Price vs. Value and Highest & Best Use
In common usage, price, cost, and value mean essentially the same thing. However, when used for real estate appraisal purposes, each means something different.
Price refers either to the asking price or selling price—the dollar amount that actually was asked or offered for a property, either now or in the past. Price, therefore, represents one person’s individual assessment of value. It is not the broader, more objective, assessment for which appraisers strive.
Cost is either the actual dollar amount paid for a property in the past or the dollar amount needed to build or improve a property at a specific time. Cost may or may not equal the market value of the improvement, depending on market conditions, which may inflate or depress rents, vacancies, or interest rates.
Value traditionally is defined as the power of a good to command other goods or services when exchanged in the marketplace.
Cost, price, and value are rarely equal. However, in some cases, such as new construction representing the highest and best use of a site, cost, price, and value could be equal.
Types of Value
Within the broad definition of value, numerous types of value are given to real property. They include investment, insurable, assessed, liquidation, reproduction or replacement, and market value.
Investment value is the value to a specific investor, based on that investor’s requirements, tax rate, and financing.
Insurable value is the value of portions of a property that are physically destructible. It is used for determining insurance coverage.
Assessed value is the value the tax assessor establishes to levy local real estate taxes.
Liquidation value is the likely price that would result from a forced sale, such as a foreclosure or tax sale. It is used when a sale must occur with limited exposure time to the market or with restrictive sale conditions.
Reproduction value or replacement value is the value of constructing a substitute property, either identical (a reproduction) or substantially the same utility (a replacement).
Market value is generally the value used for loan underwriting purposes. As adopted by the Appraisal Foundation and as published in the Uniform Standards of Professional Appraisal Practice (USPAP), "market value is the most probable price a property would bring in a competitive and open market under all conditions requisite to a fair sale, with the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimuli."
Implicit in this definition is the consummation of a sale on a specified date and passing the title from seller to buyer under conditions whereby:
• Buyer and seller typically are motivated
• Both parties are well informed or well advised and are acting in what they consider their own best interests
• A reasonable time is allowed for exposure in the open market
• Payment is made in cash in U.S. dollars or in terms of comparable financial arrangements
• The price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.
A single property may have any or all of the types of the above values, with no two values necessarily being equal. However, before a property’s value can be determined for appraisal purposes, the property’s highest and best use must be identified.
Highest And Best Use Considerations
Highest and best use (HABU) is the legal use of a property that yields the highest present value (PV). HABU analysis is an attempt to identify a property’s most productive use.
The HABU analysis begins with a discussion of legally permitted uses for the property, primarily considering the zoning ordinance that determines legally permissible uses for the property, as well as any applicable federal laws. Other factors include deed restrictions and adjoining uses.
From the legally permitted uses, physically possible uses are considered. These uses are determined by examining location, access, and physical characteristics of the site, such as size, topography, and layout.
Next, for the uses that are legally permissible and physically possible, financial feasibility is examined. The influence of economic conditions, financing availability, and market demand is examined for each potential use.
Finally, the financially feasible use that produces the highest financial return is the HABU.
In summary, determination of HABU is traditionally a narrowing process, designed to identify the maximally productive use for a property. The HABU must meet four criteria: physically possible, legally possible, financially feasible, and maximally productive.
Improved properties are analyzed for HABU as if both vacant and improved. The analysis of examining an improved property as if it were vacant is designed to identify possible superior uses. The HABU of a property, as improved, examines the improvements for adequacy for intended use and obsolescence. Potential modifications to the improvements that could increase financial return then are explored.
Sometimes, mostly on older structures, the current use contradicts with the zoning and legally permitted use requirements set forth on the property. This usually occurs when the local planning board changes the zoning and use for an area, after the property has been developed, causing the property to be contradictory to current uses. In this case, determining if the property has a "grandfathered use" exception, and if there is a distinct benefit or detriment to the property, will be necessary to determine the proper HABU and how to structure the appraisal report.
In closing, in Part's 1 & 2 we have discussed the necessary procedures that need to occur BEFORE an appraiser can even start the research and analysis of a specific property to have a credible appraisal assignment. We have discussed that the Scope Of Work is necessary to determine the "Who, What, Where, When, Why, and How" the report will be used, we have determined which Report Type is necessary for the client and intended users, we have determined what Type Of Value is needed, and we have determined the property's Highest And Best Use... Now, and only after all of these initial processes are complete, can the appraiser start the process of determining how to develop the appraisal.
Stay tuned for Part 3, where we will be discussing "The Three Approaches To Value"