Understanding Highest and Best Use Can Yield a Hidden Profit

highest and best useHighest and best use is an important concept in real estate that should be understood in the process of making a real estate investment.

Simply put, highest and best use for real estate can be defined as “the best economic use of a property with respect to what is legally and physically possible at any given time”.

We undoubtedly have all driven through a commercial area where office buildings and retail stores surround a lowly single-family home. Although the current use of the property might be residential, and at face value the property worth as much as other similar single-family homes throughout the city, obviously this is might not the highest and best use for the property.

A change in zoning or other regulations that would allow the owner to convert the property to commercial use (for instance) can indeed increase the property value dramatically.

Understanding that developed property can have more than one use can yield a hidden profit. So there are some situations that would warrant a real estate investor to consider that the best and most profitable use with respect to a rental income property might not be its current use.

For example,

  1. A house or small units on a commercial or industrial lot
  2. A house or small units on a large lot zoned for a larger multiple unit complex
  3. A property where the parcel map shows the building sitting on two or more separate tax lots
  4. A four-plex that actually consist of two duplexes on separate tax lots
  5. An apartment with large enough unit’s to configure and add a second or third bedroom
  6. A rental property where zoning permits additional extra units

Naturally, the mathematics will vary greatly due to local restrictions, building setbacks, green belt requirements, parking codes and such, to the extent that each property has a different end result. Nonetheless, real estate investors should always consider the highest and best use for a property and understand that its real value (and profitability) might lie just beneath the surface; if not immediately, perhaps in the nearby future.