Highest and best use

Key Takeaways

• Highest and best use must clear four tests in order: legally permissible, physically possible, financially feasible, and maximally productive.
• A use that zoning or a recorded restriction forbids cannot be the highest and best use, no matter how profitable it would be.
• Appraisers run the highest and best use analysis twice, once on the land as though vacant and once on the property as improved.
• In Washington, an assessment may not assume a highest and best use that existing zoning or land use ordinances do not permit (RCW 84.40.030).

What It Means

Highest and best use is the reasonably probable use of a property that produces the greatest value, and it is the assumption underneath almost every Appraisal. An appraiser is not asked to value whatever the current owner happens to be doing with a parcel. The appraiser values what the market would do with it.

Four tests are applied in sequence, and a candidate use has to survive all four. Legally permissible screens out anything zoning, recorded restrictions, or environmental rules forbid. Physically possible screens out what the site cannot carry: too small, wrong shape, poor soil, no legal access. Financially feasible screens out uses that would not return enough to justify the cost of building them. Maximally productive selects, from the uses still standing, the one that yields the greatest value. Order matters, because a highly profitable use that the code forbids never reaches the last test at all.

The analysis is performed twice. First on the land as though vacant, which asks what a buyer would build on an empty site. Then on the property as improved, which asks whether the existing building should stay, be renovated, or be torn down. When the two answers point different directions, the current building is an interim use on land the market wants for something else.

How It Works in Washington

In Washington, highest and best use is not only appraisal theory; it is written into the property tax statutes. RCW 84.40.030 requires that all property be valued at one hundred percent of its true and fair value in money, and the same section draws the legally permissible line in so many words: an assessment may not be determined by a method that assumes a land usage or highest and best use not permitted, for that property being appraised, under existing Zoning or land use planning ordinances or statutes or other government restrictions.

That single sentence is the first test stated as law. A county assessor cannot value a lot as though a developer could put apartments on it when the code allows one house. RCW 84.40.030 also permits consideration of cost, cost less depreciation, reconstruction cost less depreciation, or capitalization of income that would be derived from prudent use of the property, which is how an income property's Assessed Value is built up. For a Washington broker the practical consequence is direct: a rezone, a comprehensive plan amendment, or a new land use overlay can move Market Value before anyone breaks ground, because it changes which uses are legally permissible.

Example

Priya owns a 9,600 square foot corner lot in Everett and is deciding whether to sell it as is or build on it. Her appraiser first tests the single house use: comparable land sales on nearby blocks support $285,000 for a lot of this size.

The appraiser then tests a four unit building. A completed four unit building on that block would be worth $1,240,000, and construction would cost $860,000, so the land can support $1,240,000 minus $860,000, or $380,000. That residual land value is $95,000 more than the single house use produces. If four units are legally permissible, physically possible on a 9,600 square foot lot, and financially feasible at those costs, then the four unit use is maximally productive and the land is worth $380,000.

Now change one fact and watch the answer flip. Suppose the zoning on Priya's block allows one dwelling unit per lot and no rezone is pending. The four unit use fails the first test, so its $380,000 residual is never weighed at all, and the appraiser values the land at $285,000. Under RCW 84.40.030 the county assessor is held to the same limit and cannot build Priya's assessment on a use the code forbids.

Common Mistakes and Exam Traps

• The four tests are a screen applied in order, not a scoring system. A use must clear legal, physical, and financial tests before it can be judged maximally productive.
• Highest and best use is not always the current use. An aging house on a commercially zoned corner may be an interim use on land worth more for something else.
• Highest and best use does not mean the most expensive improvement. Spending beyond what the market will pay is answered by the principle of contribution, not by this concept.
• Highest and best use is an input to a value estimate, not the value estimate itself. Market value is the conclusion the appraiser reaches after assuming the highest and best use.