Importance of highest and best use in Appraisal

How do you know if you’re making the most value possible from a property? Are you
getting the greatest economic and functional value from your real estate investment?
How will the long-term value of the property be affected by zoning changes, new
developments, and the usages of surrounding properties?

Highest and best use analysis considers these issues and provides indicators of how
the value is, and will be, influenced by emerging local market factors. When you
understand what usage of the property is likely to produce the greatest value over
time, you can formulate development and disposition plans that will yield the greatest
ROI, and reflect the most positively on your Massachusetts investment portfolio and
resume.

Zoning Issues
The most common influences on best use are zoning changes that impact how current
and future occupants can use the property. When local officials change zoning rules
for a subdivision, older properties that do not conform with the new usages can
become obsolete. The existing usage of a property will typically be ‘grandfathered,’ or
allowed to continue in its current usage until transferred. This is important to consider
in a valuation as most properties will need to be resold, often in the near future.

If the appraiser fails to consider, and research existing and emerging zoning
regulations, the valuation could be drastically inaccurate when the current usage will
no longer be allowed after transfer. The most common example of this situation
iswhen existing residences are supplanted by commercial developments, or when
agricultural uses are shifting toward new residential subdivisions.
Prevailing Usage and Anticipated
Developments
Sometimes changes in usage are gradual and not driven by zoning regulations. This
can occur when the current property design, style, or functionality is not consistent or
‘uniform’ with surrounding properties. In valuations, uniformity in a subdivision is
considered desirable and contributes to increased property values. The opposite is the
principal of regression that holds that properties of lesser uniformity, condition, or
desirability will have a negative impact on the value of properties in the surrounding
community.

When the predominant style and functional utility of homes in a neighborhood are
evolving, older homes tend to lose value more quickly. This can also be the case in
commercial developments when the dominant usage gives way to a new industry. The
zoning may remain the same, but the impact of new operations can have a disruptive
effect on declining industries, decreasing the value of existing improvements that are
no longer relevant or functional for emerging industry.

Another common influence are developments and changes that are planned, but not
yet confirmed or implemented. These types of market forces have a potential
speculative effective on the market that can drive up prices. A valuation must temper
the potential positive and negative effects to offer a balanced opinion of value.

A Complete Valuation
A reliable commercial or residential appraisal, especially in dynamic and growing
markets such as Massachusetts and Boston, must consider highest and best use to
offer the most insightful and complete valuation. Take special care in reviewing your
next appraisal to ensure that it addresses emerging market factors. When in doubt,
consult with quality-oriented and experienced valuation professionals that specialize
in the market in question.

Importance of Analysing Market Trends in Real Estate Appraisal

A market is different from neighbourhood. In choosing comparables and reconciling

values, it is worthy to consider the distinction of the two in analysing market
trends. This is vital in real estate appraisal.

A neighbourhood is a grouping of complimentary land uses. This is a geographical

term and include residential, commercial and even industrial uses within a
neighbourhood. Meanwhile, market is the sum total of all competing properties of
buyer and sellers in a given area or region under consideration. A market study is
focused on competing properties. Therefore, in conducting market analysis one
should not limit themselves in analysing properties in a given geographical units.

Most appraisers can easily identify appreciating market indicators. Some of which
are the undersupply of competing properties and listings; reduced marketing time;
and increase in list price than the previous sales price.

The presence of one or all of the indicators would be a signal of market appreciation
and the appraiser should consider it in making adjustments and choosing
comparables to produce credible reports.

The other method in analysing the market trend is to distinguish the market if it’s a
seller’s market or a buyer’s market.

In a seller’s market where a high level of competition exists, seller will make
concessions which is either non-existent or very minimal. This is in contrast to a
buyer’s market where an abundance of competing properties exist and sellers are
motivated to offer concessions to stimulate contracts.

A reliable appraisal, especially in dynamic and growing markets such as Cebu and
Metro Manila, must consider real estate trends to offer the most insightful and
 complete valuation. When in doubt, consult with quality-oriented and experienced
valuation professionals that specialize in market analysis.

A Market vs. A Neighborhood

We start with the distinction between a Market and a Neighborhood.

A neighborhood is a grouping of complementary land uses. This is a geographically defined term and therefore could include
residential, commercial and even industrial uses within the neighborhood.

A market study is focused on competing properties. Therefore, a market analysis need not have the same geographic limits as the
neighborhood. When defining a market, it is important to use parameters that include competing properties and exclude
noncompetitive properties. The market area may be more important than the neighborhood. This might result in utilization of
comparable data located outside your defined neighborhood, and yes, it will require justification and commentary in the Sales
Comparison Approach comments but is acceptable within appraisal practice when an insufficient population of competitive
market data is not available within the defined neighborhood.

Our analysis of competitive market data should be more focused on identifying the subject market which might be encompassed
within the identified neighborhood, but not necessarily.

Recognizing the characteristics of an appreciating market.

Most appraisers can identify the indicators of an appreciating market. However, many have trouble interpreting the indicators
and then deciding when the indicators lead to a conclusive identification of an appreciating market. Some characteristics of an
increasing market are as follows:

 Undersupply of competing properties (i.e., supply and demand are out of balance).
 Reduced marketing times for active, pending and closed sales.
 Prior listings of the subject that reflect list prices lower than the current contract, sale price or value.
 Prior sales of the subject and/or comparable sales that reflect lower prices than current prices.
 Increase in sale prices as a percent of list prices.
 Decrease in REO and Short-Sale listings in neighborhood.
The presence of only one or two of the indicators from this list would not necessarily be enough evidence to confirm an
appreciating market, however, the presence of several or all of the indicators would be a strong indication that the market is
appreciating and appropriate analysis and adjustments for date of sale/time to comparable sales becomes necessary to produce
credible assignment results.

Quantifying Market Adjustments in Appreciating Markets.

When a market has been identified as appreciating, appraisers are tasked with identifying and supporting appropriate adjustments
to any dated sales used in the appraisal. Analytics include:

1. Tracking over time the median sale prices in a defined market segment (e.g., 1004 MC form).
2. Researching and calculation of rates of change from sales and resales of the same properties.
3. Tracking over time the Days on Market (DOM) of comparable listings or comparable sales.
4. Tracking over time the sale price to list price ratios (SP/LP). The assumption is that diminishing discounts from list price to
sales price are a reflection of motivated buyers willing to pay prices higher than previous sales.
5. Tracking over time the number of REO/Short Sale properties. The assumption is that REO/Short Sale properties adversely
impact property values within their respective markets. As the number of REO / Short Sale properties diminish, that negative
impact diminishes, thus improving the market appeal of the other properties in the market.

Sales Concessions and Property Condition

In addition to the traditional market trend indicators noted in the list above, other indicators that help to distinguish whether the
market being analyzed is a Buyer’s Market or a Seller’s Market include the existence or absence of seller concessions and
whether property condition impacts marketability.

In a seller’s market where a high level of competition exists, seller concessions will either be non-existent or very minimal. This
is in contrast to a buyer’s market where an abundance of competing properties exist and sellers are motivated to offer concessions
to stimulate contracts.

Also in a seller’s market where a high level of competition exists, buyers are less likely to write contracts that include repair of
deferred maintenance or replacement of older appliances/fixtures for fear a competing buyer will not require the repairs and gain
a competitive advantage in the bidding process.

This is significant for appraisers to appropriately analyze and recognize such trends to prevent making condition adjustments the
market is not recognizing as of the transaction dates.

When appraising a sale, appraisers are reminded the subject is also a market transaction / agreement that occurred between a
willing buyer and a willing seller and has also just become a pending sale comparable within that market. This is especially
significant when it is the most recent sale in an escalating market and as a result is the highest sale of directly competing
properties in that market.

The tendency might be to appraise a sale at a value that is no higher than the highest previous comparable sale. However, that
might result in a deficient analysis and reconciliation and even be misleading if the sale price is consistent with the market trend,.

Example:
 Subject was listed for $305,000, is in contract for $300,000 after 12 Days on the market.
 Sale 1 was listed for $300,000 and sold for $295,000 three months ago after 15 DOM;
 Sale 2 was listed for $289,000, sold for $285,000 five months ago after 20 DOM;
 Sale 3 was listed for $280,000, sold for $270,000 seven months ago after 25 DOM.
 There is a pending sale that listed for $300,000 and sold for an undisclosed price after 5 DOM.
The highest previous sales price is $295,000. However, based upon the sales price trend, reduction in DOM and increase in SP as
a % of LP, the $300,000 appears to be consistent with the upward market trend and could be supported in an appraisal (all other
things being equal). The point of the demonstration is to remind everyone to not get “boxed in” and let the data tell you where the
market is at and reconcile accordingly.