Have you ever driven down the street and seen single family houses surrounded by a rail yard and loading docks and thought how strange it was to have people living in the middle of all of that industrial activity? If so, then you are already somewhat familiar with the concept of highest and best use. At one point in time, having houses very close to a rail station might have made great sense: transportation for railway workers wasn’t what it is today or perhaps the rail station wasn’t as developed as it is today and was a very small part of the dynamic. With those circumstances not present today, having residential property in close proximity to a bunch of trains might strike you as a little nuts.
Highest and best use is a concept that you may think is only the domain of real estate developers, but that is not necessarily so. When researching your intended commercial real estate acquisition, highest and best use should be a filter you apply to the prospect before any serious acquisition work is employed.
This filter check doesn’t have to be a complicated process, in fact, you may know on an intuitive level whether your piece of commercial real estate is being used in a reasonable fashion or not (as you figured in the opening example), but quite often research needs to be done to make this determination. Your job in this evaluation process is to determine what is the very best way to use the property under consideration, in other words, what is its highest and best use?
It may be that the property is being used exactly the way it ought to be used. An apartment building located downtown in the business district is likely a very good use of the property. It could be that there is no better use for the property given its surroundings, happenings in terms of city development and proximity to work centers.
On the other hand, an influx of Millennials to the downtown area could indicate the property may be better suited for a mixed use building or some other use instead. Perhaps the existing and incoming tenant base are exhibiting a great demand for retail close by and convenient to both their dwelling and workplace. A viable option might mean a coffee house and an eatery on the ground floor of their apartment building where they can meet colleagues for a coffee meeting or a quick bite. It turns out that your mid-rise multifamily property could have a new, higher purpose for its users. The benefit to you as the prospective owner, you ask? That’s simple — greater income and returns to you as the property owner.
How can you determine the highest and best use for your property without guessing? Here are a couple of ideas to get you started:
> Examine the existing properties in close and mid-proximity to yours and determine whether yours is similar, complementary or totally out of place to what you are finding.
> Figure out what new development is going to take place in close and mid-proximity to your property. Will this development be similar, complementary or a brand new direction for the area? How will your project fit in after the development is complete?
> Take a look at what the city has planned for the part of town in which your asset is located. This master plan may offer you a wealth of information as to what investments are planned for your neighborhood. Wouldn’t it be awful to buy a Class-C retail strip center to find out via the master plan and building permits that a brand new Class-A retail center complete with competing stores is going up across the street from your Class-C? It probably wouldn’t take long for your customers to abandon your center for the brand new one across the street.
Having that information could turn a potential investment catastrophe into a money-making proposition. How? Well, instead of leaving your Class-C retail strip center intact, you could repurpose the facility for highest and best use and alter its offerings. Perhaps a couple of restaurants to serve the customers shopping across the street or maybe even a parking garage for the new center. Instead of competing and withering on the vine, your repurposed center can soar to new heights on the coat tails of that brand new center.
You can see that consideration of highest and best use of a piece of commercial real estate will have a long-term impact on what you buy, how you intend to position the property and ultimately, the returns you will realize during your hold period. Highest and best use is not just a ‘nice-to-know’ item, it is a mandatory consideration for you to maximize your commercial real estate investment.