may not be possible from legal standpoint. The alternative construction or use must be allowed by the zoning laws. If the property is in a residential area, it may not be allowed for industrial uses. If certain commercial activities are allowed, it will have to be seen which commercial activity can be carried out from the premises as per the zonal law. There are various building codes and even height restrictions. The proposed use changes to the property must not violate those. There can be restrictive covenants to the property. There can also be certain easements which must be adhered to and the building cannot go beyond those.

Zoning restrictions change from time to time and a certain use many have been illegal until few weeks ago but is now legal because of change in the local laws. It is very important to get all the updated information and laws relating to the property including and changes in the zonal laws to be able to arrive at the correct assessment.

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3 Is Any Other Use Financially Gainful: If there is any alternative sue which is legally and physically possible, then it has to pass the test of financial feasibility. This is slightly difficult than the previous two determinants. For looking at the financial gains, cash flow estimates have to be drawn and the market analysis has to be carried out. The cost of construction, operating costs, CAP rate, vacancy rate and cost of getting environmental and other permits will also have to be drawn. The kind of competition present in the same area or region for the proposed changes will also have to be taken into account. If there is already a similar property or business in the same locality then the proposed changes to the property may not bring substantial gains. However, if the area is in initial stages of development and there are good chances of substantial population increase in the locality, then presence of a similar business would not be very material from income and operations point of view. The discounted cash flow technique can also be used to see whether the proposed changes in the property will be financially feasible or not.

4 Is Any Other Use Be Maximally Productive: This is the final determinant and is the slight complex than the other three. This determinant ranks the various proposed uses in descending order in terms of rate of return.  For example, an existing property can be converted into a warehouse, a factory or a serviced apartment complex. Lets say all these have passed the first three tests, that is, these three uses are physically, legally and financially possible. Now which among these will give maximum returns, the second highest returns and the least. All these will be ranked and an assessment of the risks associated with each use will also have to be examined. A discount rate consumerate with the risks involved will have to be applied. Lets say a certain use has maximum returns but the risks associated with that use may be too high which will take the discount rate so high that the value of the property falls below its present value. Hence, the second most profitable option will have to been seen in light of the risks associated with that and so on and so forth. The highest potential rate of return and the net present value will be used to determine the maximally productive use.

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Category: Lifestyle

Debora Berti

Università degli Studi di Firenze, IT

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