Valuation Management Group (VMG) often receives appraisal orders for properties that are located within transitioning markets, where commercial development is sprawling into residential areas. Whether the subject property is land or an existing residential structure, the appraisal concept of HBU determination becomes crucial in this type of valuation.
Highest and best use (HBU) is defined as “the reasonably probable and legal use of vacant land or an improved property that is physically possible, appropriately supported, financially feasible, and that results in the highest value”, by The Dictionary of Real Estate Appraisal. If a vacant site is being valued, the appraisal must address the question of the HBU as vacant. If an improved property is being valued, the appraisal must address the question of the HBU as improved. In order to answer the question of HBU in either scenario, the appraiser must apply the four tests of HBU:
- physical possibility,
- legal permissibility,
- financial feasibility, and
- maximum productivity.
Proper analysis includes performing the test in the order presented here, in a funneling down manner. After applying the first three tests, which remaining use will bring the highest economic return to the property owner? The answer to that question is referred to as the HBU of the property.
In our experience, residential appraisers may not have the resources and data necessary to fully analyze the zoning, land use matters, and relevant commercial sales. Therefore, we generally recommend that a commercial appraiser be engaged for the valuation in order to ensure that all relevant factors are considered during the analysis of HBU for the subject property. While it is typically true that a commercial appraisal will cost somewhat more than a residential appraisal, it is considered to be a wise investment in order to have an appraisal that truly reflects market value and expectations.
Valuation Management Group recently received an appraisal order that was marked as residential by the client. The property was improved with an older house along a highway on the outskirts of a small town. As such, the assignment was given to a residential appraiser. Our reviewer noted during the review of the appraisal, that the subject highway was a busy, four-lane road and aerial photos showed several nearby commercial properties, some of which had been converted from former residential uses. The appraiser stated within the report that the HBU as improved was residential. When the reviewer questioned that statement based upon the indications of a transitioning market and surrounding commercial redevelopment, the appraiser admitted that he thought the HBU was likely for some sort of commercial development. The appraiser further indicated that he did not have the resources and data necessary to adequately complete a full HBU analysis. Subsequently, the assignment was reassigned to a commercial appraiser in order to best serve the client and their borrower/member and achieve the most accurate, sound appraisal.
VMG’s staff works diligently to confirm that appraisal orders are categorized correctly during the initial processing before assignment to an appraiser. However, every property and location is subject to different factors that need to be considered, and sometimes that is not identifiable until the appraiser performs their appraisal inspection of the subject property. To our clients, we urge you to contact us if you ever have questions or concerns about an order that you suspect may have commercial potential. To our appraisers, please always remember to contact us immediately if the subject property is not as described, or you suspect requires a commercial appraiser. Our goal is to make sure the client has a fully supported valuation, performed by an appraiser with the necessary licensing level, and to support our appraiser partners when they discover additional information about the subject property.
Valuation Management Group is a national, full service appraisal management service company that manages the appraisal process, including the required review, for financial institutions, banks, mortgage bankers, and credit unions. We offer the full array of commercial and residential appraisal products and services, taking the appraisal process from ordinary to extraordinary.