Please! Not Another Highest and Best Use Question?!

QUESTION: When it comes to the highest and best use of an existing single-family residence, how do I go about supporting my conclusion that it is financially feasible? It’s already built, so what difference does it make about the feasibility of its construction as if new!? Is not highest and best use a jaywalking-thing when state appraisal boards should be going after bank robbers!? This all seems silly to me!

You are right! It is silly to worry about the financial feasibility of new house when the subject improvements are already up and seasoned. And the reason such an analysis is silly is because, in the context of USPAP SR1-3, or financially feasible in the context of highest and best use in the 15th ed of The Appraisal of Real Estate, that is not what financial feasibility means in the context of an already-existing house.

Since the house (and other vertical and horizontal improvements) already exist, financial feasibility of construction is not the issue. It cannot be since the house has already been built. Therefore, by elimination, the only aspect of value to which it can refer is the use(s) to which the current improvements can be put. That could mean doing nothing. It could mean repairs, replacements, and fixing deferred maintenance. It could mean letting contractors go all Chip and Joanna on it. Or, it could mean razing the current improvements, and then developing the now-vacant site to its highest and best use. These are the reasons we appraisers analyze highest and best use – to listen to what the market tells us will bring the highest value!

To analyze the improvements’ highest and best use as improved, (step 1) assume someone were to purchase the property for more-or-less what you the appraiser think it is worth. Then, (step 2) add to this whatever it would cost to raze the house including the horizontal and vertical improvements (i.e., take the property back to the vacant site). Next, (step 3) recreate the house on paper (i.e., the cost approach). However, this will not be the house that was just torn down. Rather, it will be whatever costs are involved (including an entrepreneurial profit or incentive) to improve the site to its highest and best use, i.e., to improve the vacant site with the ideal improvements. Now the appraiser (step 4) totals these costs.

If the total of the four steps is greater than the value in step one, then it is financially infeasible to tear the house down and start all over again (and chances are, yes, the total of (4) will be higher than (1)). Alternatively, to put this in a positive context, if the total value of the property in it’s as-is state (less demolition costs) is greater than the value of the site as if vacant, etc., then the improvements add value to the site, thus are the highest and best use of the site as improved. (Note that this protocol requires the appraiser to value the subject site as a separate step in that protocol.)

So, when the 1004 form asks if the present improvements are the site’s highest and best use as improved, it assumes the appraiser has gone through the analytical steps (1) thru (4) (above) to answer the question, that those analyses are in the workfile, and that they are reproducible. Note that to indicate the present improvements are indeed the site’s highest and best use as improved, yet the above analyses are not in the appraiser’s workfile then since, by that positive statement of fact, the appraiser implied they went thru those analyses, but then they really did not, that is misleading the client, a serious violation of USPAP 2-1(b), thus a serious violation of the ETHICS RULE, thus a serious violation of the COMPETENCY RULE, as well as a serious violation of the RECORD KEEPING RULE.

Such a positive statement is also a violation of SR2-3, the Certification Standard Rule. In it, an appraiser certifies that “…each statement of fact in this report is true and correct.” To certify the appraiser went through the highest and best use analyses necessary to make the above statement, when, indeed, that is not true, is to certify to a lie via that positive, but untrue, statement.

To certify a lie about highest and best use also calls into question the validity of the comparable sales. The reason for this is the definition itself of a comparable sale. Unfortunately, there is not such a definition in current appraisal literature. However, according to all sorts of sources, a sale is not a comparable sale unless the appraiser can support out of the market it has the same highest and best use as the subject. Therefore, to use 1234 Oak Street as a comparable implies the appraiser has done its highest and best use analyses to support the statement of fact it is comparable to the subject. To use 1234 Oak Street as a comparable is a statement of fact. That fact is that the appraiser supports the conclusion to use it as a comparable sale via demonstration of its highest and best use analysis in the workfile. That statement of fact is that it is truly a comparable sale and that the appraiser has verified it as such as per SR1-4.

To certify to a fact, when it is not demonstrably both true and correct, is a violation of the ETHICS RULE, specifically the part that that avows “…[a]n appraiser must not use of communicate a report or assignment results known by the appraiser to be misleading….” To certify something, yet to know it is not true and correct, then that statement is misleading, thus the report containing it is misleading, too.

The take-away here is that a property’s highest and best use may seem obvious (and likely is). But the issue is that when the appraiser says “…the subject’s highest and best use is its present use…,” but there are no analyses to support that statement, the report has misled the client. Really, is that what an appraiser wants to do? By making sure the proper analyses are in the workfile supporting statements of fact (such as the H&BU statement), this inclusion helps to guarantee the state has no reason to doubt the appraisal’s conclusions as well as the appraiser’s professionalism and integrity. This also helps to guarantee that clients get better service from the appraiser than they can get from an AVM or an evaluation.

When clients know they will get better service, more credible service, and more reliable service from an appraiser than from some printout, they will call us appraisers first and they will call us more often. That is what we want, right?

Now, about the whole jaywalking/bank robbery thing: Yes, an improper highest and best use analysis or summary in your appraisal report is, in and of itself, probably not going to bend a state appraisal board all out of shape. Yes, it is a jaywalking-style issue. However, the problem before a state board is rarely that a poor highest and best use analysis or summary is the only problem with an appraisal or report. Typically, a poor highest and best use analysis or summary is but one of many problems there is with that appraisal and report.

And just so we all will know, issues of highest and best use are one of the central areas for which states bring charges against appraisers. Here is a question to answer: “How is it possible to state the H&BU of a site as if vacant is to build the house that’s on the site, when the value indication via the Cost approach comes in higher than the value indication via the Sales Comparison approach?” Here is another one. Why do almost all SFR appraisal reports with a cost approach fail to include an entrepreneurial incentive or profit? Please do not say that is built into the cost figures, because it is NOT. Only the market can bestow such a reward. It is not a fixed cost of construction. But frankly, that is the subject of another essay.