What is the definition of "excess land" in property valuation?

Site Valuation: Highest and Best Use

Site Valuation: Highest and Best Use

Accurate property valuation is paramount in real estate, influencing investment decisions, lending practices, and property tax assessments. This chapter, within the "Mastering Property Valuation: The Sales Comparison & Income Approaches" training course, addresses a cornerstone of property valuation: determining the "Highest and Best Use" of a site. As highlighted in the course description, this training focuses on the practical application of the Sales Comparison and Income Approaches to estimate value. This chapter builds a critical foundation for utilizing these approaches effectively. Accurately determining the site’s Highest and Best Use is not just theoretical exercise. As the book content indicates, it is crucial in several situations including the Cost Approach to value (Chapter 8) and the building residual technique (Chapter 10). Furthermore, legal requirements, particularly for property tax assessments and condemnation proceedings, may necessitate separate site valuation, where the concept of Highest and Best Use becomes paramount.

Scientifically, understanding Highest and Best Use is vital because it applies the economic principles of utility, scarcity, demand, and transferability to the specific context of real estate. It seeks to identify the most productive use of land, aligning with the core economic concept of resource allocation for maximum value creation. This process involves rigorous analysis of legally permissible uses, physically possible uses, and economically feasible uses, all underpinned by the principle of anticipation, which emphasizes the impact of future benefits on present value. Moreover, it also plays a crucial role in applying the sales comparison approach (covered in chapter 9)

The educational goals of this chapter are designed to provide you with the practical tools to:

• Understand the Concept: Clearly define Highest and Best Use and its underlying principles.
• Analyze Site Potential: Critically evaluate a site's potential uses considering legal, physical, and economic constraints.
• Apply Valuation Methods: Employ the core Sales Comparison and Income Approaches learned in the course, informed by an accurate determination of Highest and Best Use.
• Distinguish Between Vacant and Improved Land: Differentiate between the analysis of Highest and Best Use for vacant and improved properties, considering the implications of existing improvements and their removal.
• Master Site Valuation Techniques: Learn and apply various site valuation techniques including sales comparison, allocation, extraction, development, land residual and ground rent capitalization.
• Recognize Legal and Practical Implications: Understand the legal implications of non-conforming uses, excess land, and plottage, and their impact on valuation.

By mastering the content of this chapter, you will gain a critical skill that is fundamental to accurate property valuation and achieving a competitive advantage in the real estate industry, as promised by the course description.

Site Valuation: Highest and Best Use

Chapter 6: Site Valuation: Highest and Best Use

Description: Unlock the secrets of accurate property valuation! This course dives deep into the Sales Comparison Approach and Income Approach, equipping you with the tools to analyze comparable sales, understand income capitalization, and confidently determine property value. Gain a competitive edge in real estate with practical skills and expert knowledge.

I. Introduction to Site Valuation and Highest & Best Use

This chapter focuses on site valuation, a critical component in property appraisal. It builds upon the sales comparison and income approaches introduced in previous chapters, adding the dimension of land value assessment. Crucially, accurate site valuation is predicated on determining the Highest and Best Use (H&BU) of the property. This concept dictates that property value is directly linked to its potential use, assuming a reasonable and probable scenario. The cost approach to value, and the building residual technique of income capitalization, both require a separate estimation of site value. Furthermore, some appraisals require a separate valuation of site and improvements such as appraisals for property tax assessment and condemnation.

II. Highest and Best Use: A Scientific Framework

The highest and best use (H&BU) is defined as:

• Definition: The reasonably probable and legal use of vacant land or an improved property, which is physically possible, appropriately supported, financially feasible, and that results in the highest value.
• Importance: The H&BU acts as the cornerstone for all subsequent valuation analyses. Misidentification leads to flawed data selection and ultimately, an inaccurate value opinion. It directly influences:
  • Data Selection: Guides the appraiser to collect pertinent market data like sales comps, construction costs, and income data that is relevant to the specific highest and best use.
  • Valuation Approach: It influences which valuation approach (sales comparison, cost, or income) is most applicable and relevant to the subject property.
  • Comparable Selection: H&BU is used to determine the most similar properties to use for comparison. Properties with differing H&BU will not be similar.

A. Four Tests of Highest and Best Use

These tests must be applied sequentially to determine the H&BU:

1. Legally Permissible: The use must conform to all applicable laws and regulations: zoning ordinances, building codes, environmental regulations (e.g., wetlands restrictions), historical preservation guidelines, and private restrictions (e.g., easements, deed restrictions, homeowner association rules).
   • Example: A lot zoned exclusively for single-family residential use cannot be considered for a high-rise apartment complex.
   • Scientific Principle: Compliance with the regulatory framework is a constraint on maximizing utility, a core concept in economics.
2. Physically Possible: The site must be physically capable of supporting the proposed use. Consider:
   • Size & Shape: Is the site large enough and appropriately shaped for the intended development?
   • Topography: Is the slope suitable? Are there excessive grading or remediation requirements?
   • Soil Conditions: Can the soil support the foundation? Are there environmental hazards present (e.g., brownfields)? Geo-technical report is crucial here.
   • Access: Is there adequate access to utilities (water, sewer, electricity, gas) and transportation?
   • Example: A steep, rocky hillside may not be physically suitable for a large-scale manufacturing plant.
   • Scientific Principle: Principles of engineering and geosciences dictate the feasibility of construction based on physical site characteristics.
3. Financially Feasible: The use must generate sufficient revenue to cover all costs of development and operation, providing a reasonable rate of return to the investor.
   • Considerations:
     • Construction Costs: Materials, labor, permits, and other development expenses.
     • Operating Expenses: Property taxes, insurance, maintenance, utilities, management fees.
     • Market Demand: Is there sufficient demand to justify the development (absorption rates, occupancy levels of similar properties)?
     • Market Rents/Sale Prices: At what price can the units/spaces be rented or sold?
     • Capitalization Rates/Discount Rates: What is the appropriate rate for this type of investment, accounting for risk?
   • Mathematical Modeling: A pro forma analysis (projected income and expenses) is used to test financial feasibility.
     • Net Operating Income (NOI) = Gross Potential Income - Vacancy & Collection Losses - Operating Expenses
     • Present Value (PV) = CF1/(1+r) + CF2/(1+r)^2 + ... + CFn/(1+r)^n + RV/(1+r)^n
       • Where: CF = Cash Flow, r = Discount Rate, n = Time Period, RV = Reversion Value (sale price at the end of the holding period)
   • Example: While a luxury condominium might be legally permissible and physically possible, if market rents and sale prices cannot support the high construction costs, it is not financially feasible.
   • Scientific Principle: Economic principles of supply, demand, and investment analysis determine whether a use is economically viable.
4. Maximally Productive: Of all the financially feasible uses, the one that generates the highest net return and therefore, the highest present value is the H&BU. This use maximizes the landowner's utility.
   • Mathematical Comparison: Compare the present values of different uses to determine the maximally productive alternative.
   • Example: Two financially feasible uses are a garden apartment complex or an office building. Calculate the present value of each to determine the use that generates the highest present value. This will be the highest and best use.
   • Scientific Principle: Principles of finance and investment determine which of the financially feasible uses will give the highest return.

B. Principle of Anticipation:

This principle underlies the H&BU analysis. The value of a property is based on the future benefits it is expected to provide, not just its current income or use. Appraisers consider potential changes in zoning, market trends, and development opportunities.

C. Interim Use:

An interim use is a temporary use of a property while it awaits its ultimate H&BU. This use should generate some income, but not preclude future development. Example: A parking lot on a site slated for a future office tower development.

III. Vacant Land vs. Improved Property: Identifying the True H&BU

Distinguishing between the H&BU of land as if vacant and as improved is essential.

• H&BU as if Vacant: Assumes the property is vacant and ready for development. What is the most profitable use in this scenario, considering legal, physical, and financial constraints? This provides an indication of the underlying land value.
• H&BU as Improved: Considers the current improvements on the property. Does the current use represent the H&BU, or would a different use (perhaps requiring demolition or renovation) generate higher value?
  • Key Calculation:
    • Value (New Use) - Demolition/Renovation Costs > Value (Current Use) ?
    • If YES, the new use is likely the true H&BU.
    • If NO, the current use is likely the true H&BU.
• Legal Non-conforming Use: An existing use that no longer conforms to current zoning regulations but is allowed to continue. It may be the H&BU as improved, but likely not the H&BU as if vacant.
• Consistent Use Principle: When valuing land and improvements separately, they must be valued for the same H&BU.

A. Special Considerations

• Excess Land: Land that is not needed to support the H&BU of the existing or proposed improvements and that has its own, independent H&BU. This land should be valued separately.
• Surplus Land: Land that is not needed to support the existing or proposed improvements, but cannot be sold off separately from the primary improvements. Should not be valued separately from the existing use.
• Plottage: The increase in value that results from assembling multiple parcels of land into a larger site, allowing for a more intensive or profitable use.

B. H&BU in Residential Appraisals (Specific to Course Description)

While a detailed H&BU analysis is always required, residential appraisals often assume the current use is the H&BU if:

1. The value of the property as improved exceeds the value of the site as if vacant (considering demolition/renovation costs).
2. Sufficient comparable sales data exists to demonstrate that the existing improvements are typical for the area, as demonstrated with Sales Comparison Approach.

IV. Site Valuation Methods: Bridging Theory with Practice

Following H&BU determination, these methods are used to estimate land/site value:

A. Sales Comparison Method (Most Important)

• Principle: The value of the subject site is directly related to the sale prices of comparable vacant sites.

  • Subject Value = Comparable Sales Price +/- Adjustments

• Data Requirements:

  • Verified sales prices of comparable vacant land parcels.
  • Detailed information on each comparable:
    • Location: Neighborhood characteristics, proximity to amenities, environmental influences.
    • Physical Characteristics: Size, shape, topography, soil conditions, access to utilities.
    • Zoning & Legal Restrictions: Permitted uses, density restrictions, setbacks, easements.
    • Date of Sale: To account for market conditions changes.
    • Terms of Sale: Financing, special conditions, motivations of buyer/seller.

• Adjustments: The sales prices of comparables are adjusted to reflect differences from the subject property. Adjustments can be expressed as dollar amounts or percentages. The appraisal process requires the proper use of bracketing.

• Experiment: Conduct a sensitivity analysis by varying the adjustment amounts to observe how the estimated value range changes. This helps quantify the uncertainty in the valuation.
• Elements of Comparison:
  1. Real Property Rights Conveyed
  2. Financing Terms
  3. Conditions of Sale
  4. Expenditures Immediately After Sale
  5. Market Conditions Adjustment
  6. Location Adjustments
  7. Physical Characteristics
  8. Economic Characteristics

B. Allocation Method

• Principle: Assumes a typical ratio between land value and total property value for similar properties.
• Data Requirements:
  • Estimated market value of the improved subject property (using sales comparison or income approach).
  • Typical land-to-total value ratios for similar properties in the market area. Data should be current.
  • Allocation Ratio = Land Value / Total Property Value
  • Site Value (Allocation) = Total Property Value x Allocation Ratio
• Limitations: Less precise than sales comparison; relies on broad averages that may not reflect specific property characteristics.

C. Extraction Method

• Principle: Derives land value by subtracting the depreciated cost of improvements from the total property value.

  • Site Value (Extraction) = Total Property Value - Depreciated Cost of Improvements
  • Data Requirements:
  • Estimated market value of the improved comparable property.
  • Detailed cost data for the improvements (materials, labor, overhead).
  • Estimate of accrued depreciation (physical deterioration, functional obsolescence, external obsolescence) on the improvements.
  • Formulas:
  • Depreciation = (Effective Age / Total Economic Life) x Replacement Cost New
  • Experiment: Quantify the impact on value by changing depreciation rates and methods.

D. Development Method (Subdivision Analysis)

• Principle: Estimates the value of raw land by subtracting development costs and entrepreneurial incentive from the projected sales revenue of finished lots/units. It utilizes DISCOUNTED CASH FLOW (DCF) techniques.
• Data Requirements:
  • Highest and best use of the land (e.g., single-family subdivision, commercial development).
  • Detailed development plan (number of lots/units, layout, infrastructure).
  • Projected sales prices for finished lots/units.
  • Detailed breakdown of development costs (construction, infrastructure, marketing, legal, administrative).
  • Absorption rate (how quickly the lots/units will be sold).
  • Discount rate (reflecting the risk and time value of money).
• Steps for Development Value
  • Find out what the property could be sold for if improved (Hypothetical Sales Price)
  • Estimate all costs of construction.
    • Materials
    • Labor
    • Permits
    • Overhead
    • Contingency
    • Marketing
    • Finance Costs
  • Subtract all costs from improved sales price.
  • Profit and Overhead (Entrepreneurial Incentive)- (Total Project Cost x Desired Profit Level-usually stated in percentage terms)
  • The profit should be subtracted to get a true value of the site.
• Application: This method is best suited for large, undeveloped parcels with potential for subdivision or major development.

E. Land Residual Method

• Principle: Attributable income can be earned from both land and buildings. The Land Residual Method calculates what the land contributes. A form of income capitalization, valuing the land by isolating the net operating income (NOI) attributable to the land.
• Formulas
  • NOI= EGI- Operating Expenses
  • Land Charge= Land Value x Market Rate of Return
  • Building Charge= Building Value x Market Rate of Return
  • NOI – Building Charge = Land Income
  • Site Value = Land Income/ Cap Rate
• Data Requirements:
  • Estimated net operating income (NOI) of the improved property.
  • Value of the improvements (estimated using the cost approach).
  • Market capitalization rates for similar properties (land and improvements).

F. Ground Rent Capitalization

• Principle: Capitalizes the ground rent income generated by a land lease to derive land value. In a Ground Lease, the tenant leases the land, and constructs a building on the site.
• Data Requirements
  • Market ground rent capitalization rate
  • Annual income stream from ground rent
• Formula
  • Site Value = Annual income stream from Ground Rent / Ground Rent Capitalization Rate
• Application- Works best when ground leases are common in the area.

G. Depth Tables

• A depth table estimates the loss in value due to a reduction in the depth of a lot. These are not to be given full weight due to not accounting for other uses.

V. Conclusion: Mastering Site Valuation and Highest and Best Use for Confident Property Valuation

This chapter provided a robust framework for accurate site valuation, emphasizing the paramount importance of the highest and best use analysis. Successfully determining the H&BU and applying an appropriate site valuation method empowers appraisers to perform confident and accurate property valuations. By integrating these skills with the sales comparison and income approaches discussed in other chapters, course participants gain a competitive edge in the dynamic real estate market.

OK, here is a detailed scientific summary in English for the chapter "Site Valuation: Highest and Best Use" from the training course "Mastering Property Valuation: The Sales Comparison & Income Approaches," based on the provided book content. The summary will cover the main scientific points, conclusions, and implications of the topic, and relate to the course description and book content.

Summary: Site Valuation and Highest & Best Use in Property Valuation

This chapter from "Mastering Property Valuation: The Sales Comparison & Income Approaches" focuses on the crucial concept of site valuation within the framework of determining the highest and best use (HBU) of a property, a foundational step in accurate property valuation, as described in the COURSE DESCRIPTION. The chapter directly addresses unlocking the secrets of property valuation. As mentioned in the BOOK CONTENT, determining the HBU is not just an academic exercise; it's a practical necessity when employing valuation techniques like the cost approach and building residual income capitalization (as discussed in later chapters). Furthermore, legal requirements in property tax assessment and condemnation proceedings, as stated in the BOOK CONTENT, underscore the real-world significance of separate and accurate site valuation.
The chapter builds on the preliminary data analysis and collection discussed in earlier sections, which are also covered in the BOOK CONTENT. It positions site valuation as a necessary precursor to applying the three standard approaches to value (sales comparison, cost, and income), reinforcing the course's emphasis on mastering these approaches. After an HBU determination for a site has been completed, then the book material refers to the three approaches to value, which are covered in later chapters. The accurate reconciliation of these approaches also helps the appraisers come up with the most appropriate method to determine the final estimate of value.
Main Scientific Points and Conclusions:

• Definition of Highest and Best Use: HBU is defined as the "reasonable and probable use" of a property that results in the highest present value as of the appraisal date. This definition emphasizes a forward-looking perspective (probability, anticipation of future benefits) and economic rationality (highest value).
• Four Tests of HBU: The chapter establishes the scientifically rigorous framework for HBU analysis by outlining the four interdependent tests:
  • Legally Permissible: The use must comply with all applicable laws, regulations, and private restrictions (zoning, environmental regulations, deed restrictions, etc.). This acknowledges the significant impact of the legal/regulatory environment on land use and value.
  • Physically Possible: The use must be physically feasible, considering the site's size, shape, topography, soil conditions, and availability of utilities. This test incorporates geological and engineering considerations into the valuation process.
  • Economically Feasible: The use must generate sufficient income or utility to justify the costs of development and operation. This test introduces economic principles (supply and demand, market analysis) into the HBU analysis.
  • Maximally Productive: Of all legally permissible, physically possible, and economically feasible uses, the HBU is the one that yields the highest present value (greatest return or amenity). This criterion is the ultimate arbiter in the HBU decision.
• Vacant vs. Improved Land: A clear distinction is made between determining the HBU of land as if vacant and as improved. This distinction is crucial for identifying properties that are underutilized or where existing improvements detract from the site's potential value. This introduces a dynamic element to property valuation.
• Interim Use & Non-Conforming Use: An existing property can be used differently now then it will be in the future. If the highest and best use for the property is reasonably expected to be a different use in the future, then the use of the property between now and that time is an interim use. If an existing property is different than what is generally allowed in that zoning district, but was constructed legally prior to any zoning laws, or was subsequently granted and exception from the planning department of a city, than that property has a legal non-conforming use.

Implications for Property Valuation:

• Foundation for All Approaches: The chapter emphasizes that accurate HBU analysis is a sine qua non (essential condition) for applying all three traditional valuation approaches: Sales Comparison, Cost, and Income. Misidentification of HBU can lead to flawed data selection, inappropriate adjustments, and ultimately, inaccurate value estimates, undermining the course's objective of mastering accurate valuation.
• Data Selection and Comparables: Correctly determining HBU dictates the type of data that is most relevant. This point directly supports the course's emphasis on analyzing comparable sales. An HBU focused on commercial development would necessitate a different set of comparables than an HBU focused on single-family residential use.
• Land Value Estimation: The HBU analysis influences the selection of appropriate land valuation techniques (Sales Comparison, Allocation, Extraction, Development, Land Residual, Ground Rent Capitalization). As described in the COURSE DESCRIPTION, the techniques are critical for obtaining data for certain valuation purposes.
• Market Adaptability: The concepts of interim use and plottage, explained in the BOOK CONTENT, highlight the need for appraisers to remain abreast of market dynamics and anticipate potential shifts in property values based on changing conditions or development opportunities.

In conclusion, this chapter, as indicated in the BOOK CONTENT, provides a critical framework for understanding and applying the concept of HBU in property valuation. It links theoretical principles with practical application, equipping students with the knowledge base necessary to accurately assess the highest and best use of a site. This will help unlock the secrets of property valuation that the COURSE DESCRIPTION mentions. Mastery of this concept is vital for success in applying the Sales Comparison and Income Approaches, and for developing sound opinions of property value.