Many real property owners don’t realize that estimating the market value of their property is really a complex and technical process – which needs the expertise of the appraiser (or broker – in the case of a Comparative market Approach) – thoroughly familiar with the local market.
In the Philippines, we have adopted the International Valuation Standards Council Valuation Standards (IVSC) and called it the Philippine Valuation Standards (PVS) 1st Edition (Adopting the IVSC Valuation Standards under the Philippine Setting).
Before a real property is valuated, it is necessary that the Highest and Best Use (HABU) of the real property is determined. Of course, the highest value of a property would be if it is used at its highest and best use.One example of this is of a property located in a commercial area that is still continually used as a residence by the owners – despite the obvious commercial possibilities of the said property.
Naturally, and by definition, the highest value of the property could only be determined at its HABU. It’s really just a process of elimination. To determine the HABU, a property is subjected to a series of tests.
1. Is the proposed use legally allowable? – Is it allowed by Zoning laws? It may be nice to put up a profitable small fabrication business or a funeral parlor in that lot of yours, but if its a residential area then it is against the law (in many countries).
By the way an exception may be are those structures that predates the zoning laws which are called legally nonconforming.
2. The proposed use should be physically possible! “Any potential use must be physically possible given the size, shape, topography, and other characteristics of the site. For example a 40,000-square-foot (3,700 m2) single story warehouse would not fit on a 10,000-square-foot (930 m2) site; therefore, that use would fail the physical possibility test.” (Source: Wikepedia).
3. Is it financial feasible? In other words, the proposed property use must generate enough income to justify the cost of the construction plus the profit of the developer. For vacant land the HABU is determined as vacant.
For improved sites however, the HABU is determined in two ways: as vacant, and as improved. This is because in some situations, the real estate has more productive use as vacant, than as improved (“improved” meaning it has already some structure, and the land is already developed for construction purposes).
4. Finally, the proposed use is tested whether it is maximally productive. It must be that use that generates the highest net return to the developer.
The real property’s HABU is determined by generating several use options. These are each subjected to the first three tests, and eliminated accordingly. The remaining few survivors are then compared to each other to determine the one with the highest net return or revenue.
That would be the HABU of the property – from which we could determine the Market Value of the property.
But wait! What will be the selling price we would recommend for the owner to sell his property, or for a buyer (if we are a Buyer’s broker) to buy a property?
In our next few blogs, we shall attempt to explain the differences in concept of a price, cost, and value of a real property; as well as the various the various economic concepts as they are related to the detemination of the HABU, and the valuation of a property.
Motto: “Assiduus usus uni rei deditus et ingenium et artem saepe vincit ” (Constant practice devoted to one subject often outdoes both intelligence and skill” — (Marcus Tullius Cicero, 106 B.C. – 43 A.D. -great Roman orator, and philosopher)