When buying real estate, investors look for what is feasible to achieve maximum use and legal permissibility for their money. To do this, they must undertake a market analysis to determine the highest and best use of a property. The question is, “How do you determine the highest and best use of a property?”
When should you determine highest and best use of a property?
Highest and best use is a term used in accounting and finance. Determining this value is vital for analysing and assessing the value of a property.
Determining the highest and best use of a property is a critical decision. Both accountants and investors must seriously consider it. It helps them know whether it’s essential for investors to invest in more improvements or sell the real estate to help them understand which option will provide the best financial future.
When do you know if a commercial property is the best one for you?
There are several factors to consider: location, amenities, zoning, and more. Consider these questions to help you figure out which commercial properties will be the best for your needs:
What is the process for determining the highest and best use?
The process for determining this value may differ for various reasons.
Different owners may have different plans for the property. Some people want to rent it for a while, while others want to run their business from the property. The usage of commercial real estate might differ according to what its owner intends for it. Consulting a specialised commercial real estate agent before deciding on a plan is advised.
When considering the potential of a property, some of the most important considerations are its long-term tenant value, short-term tenant value, marketability, development potential, zoning considerations, and tax consequences. The higher the long-term or short-term tenant value for a property, the higher its marketability. The more desirable a property is for development, the more its marketability increases. Zoning restrictions can either increase or decrease a property’s appeal and value.
Depending on your state and country, most contracts of sale have zoning certificates. They usually outline what is allowed, what is permissible under certain conditions and what is prohibited on the property. Most councils can provide them for a fee.
When going through the zoning certificates, you should ensure they are the most current, as they are changed regularly. I would also recommend that my clients go through the local and state planning websites to find out if new zoning changes are proposed for the area.
Another recommendation is to speak to the local planning officer(s) on the individual property. Sometimes, you may be able to get pre-development approval.
What purpose should my commercial property serve?
It is essential to find the one that will provide the most economic benefit without considering how it could be used differently. This process provides the most significant economic return without considering a financial return.
Questions should be answered before spending money on your commercial investment property. Items can be considered a test of the highest and best use. They include the following items:
Is a re-development proposal physically possible?
The first test is to get an overall view, verifying that the potential user must be physically able to undertake the task.
Do the soil type, physical conditions, topography and other characteristics, shape and land size, weather conditions, and other factors allow for development or re-development? What are the best possible uses, qualities, and features of the site or property?
Regular natural disasters have also meant changes to building laws. Even though the development will be consistent in the area, there may be certain new conditions.
Here are a few examples that I have encountered with my clients:
There could be new setbacks if the development is near bushland and bushfire-prone.
There may be particular and more expensive building requirements if a property is declared to be in a flood-prone area.
Underground parking development and underpinning costs could be much more expensive, depending on the type of soil.
There may be contamination in the soil from previous uses, requiring an expensive decontamination process.
Can you afford to develop the property? Would the use be financially feasible?
Construction and improvement costs can escalate well beyond your initial estimate. Do you have the funds to afford the construction cost for the land of improved design to achieve this?
You would need to undertake market analysis to generate cash flow projections. You would also need to analyse the commercial property to determine whether it is financially feasible. If the real estate meets these conditions, you will be prepared to move on to the next stage.
One way that many of my clients have worked around this is to try to do presales if they are planning to develop and subdivide to individual business operators or investors. If they plan to lease the property, they can also try pre-leasing.
Getting this pre-commitment before the development is started increases the likelihood of satisfying the bank’s project loan requirements.
I have had clients looking at purchasing a property for development and buying time for resales before purchasing by negotiating an option to buy the property. This is usually around 2-3 years but can be any length, giving the developer the time to carry out more detailed feasibility, draw up plans, and do resales.
The incentive for the vendor is that the option fee is non-refundable and is usually 1-2% of the purchase price paid when the agreement is signed. To encourage the vendor to accept an option agreement, the negotiated price can often be slightly higher than the market price. Sometimes, the vendor can arrange to be given a part (unit) of the finished property when it is fully completed. So, it can be a win-win situation for both the vendor and the property buyer.
Is it a legal commercial investment project?
The commercial investment market has seen many changes over the past few years, and generating a return on your investments is becoming much more challenging.
When buying a property or making plans to develop your vacant land, there are many things you must consider, including the legalities of the use of that land. For instance, does the zoning allow for it? Have you checked with the City Council or the planning department about any necessary approvals? Does the property have the appropriate size, shape, topography, and physical features? Specifically, are you legally permitted to do it?
What are the risks of undertaking this construction project?
Construction projects are risky because there is a lot that can go wrong. There could be an accident, or completion may be delayed. The most challenging part of the construction is the design phase, which includes ensuring the plans are accurate and current.
Designers need to ensure they have all the information necessary to draw up plans for a project to avoid mistakes in their designs. This includes knowing what materials to use, how much each material will cost, and understanding how long it will take for each step in the process.
I have seen developers go for the cheapest possible options in terms of materials and finishes in their developments. In some ways, this may seem like the best option. Unfortunately, it has worked against them in plenty of situations.
One of the questions I ask clients is about developing a commercial property for the highest and best use, especially a property with increased usage, such as a hotel, resort, or accommodation development. I ask them whether they intend to keep it long-term. In most cases, they reply that they would like to keep it long-term only to end up, in most cases, taking the profits or selling from growing debt within a short period.
The problem is that even though the property still presents fairly well with cheaper materials, it soon shows its age, and buyers see this quickly. They know that repairing these building shortcuts can be very costly. As such, they factor this into their offer to buy the property.
My suggestion has always been to ensure that the construction and materials used are congruent with the use of the property. More importantly, it is easy and cheaper to maintain; otherwise, it can affect your returning cap rate and eventual selling price.
Are there any other risks involved with this project?
Have your feasibility studies shown that the building improvement will have a positive return on investment? Does your market research show that demand for this type of project is increasing?
Will the value of commercial investment property be higher if you undertake the redevelopment?
There are many reasons why a property’s value may increase after a re-development.
Firstly, the new property is likely to be more appealing to buyers because they will see what is on offer and make comparisons.
Secondly, it might have been poorly maintained in the past and will look better with some work done.
Thirdly, if the area is in high demand, there may be more potential for rental income.
Have you spoken to any specialised commercial real estate agents in the area for a real estate appraisal?
Have you discussed any recent sales or leases that have confirmed good demand for your proposed project? Would the project result be improved for the more significant market?
Would the intended new use of the property achieve maximum productivity?
In this stage, the property investor or developer must rate every proposed improvement on its ability to generate the highest net return. Then, this is compared to the risk. How does the risk-return factor for a proposal compare to that of another? Is it worth taking the risk with the best possible return scenario?
Have you thought about the possible highest and best uses for your commercial property?
Land is becoming more scarce. The commercial property industry is changing all the time. With these changes come new and profitable opportunities for property investors like you.
It may be worth considering your property’s possible medium- and long-term options. Whether it can be converted from residential to commercial use or if the current commercial property use could be opened to more lucrative opportunities for you
We may be able to help you. Contact Con Tastzids at CST Properties at 02 9882 2221 for a confidential, no-obligation, free chat to discuss your options.
Written by Con Tastzidis
Con is Managing Director of multi award-winning Commercial Real Estate brokerage and consulting company CST Properties since 2001.
With over 40 years of hands-on experience, Con Tastzidis has etched an indelible mark in the Hotel, Tourism and leisure commercial property and business sectors. Having engaged with national and international hotel and property companies/owners, Con possesses a profound understanding of the intricate dynamics that drive success in this arena.
Con is the author of several books, including Amazon top-selling book “Real Estate Investing For The Residential Investor-The- The 7 Myths of Commercial Real Estate Explained”. In this book, Con outlines many of the successful outcomes he has achieved in both good and adverse economic conditions for his clients. More importantly, how working with Con can work for you. Con has been featured in several national and international media outlets, including FOX, CBS, NBC, ABC, CNN, and BLOOMBERG.
If you would want to work with Con, he can be contacted through this link Feel free to contact Con Tastzidis at CST Properties.