Property Analysis, Highest and Best Use, and Market Analysis
Domain 3: Property Analysis, Highest and Best Use, and Market Analysis
This domain tests whether you can analyze a property and its market before choosing a value. Highest and best use is the reasonably probable, legally permissible, physically possible, financially feasible, and maximally productive use that results in the highest present value.
Core rules
- Test uses in order: legally permissible, physically possible, financially feasible, maximally productive. A use that fails any test is eliminated.
- Analyze as vacant and as improved. As improved, the existing use may continue if it produces more value than demolition and redevelopment.
- Market analysis examines demand, supply, absorption, vacancy, rents, expenses, and competitive properties.
- Distinguish market rent from contract rent; use market rent for market value unless a lease controls.
- An interim use is temporary until a higher use becomes feasible.
Worked example
A vacant parcel could support a small office building. Stabilized NOI is estimated at $180,000; the market cap rate is 9.0%, indicating a completed value of $2,000,000. Construction and entrepreneurial profit total $1,650,000. Residual land value = $2,000,000 - $1,650,000 = $350,000. If the parcel's market price were $400,000, the office use would not be financially feasible at these assumptions, so another use must be tested.
Traps
- Skipping the legally permissible test and analyzing a use zoning prohibits.
- Calling the current use the highest and best use without testing alternatives.
- Using contract rent when market rent is required.
- Treating absorption as the same thing as vacancy.
- Ignoring entrepreneurial profit in a residual land calculation.