Best and highest use
Investment and residential real estate meet when I work with buyers who are looking to buy land or a tear-down house so they can reconstruct their choice of single family home. Or, when I work with someone buying a two-family home, either to live in or to rent out (but not to flip for condos.) When the listing agent starts talking about “best and highest use” I know I am about to hear why the inflated price is justified. In my opinion, the price others have paid for properties like this one is still a stronger indicator than some pie-in-the-sky “best and highest use” price.
The “highest and best use” of a property is a financial term. The “highest and best” is price, not necessarily use. Here’s an example: If a lot can hold three ugly condos which sell for $300,000 each, this is a better and higher use than if the lot holds one beautiful single family house worth $700,000.
The condos bring highest and best price, if a number of things fall into place. First, the would-be developer must check zoning to be sure that this lot can legally hold his three ugly condos. That can be checked out ahead of time. Easy. Any developer who doesn’t do his homework on zoning should go back to being a contractor.
It is the second wave of variables that gets most new developers: Will construction costs go up before the project is finished? Will the housing market go down before the project is finished? Will the demand for this kind of condo go down before the project is finished? If you have to hold it or rent it, what will it cost monthly? All of these risks are possible and not entirely predictable. The sale price of the initial land or two-family house purchase needs to hedge these bets.
I know I have a lot of developers reading this. What would you tell the wanna-bes about how much the hedge needs to be to make a project worthwhile? When I have these debates with the listers, they talk about the profit possible, but the do not want to discuss the risk.
Now back to my client’s dilemma. They are not buying to turn it over for a profit. However, they compete with investor-buyers who could make a profit. My clients figure the cost of the land or house acquisition, plus building or repair costs to equal their housing cost, plus time and aggravation. There are fewer variables and somewhat less risk for them.
Have you bought land and built, for yourself or as an investor? Did “highest and best use” have any relation to the market price you paid? Am I wrong to stick to comparable properties as my touch-stone for pricing?
