Highest
& Best Use Analysis
There is a lot of emotion inherent in the
objections being voiced over the Port of
Los Angeles / BNSF Southern California Intermodal Gateway Project (SCIG). In an effort to reduce or eliminate some of
that emotion so that emphasis can be placed on facts, I am providing definitions
and basic procedures followed in highest and best use analysis of land. Whether you support or oppose this project
already, these are the considerations that Port and Railroad planners had to
look at when trying to search for the best place to put this project. That the project is necessary someplace appears to be beyond dispute. Proponents of the project cite the need for
expansion of port capabilities to remain competitive with the rest of the
country’s ports. Even the inventor(s) of
the so called zero emissions technology touted by project opponents acknowledge
the need for port expansion of capability.
The only real argument appears to be the how and where aspects of the needed expansion. I’ve addressed the ‘how’ portion elsewhere,
demonstrating that while highly desirable, zero emissions technology in the
form of MagLev™, LIM or LSM is simply not commercially available or viable for
heavy freight movement in the Ports of Los Angeles and Long Beach. It is my intent that the following addresses
the reasons behind the ‘where’ question, ad helps readers to understand why the
selected location really is the only viable location.
The following article, beyond the
introductory comments, consists of a near verbatim quote from Chapter 12 of The Appraisal of Real Estate, 13th
Edition, published by The Appraisal
Institute. There are this authors comments interspersed (and identified)
throughout. The value of noted
publication cannot be understated. It is
this publication that is often referred to in the industry as the Appraiser’s Bible. In any event, it is generally acknowledged
among appraisal professionals as the final authority or guide, on appraisal
issues and concepts. For these reasons,
it was considered more appropriate to quote this authoritative and primarily
educational work, than to paraphrase the concepts and procedures described within it.
Where the terms property ‘to be appraised’ or
‘subject property’ appear in the quoted text, it is often easier to follow if
you simply mentally translate it as ‘the property’ (any property). Where “appraiser” is used, think of any
person performing or critiquing highest and best use analyses.
Many years ago (early 1970’s) when I first
entered the real estate field, the concept of highest and best use of real
estate included a consideration of socio-economic benefits. Over the years that aspect or consideration
was eliminated from virtually all recognized definitions of highest and best
use. As currently accepted, highest and
best use is considered to be that (those) use(s) that are:
Legally Permissible
Physically Possible
Financially Feasible
Maximally Productive
Most communities are bound either by
regulation (including local ordinances; state and or federal laws), or custom,
to insure that the highest and best use is achieved in the development or use of
publicly owned real property. Where it is
not a statutory requirement, it is usually a customary political reality. What public official; elected, appointed, or
salaried, wants to explain to their citizens why property owned by that
jurisdiction is not be put to its highest and best use? In some instances, use or uses that are less
than highest and best use, could be perceived as potential malfeasance, or at
best, incompetence, in the stewardship of public assets. Optimal use of ALL real estate and real
property interests assumes responsible
management.
Highest & Best Use Analysis
“The analysis of relevant data to develop a
market value opinion requires two important steps in the valuation process
before the applicable approaches to value are applied. Market / marketability
analysis begins the process of narrowing the focus from a broader macro view to
data that is especially pertinent to the appraised property. Highest and best use relies on that analysis
to then identify the most profitable, competitive use to which the subject
property can be put. The highest and
best use is shaped by the competitive forces within the market where the
property is located and provides the foundation for a thorough investigation
of the competitive position of the property in the minds of market participants.
An understanding of market behavior developed
through market analysis is essential to the concept of highest as best
use. Market forces create market value,
so the interaction of market forces that identifies the highest and best use is
of crucial importance.
Fundamentals of
Highest and Best Use
Highest and best use may be defined as The reasonably probable and legal use of
vacant land or an improved property that is physically possible, appropriately
supported, and financially feasible and that results in the highest value
The theoretical focus of highest and best use
analysis is on the potential uses of the land as though vacant. In practice, however, the contributory value
of the existing improvements and any possible alteration of those improvements
are also important in determining highest and best use and, by extension, in
developing and opinion of the market value of the property. In the analysis of highest and best use of
land as though vacant, the appraiser seeks the answers to several questions:
·
Should
the land be developed or left vacant?
·
If
left vacant, when would future development be financially feasible?
·
If
developed, what kind of improvement should be built?
In
the analysis of highest and best use of the property as improved, additional
questions must be answered:
·
Should
the existing improvements on the property be maintained in their current state,
should they be altered in some manner to make them more valuable, or should
they be demolished to create a vacant site for a different use?
·
If
renovation or redevelopment is warranted, when should the new improvements be
built?
In general, if the value of a property as
improved is greater than the value of the land as though vacant, the highest
and best use is the use of the property as improved. However, a property’s existing use may
represent an interim use, which begins with the land value for the new highest
and best use and adds the contributory value of the current improvements until
the new highest and best use can be achieved.
In practice, a property owner who is redeveloping a parcel of land may
remove an improvement even when the value of the property as improved exceeds
the value of the vacant land. The costs
of demolition and any remaining improvement value are taken into consideration
in the test of financial feasibility for redevelopment of the land. Likewise, if an improved property has value
but may have greater value if modified in some way, the cost of modifying the
improvements and the value gained in that modification are accounted for in the
determination highest and best use.
The Four Tests
As market / marketability analysis progresses
to highest and best use analysis, appraisers first consider the reasonably
probable uses of a site that can be legally undertaken. In the analysis of pertinent data, four steps
are implicit and are applied in the following order to develop adequate support
for the appraiser’s highest
and best use opinion:
1.
Legally
permissible
2.
Physically
possible
3.
Financially
feasible
4.
Maximally
productive
These criteria are usually considered
sequentially. The tests of physical
possibility and legal permissibility can be applied in either order, but they
must both be applied before the tests of financial feasibility and maximum
productivity. A use may be financially
feasible, but this is irrelevant if it is legally prohibited or physically
impossible.”
M. Ford’s
Comment: This is the area
where most abuse takes place; either by applicants seeking to ‘enhance’ a
specific property’s ‘highest & best use’, or by opponents to specific
developments. In each case the existing
land use regulations are either exceeded by the applicant, or claimed to be
illegally (or unreasonably) excessive by the opponents. On the one hand an applicant seeks to gain
market advantage by acquiring land for one (lower) purpose, and then through
‘special consideration’ (legal or otherwise) getting the allowable zoning or
density increased (raised to a more intensive use). Conversely, an opponent may claim that
although a proposed project use is perfectly legal under an approved General or
Specific Land Use Plan, and zoning, that it is somehow now uniquely necessary
for the governing jurisdiction to ignore its own voter-approved land use
regulations for a limited special interest constituency. This could be a group of homeowners adjacent
to the property that never liked the general or specific plan in the first
place, but lost in the elections to approve it, so they now use every means to
oppose legal, conforming uses of the property; or it could be environmental
groups opposed to either the specific project, or seeking to ‘force’ extra
conditions that are not already statutorily required under the existing lad use
regulations, and lastly it could be a political interest group seeking to promote
themselves by either creating, or riding
the wave of emotional fears associated by a project. Each of these scenarios can be costly to the
governing agency and citizens who invariably get sued by one side or the other.
The whole point of
having an approved general plan, or specific land use plan; zoning, and
development standards, is to avoid this type of scenario by having
categorically approved uses that are permitted in each zone or district. It is truly unfortunate that taxpayer dollars
are wasted by self interest groups that do not want to play by the rules
established by the community at large.
On the ‘positive’ side, it does provide more employment opportunities
for attorneys.
(Quotes from the 13th
edition resume below)
“The six step market analysis
process…provides the data required for the four test criteria…. The initial
analysis of the market and land use regulations (i.e., property productivity)
usually limits the number of property uses to a few reasonably probable
choices. For example, market analysis
may suggest that there is demand for a large office building in a
community. If the subject sites is
surrounded by modern, single unit
residential developments, however, a large multistory office building would
probably not be a reasonably probable use, even if it were legally permitted.
Similarly, a housing development for the elderly might be a permissible use for
a site, but, if most residents of the area are under 40 years old, this us is most likely not reasonably probable and would not be tested
for financial feasibility. Consideration
of whether a use is reasonably probable
should continue throughout the analysis of the highest and best use as more is
learned about the potential use of the property. Reasonable probability is both a tentative
starting point a conclusion for the use or uses that are ultimately deemed
probable. Appraisers constantly evaluate
and reconcile what develops through competent application of the steps in the valuation
process. Many of the considerations and
discoveries that are made through their analyses become important points not
only for the development of their own value conclusions, but also for inclusion
in their reports to clients.
There may be a significant demand for a use
in the market area of the subject property and the subject may be suited for
this use, but a number of other sites may be equally or more appropriate. The appraiser must test the highest and best
use conclusion to ensure that existing and potential competition from other
sites has been fully recognized.
An appraiser must also consider the
competition among the various uses for a specific site. For example, competition for available sites
along a commercials trip development may be intense. Developers of community retail uses, garden
office uses, and fast food franchises may bid against one another for these
sites, and the prices they pay for these sites will reflect this
competition. Market demand is not
infinite. Even though the subject may be physically and locationally suited for
that use, better-located sites may satisfy the market demand completely before
the subject property can realize its development potential.
The same observation may be applied to
central business districts (CBDs). The
market may define the highest and best use of land in the CBD simply as
high-rise development, which often includes a mix of uses such as office,
retail, hotel, and residential apartment or condominium use. At times the highest and best use conclusion
for a CBD does not indicate a specific highest and best use, but rather a class
of uses that is supported by market area trends and reflects a consistent
density of development.
Application of
Highest and Best Use
Highest and best use analysis builds on the
conclusions of market / marketability analysis.
The analysis of land as if vacant focuses on alternative uses, with the
appraiser testing each reasonably probable use for legal permissibility,
physical possibility, financial feasibility, and maximum productivity. In contrast, the appraiser applies the four
tests in the analysis of the property as improved, but the focus is not on
alternative uses but on three possibilities: continuation of the existing use,
modification of the existing use, or demolition and redevelopment of the land.
Highest and Best Use
of Land as though Vacant
Land is generally valued as if vacant. When land is already vacant, the appraiser
values the land as it exists. When land
is not vacant, however, its contribution to the value of property as improved
depends on how it can be put to use.
Therefore, the highest and best use of land as though vacant must be
considered in relation to its existing use and all potential uses. A conclusion of highest and best use of the
land as though vacant is required in nearly all appraisal assignments. However, the level of study will be
significantly greater when a larger proportion of the total property value is
in the land. The level of study will be significantly less when only a small
proportion of the total property value is in the land. Appraisers explain in the appraisal report
why a lower level of study may have been applied so that others can understand
the justifications and the data on which they are based.
Testing the Legal
Permissibility of Land as though Vacant
Private restrictions, zoning, building codes,
historic district controls, and environmental regulations may preclude many
potential uses. The appraiser must also
consider whether there is a reasonable probability that the zoning or other
restrictions could be changed in order for the highest and best use of the
property to be realized.
In applying the test of legal
permissibility, the appraiser determines which uses are permitted by current
zoning, which uses could be permitted if a zoning change were granted, and
which uses are restricted by private restrictions on the site. Private restrictions, deed restrictions, and
long term leases may prohibit certain uses or specify building setbacks,
heights, and types of materials. If deed
restrictions conflict with zoning laws or building codes, the more restrictive
guidelines usually prevail, but this may pose a legal question that the
appraiser cannot answer without assistance with the appropriate legal
expertise. A long term lease may affect
the highest and best use because lease provisions may limit use over the
remaining term of the lease. For
example, if a property is subject to a land lease that has 12 years to run, it
may not be economically feasible for the tenant to construct and move to a new
building with a longer remaining economic life.
In such a case the appraisal report should state that the determination
of highest and best use as leased is influenced by the lease’s impact on
utility over the remaining lease term.
In addition to analyzing zoning and
private restrictions, testing the legal permissibility of a land use also
requires the appraisers to investigate other applicable codes and ordinances,
and environmental regulations.
Building codes can prevent the land
from being developed to what would otherwise be its highest and best use by
imposing burdensome restrictions that increase the cost of construction. For example, the additional cost of a water
retention pond with excess capacity that is required by local ordinance could
impact the size of a proposed community shopping center. Less restrictive codes typically result in
lower development costs, which attract developers. More restrictive codes tend to discourage
development. In some areas, more
restrictive building codes are used to slow new construction and limit
growth. Historical ordinances, such as
historic facade easements, and overlay districts may be so restrictive that
they preclude development.
Concern over the long range effects of
certain land uses sometimes result in increased environmental regulation and
stricter development controls.
Appraisers must be familiar with environmental regulations pertaining to
clean air, clean water, and wetlands, and they should be sensitive to the
public’s reaction to proposed development projects. When resistance from local residents and the
general public occurs, it can pressure public officials to stop or limit
certain real estate developments or change the density or character of a
specific plan.
As with zoning ordinances, if there
are other limitations inherent in other applicable codes, ordinances, and
regulations, the appraiser should investigate whether there is a reasonably
probability of a change relative to the subject property. “
M. Ford’s Comment: In
smaller communities (towns, villages or small cities), where the impact of a
few citizens can influence political careers, it is much easier, and frequent
to stall, or stop undesired projects, regardless of their merit and conformity
to applicable codes. In larger urban cities,
this is less common. Partly because the
influence of relatively smaller voting blocks is reduced, but also because the
impact of individual politicians influence, is watered down. There is the cost of probable lawsuits to
consider as well. Major projects tend to
be very costly and well researched prior to application submissions. Thorough research into underlying general or
specific plans is completed. Zoning and
conformity is considered. Suitability of
a project to the proposed site is considered. Alternate sites (when available)
are considered. Surrounding uses are considered. Environmental considerations
are addressed. Unless the applicant is proposing a use, or uses that have never
been considered for the site (up-zoning), or there are numerous equally
desirable opposing uses from a community standpoint for the land in question,
the applicants usually are proposing reasonable highest and best uses. When Environmental Impact Reports are
required, the door is opened for abuse from either side.
If
compliance costs are deemed excessive or overly burdensome, applicants may downplay
or even misrepresent them or alternatively, overstate the benefits and efficacy
of their proposed mitigation measures.
From the opponents perspective, challenges to specific aspects of an
Environmental Impact Report (EIR) may be made t the governing jurisdiction, or
even through the courts. This gives rise
to a potential for abuse by those completely opposed to projects for no other
reason than “just because.” It (EIR)
also presents opportunities for litigators to chase high fee payoffs under the
guise of ‘public interest’ lawsuits, or via representation of ‘community
interest’ groups. Sometimes these
‘community interest’ groups are created for the sole purpose of intended
litigation. When proposed project costs
can run to hundreds of millions of dollars, even a 1% settlement cost is far
cheaper and more cost effective for applicants than protracted litigation,
coupled with the possibility that a friendly judge, or sympathetic jury could
find partial favor with a complaint, resulting in judgment and ‘compliance
costs’ far greater than 1%. A 5%
settlement would be a windfall! (a $5
million settlement on a half billion dollar project is quite a windfall for the
attorney that takes such a case on contingency.).
“Environmental extortion” is a fact of
life. Legitimate, as well as
pseudo-environmental groups have sprung up all over the country and have
demonstrated their collective willingness to become involved in diverse causes
and projects. In best case scenarios,
they promote preservation of the environment that might otherwise be lost. In
worse case scenarios, the pseudo environmentalists can actually cause more
environmental damage, by forcing abandonment of projects that could otherwise
have resulted in more modern, cleaner use developments than currently
exist. There are negative indirect
consequences as well. Some states are
perceived in the business community as being too difficult to get things
done. In their opinion, it is more cost
effective to move entire operations to more business friendly states. This phenomenon is not limited to
states. Oil pipelines across multiple
states or countries have almost always been challenged, though such projects
present their own unique challenges from the standpoint of highest and best use
of the land under their intended path.
(Quotes from the 13th
edition resume below)
“Testing the Physical
Possibility of Land as though Vacant
The test of physical possibility addresses
the physical characteristics associated with the site that might affect its
highest and best use. The size, shape,
terrain, and accessibility of land and the risk of natural disasters such as
floods or earthquakes affect the uses to which land can be put. The utility of a parcel may also depend on
its frontage and depth. Irregularly
shaped parcels can cost more to develop and, after development, may have less
utility than regularly shaped parcels of the same size.
Ease of access enhances the utility of
a site. For certain property types,
visibility is an important feature. For
other property types, the privacy provided by the lack of a view is a benefit. The capacity and availability of public
utilities are also important considerations.
If a sewer main located in front of a property cannot be tapped because
of a lack of capacity at the sewage disposal plant, the property’s use might be
limited. When topography or subsoil
conditions make development difficult or costly, the lands utility may be adversely
affected. If the cost of grading or
constructing a foundation on the subject site is higher than is typical for
sites in the area competing for the same use, the subject site may be
economically infeasible for the highest and best use that would otherwise be
indicated.”
I have chosen to end the educational
text quotations here. The next steps in
the process are testing the financial feasibility of land as though vacant;
testing the maximum productivity of land as though vacant, and a repeat of the same
essential four steps for improved property.
Financial feasibility considerations are numerous. The bottom line is that if the intended use
does not provide either a market required rate of return, or particular
investor’s required return rate (or alternatively, required utility for owner
users), then that use would not be built.
Maximum productivity relates to being the use that produces the most
return, or highest profit. This concept
is less cut and dry than the other steps.
It often involves a category of use rather than a specific use. The defined concepts noted above are further
discussed in The Appraisal of Real
Estate, 13th Edition, published by The Appraisal Institute, in
Chapter 12, from pages 277~296. I
concluded the above at page 283. The
current cost of the book is $89.00 plus shipping. It may also be available in your local
library.
Southern California
Intermodal Gateway (SCIG), Port of Los Angeles, California
The above information was provided to assist
readers in better understanding of a specific project, proposed for land under
the jurisdictional control of the Port of Los Angeles, adjacent to land under
the control of the City of Long Beach, California.
A railroad (BNSF) has proposed broadening a
section of existing track, for the purpose of building an off dock intermodal
container transshipping terminal. The land is bordered to the North by
Sepulveda Blvd., (a regional East-West connector street). There is an existing ICTF facility located to
the North side of Sepulveda. A freeway runs immediately adjacent to the East
side. There is a large refinery to the
West and a variety of shipping and drayage services to the South (across
Pacific Coast Highway).
The project requirements make it desirable to
have a comparatively long and narrow parcel adjacent to existing railroad
tracks for on and offloading containers directly on to parallel stationed
trucks by overhead cranes. This type of
project is a heavy industrial use due to the railroad trains being stationed
and used on site. It makes use of
already existing railway lines and infrastructure for North and South freight
movement. There are no viable
alternative locations within the Port of Los Angeles itself. It is located in an area zoned for heavy
industrial use. It is buffered from
non-compatible uses on three sides by similar heavy industrial uses. The fourth side boundary is a freeway, with
housing and schools to the East of that.
Existing uses on the site are similar in character, though older, and
more prone to generate pollution than the proposed project due to the lack of
most-modern equipment in use there.
I have lived in, and around the immediate
area of this project for approximately 20 years. I presently live in the potentially affected
Long Beach neighborhood to the East of the proposed project. For fifteen years I lived on a boat inside
the Port of Long Beach, near the border of Los Angeles and Long Beach
Harbors. I am familiar with each
harbor-both on the land side and waterfront.
Satellite imagery, as well as past flights above this area, and the use
of existing aerial photographs give a good sense of what exists throughout the
harbor, and what sites are potentially available for alternative development
sites.
When I consider the highest and best use
criterion noted in the foregoing, I can only opine that there is no other site
that provides similar utility; with as effective use of existing
infrastructure, and similar or lower cost projections. There is also the consideration that much of
the harbor area is built on fill soil, and is more susceptible to liquefaction
in earthquakes. Numerous other issues
with respect to inadequate rail linkage and access exist.
Looking at the proposed site itself, it
appears that the proposed use is one of those rare land use development
occurrences in which the ‘perfect’
highest and best use is being proposed.
The site is long and narrow. Its
access for commercial development is too limited to be viable for most
uses. Its access for industrial
purposes is adequate, though again limited.
There are rail lines on the site.
A grain shipping operation and trucking (drayage) company are located
there now. Either use is legally
permissible, and physically possible.
Though expansion of either use has not been postulated, such expansion
could be financially feasible, though neither seems remotely capable of
providing maximum productivity of the site (profit, to the People of Los
Angeles), or benefit to the People of the United States through use intensity
similar or superior to that which is proposed.
The proposed use of this site, along with a competitor site to the North
(Union Pacific / ICTF) are reported to enable an increase of over two million
TEUs in port handling and shipping of containers per year. Facility cost projections of $400 to $500
million dollars are far beyond the reasonable ability of the existing trucking
company, or grain shipping company to compete with. There
are comparatively few industrial uses that are potentially alternative
candidates for this site.
Refinery expansion would appear to be
physically possible, but would encounter more legal hurdles than the proposed
SCIG project. It is unknown if it could pass
state regulations, let alone broader AQMD, local harbor and adjacent
jurisdiction regulations. The location,
configuration, and demand are inadequate to support distribution warehousing on
the site. It could potentially be used to store and ship spent nuclear fuel to other
countries for reprocessing, but that seems less likely than refinery expansion. It is too small a site for a major
manufacturing facility, even if demand for such a facility existed in this
area.
A railroad container trans-shipment center seems to be
the ideal and optimal use given the shape,
location, and existing infrastructure, including existing rail lines on site.
I can think of NO OTHER USE that would be a
higher and better use than the proposed project on this site. If any readers think they have one, please
feel free to describe it in the comments section- but remember it has to pass
the tests noted above; be financially feasible and result in the greatest
profit / use to the citizens of Los Angeles, as well as surrounding areas.
