TOPIC 12. ANALYSIS OF THE MOST EFFECTIVE USE

All value judgments are based on the use of the property. However, only the most efficient use is adequate from the point of view of market participants. It is this use that can and should be considered as the basis for determining the market value of real estate.

The most effective use of a particular land plot is not determined by the subjective opinion of the owner, developer or appraiser; on the contrary, the most efficient use is formed by competitive forces within the market where this real estate is located.Therefore, the analysis of the most effective use is, in fact, a comprehensive market research of the alternative use of real estate from the position of achieving maximum productivity, which creates the necessary basis for the selection of objects of comparison when applying the three approaches to valuation.

Purpose and objectives of the analysis

The procedure for identifying and justifying the alternative use of real estate that ensures the most productive use is called the analysis of the most effective use.

Earlier, when the principles of valuation were considered, it was indicated that the most efficient useis defined as the highest possible physical use, suitably confirmed, legally permitted, financially feasible, and which results in the highest value of the property being valued.

As you can see from this definition, the most effective use is more of a well-founded judgment rather than a fact. In valuation practice, the most efficient use is the premise on which the market value is based. In its context, as the most likely selling price, another term for the most effective use may be "Most likely use"or "Most profitable use".

Basically, the concept of best use only applies to land, as the cost of improvements is seen as the value they add to the land. The land is considered to have value, while improvements contribute to the value of the property itself as a whole. Hence, the theoretical focus of the analysis of the most effective use is on the possible use of the land as if it were free... Even for improved properties, the valuation of land as vacant is a prerequisite in determining the value of real estate. Only in this way can the real contribution of improvements to the value of real estate be determined.

At the same time, the practice of appraisal has shown that in appraisal activities it is also important to form a judgment about the market value and from the point of view of the most effective use of the improved real estate. This concept in real estate appraisal was developed in the 1960s to answer two important questions:

1) how existing improvements should be used;

2) whether they should be preserved in current use, or should they be demolished and new ones built in their place.

The concept of the most efficient use of land as free only answers the question of how a site should be improved, being undeveloped. Therefore, the assessment should distinguish between the most efficient use of land as vacant and the most efficient use of improved real estate. At the same time, the criterion for the most efficient use of land as free is its maximum cost, and the criterion for the most effective use of improved real estate is maximization of the value of real estate with an acceptable rate of return.

Thus, in the final choice of the most effective use option, they are guided by the following provisions:

If the value of the improved property is higher than the value of the land without improvement, the most efficient use will be the use of the improved property;

If the value of the vacant land exceeds the value of the improved property, the most efficient use will be to use the land as vacant.

In fact, analysis of the most effective use involves consideration of reasonably possible uses of land plots (vacant or improved) from the point of view of four unconditional criteria that are incorporated in the very definition of the most effective use.

The most effective use should be:

physically possible, those. correspond to the size and shape of the land plot, its accessibility, geotechnical and environmental conditions;

legally permitted , those. comply with the regulations for use and development established by public (urban planning and land management documentation) and private (encumbrance of the owner's rights by contracts with other persons) restrictions;

financially feasible , those. comply with the current market conditions, which determine the level of profitability of different types of real estate, and ensure a positive return on invested capital;

maximally productive , those. ensure the maximum value of the land or the maximum return on invested capital. In this case, the net present value or internal rate of return is usually used as a measure of the return on capital.

It should be noted that these criteria are interrelated and should be considered in sequence. In this case, it does not matter of principle what will be considered earlier - physical possibility or legal permission. Sometimes it is even better to start by looking at legally permitted uses, as this immediately delineates the range of possible alternatives. However, it is important that feasibility and legal feasibility studies precede financial feasibility and maximum productivity testing. Use may be financially feasible, but it will not serve as an argument if prohibited by law or physically impossible. And only after all the legally permitted, physically possible and financially feasible uses have been identified, can one move on to choosing the most productive one.

Thus, a final judgment on the most effective use can be made only after alternative uses, such as those that do not meet one or another criterion, have been excluded. The remaining use that meets all four criteria is the most efficient use.

Naturally, the uses considered in the analysis must meet another criterion - whether the use is reasonable. Reasonableness or reasonable feasibility is both a preliminary point of reference and a conclusion for use / s that are ultimately considered most effective.

As noted, valuation theory suggests that as long as the value of the improved property is higher than the value of land as vacant, the most efficient use is to use the improved property. However, in practice, the new owner of the property can eliminate the existing improvements even when the value of the improved property exceeds the value of the vacant land. It is unlikely that investors will pay large sums for land simply to maintain existing improvements on the land until the improvements are completely depreciated. Therefore, the cost of demolition and the cost of any remaining improvement will always be considered when considering the financial feasibility of changing land use patterns.

When analyzing the most effective use, it is also important to consider the time factor for a particular use. In many cases, the most efficient use of property may change for the foreseeable future. For example, the most efficient use of a farm in terms of the future development of a city may be temporary, intermediate, use that precedes the future most efficient use for residential development. If the land is ready for development at the time of assessment, then there is no temporary use. On the contrary, if the land in the near future does not have the potential for the formation of plots for residential development, then its most effective use will consist in further agricultural use. In such situations, immediate land reclamation or the conversion of improved assets towards its future most efficient use is usually not financially feasible.

Another factor to consider when analyzing the best use is intensity of current use. For example, if the site were vacant, then its most efficient use would be to construct a 10-storey office building, while the office building that currently occupies the site has only three floors. The current use of the site in terms of its intensity cannot be considered the most efficient use.

When analyzing the most effective use, existing competition should always be taken into account, both between different uses and within a particular use. The latter is especially important when the site is recommended to be used for a specific function, which can be placed on other sites that have the same or even more favorable conditions for this function.

In addition, from the point of view of the market in the areas of business activity, the most effective use may be considered not one function, but several or a combination of them. Therefore, the conclusion about the most effective use reflects the general nature of the requirements put forward by the market for the use and development of the site, rather than a specific type of use. Without reliable market analysis, it is impossible to obtain a correct judgment about the most effective use.

The most efficient use of a free land plot

The analysis of the most efficient use of a vacant land plot is usually carried out in order to determine the value of the land. When the land has no improvements, the rationale is obvious - the land is valued as it is. However, when a land plot is improved, the contribution of the land to the total property value depends on how the property can be used. Therefore, the most efficient use of land as vacant should be considered in terms of its existing and all possible uses. This requirement should always be met, unless the available land improvements are capable of maintaining the most efficient use for a sufficiently long period, or when there is no market demand for the current use.

The assumption that the land is treated as if it were vacant in the valuation of the improved property is based on the possibility of demolishing the improvements as one of the alternatives for the use of the property. After all, you can never exclude the possibility of such a use that will increase the value of land to a level where existing improvements will cease to contribute to the total value of the property or even their value will become negative.

In some cases, the most efficient use of a site will be to abstain from development or to use it temporarily until the development is confirmed by market demand. This often happens when there is external (economic) impairment in the market - for example, when real estate markets are temporarily oversaturated with supply, when excessive financial costs weaken development, when there is an economic downturn in production, or when there is a significant environmental disaster.

For many parcels of land, achieving the most efficient use requires zoning changes or major changes in transport and utilities infrastructure or other external improvements needed to transition to new uses. The most efficient use of land as vacant may necessitate its division into smaller land plots, or connection with other land plots.

Thus, the most efficient use of land as free land can be:

Its existing use,

Planned development,

Dividing a plot into smaller land plots or joining it to other plots;

It can also alternatively include temporary use or abandonment of any use until development is demanded by market demand.

If the most efficient use of land as free will be its development, then it is necessary to define and describe the type and nature perfect improvement,which must meet clearly defined criteria. First, this improvement should maximize the potential of the site in terms of market demand. Secondly, it must be consistent with current market standards and the nature of the surrounding area. Finally, the improvement must contain suitable evaluated components.

This ideal improvement is used as a comparison to determine the wear of existing improvements. Naturally, the ideal improvement will not have physical or functional wear and tear - i.e. it will be neither under-improvement nor over-improvement. Thus, any difference in cost between an existing improvement and an ideal improvement will apply to these forms of wear. At the same time, it is necessary to consider economic (external) wear and tear, which can affect both the existing improvement and the ideal improvement.

In all cases, when analyzing the most efficient use of land as vacant, the types of uses that legally allowed , those. comply with established public and private restrictions.

Public restrictions represent the regulation of development or other use of a land plot, established in urban planning and land management documentation, most often in zoning plans (rules), local building rules and other regulatory legal acts regulating the nature of land use in a given area.

Private restrictions associated with the encumbrance of the owner's rights to use and build up a land plot, which arise as a result of the conclusion of various agreements related to the alienation of his individual powers. The most typical private restrictions are various kinds of easements (right of way / passage, laying of communications, common wall, etc.), which, together with the land plot, pass from owner to owner.

Often it will be advisable to consider not only the permitted use, but also the legal possibilities for changing the established functional use and the nature of the development so that the most effective use of real estate is realized.

In a situation involving a possible change in the permitted use, the time and expense involved, as well as the risk that the change will not be permitted, must be taken into account.

For example, a land plot will cost $ 125,000 if it is allowed for commercial use. The total cost of changing the existing use of the land is $ 10,000 and the total time is 12 months. Naturally, this will reduce the cost of land, firstly, by increasing the total costs associated with its improvement by $ 10,000, and secondly, due to the need to discount its value for the period of obtaining permits for commercial use.

In addition, even if there are legal grounds for the transition to a new use, this change cannot be 100% guaranteed due to subjective factors associated, for example, with the negative public attitude to the placement of new construction.

Similar calculations are carried out when it is required to combine several sections to achieve the most efficient use. For example, a large petrochemical plant could be built on a site created by combining several small sites that individually did not have the potential for such large-scale industrial use. Allowing for such a merger, it is necessary to take into account the costs and time required to form a new site. It should be borne in mind that when merging, often for individual plots, especially those acquired at the end of the merger period, a price higher than the market price can be paid.

Thus, a study of legal permissibility should determine:

What uses are allowed by the current zoning;

What uses can be allowed if zoning changes are introduced, and

What uses are limited to the private encumbrances of a particular site.

At the same time, the time frame of the restrictive conditions for the use and development of the land plot must be taken into account without fail.

Physical capabilitythe most effective use of a free site is associated both with the parameters of the site itself (its size, shape, frontal line length, depth), and with the natural characteristics of the environment (relief, geotechnical conditions, natural hazards). In addition, from the point of view of physical capabilities, the transport accessibility to the land plot and the availability of the necessary engineering facilities and networks are assessed.

In principle, any site, even with unfavorable physical characteristics, can have a certain use, but the volume of costs associated with its development will be decisive in the analysis of the most effective use.

There are cases when the size of the site is too large for its most efficient use. The most effective use of surplus land may be to create free space, or to create room for future expansion, or to form a new, separate site.

Land adequate to the improvement function (building) - a parking lot for a shop, a sports ground for a school - is not redundant. Only land that does not meet market standards should be considered surplus and taken into account in adjustments.

In some cases, plots are not considered too large because the area not required for a given use cannot be used alone. For example, a large plot within a continuous building cannot have a surplus of area, since the separate use of this surplus is impossible.

Research focus financial feasibility will depend on the market in which the physically possible and legally permitted uses are represented. If these uses are in the rental market, then the feasibility study will focus on which of them will provide sufficient net operating income to meet the required market rate of return on the investment. If physically possible and legally permitted uses are represented in the purchase and sale market, then the financial feasibility study will seek to determine the amount of income that will be obtained from the sale of the improved property with alternative use. Financially feasible in this case will be those uses in which the income will be equal to or will exceed the amount of costs required to create and sell the improved property.

To determine the financial feasibility of a use that does not generate income, the benefits that result from the use can also be compared with the expected costs. If the benefits exceed these costs, then the use is considered feasible (profitable). If the benefits are lower than or only marginally higher than the costs, the use will not be considered financially feasible.

A financial feasibility study should be based on reliable evidence collected and analyzed in the competitive market for the real estate in question. At the same time, analysis of supply and demand and location is a prerequisite for determining the financial feasibility of use and for determining which of them is the most productive. In addition, any economic impairment associated with a specific use should be included in the feasibility study.

Checking for maximum productivity applies to those uses that meet the first three criteria. It not only involves considering the value of real estate, which can be obtained with the most productive use of it, but also the costs associated with achieving this value, including the costs of demolition and relocation of buildings, costs of environmental restoration, costs of changing zoning and others.

Of the financially feasible uses, the most efficient use is the one that provides the highest residual value of land consistent with market risk acceptance and with a rate of return guaranteed by the market for that use. At the same time, rates of return reflecting the associated risks are often used to capitalize the income received from various uses into their corresponding values.

EXAMPLE 1

It is required to determine the most effective use of a free land plot worth 35,000 dollars, for which there are three possible options for development: construction of a residential building with a total area of \u200b\u200b180 sq. M., 200 sq. M. and 220 sq.m.

Construction costs for each of the options will be:

Option 1 180 m2 × 520 USD / sq. m \u003d 93,600 dollars;

Option 2 200 sq. m × 510 USD / sq. m \u003d 102,000 dollars;

Option 3 220 sq. m × $ 500 / sqm \u003d $ 110,000
It is assumed that the built-up plot can be sold:

With a house of 180 square meters for $ 140,000;

With a house of 200 square meters for $ 155,000;

With a house of 220 square meters - for $ 160,000

To select the most effective use of a free land plot, we will determine the developer's profit for different development options:

The most effective use of a vacant land plot, ensuring the maximum profit for the developer, is the construction of a residential building with a total area of \u200b\u200b200 sq.m. Homes with more or less floor space will potentially generate less profit.

From another point of view, it is necessary to determine whether the expected profit is high enough to justify the risk of investing in construction. In this case, the total cost of acquiring and developing the land plot is $ 137,000 (35,000 + 102,000), resulting in a profit of $ 18,000.This provides a 13% return on capital investment ($ 18,000 / $ 137,000). If higher rates of return with similar risk are available, then the proposed option is not the most efficient use.

In the above example, the value of the land was known, however, most often the analysis of the most efficient use is carried out in order to determine the value of the land, and the value of the land itself is the main measure of the productivity of the use of free land. That is why the most efficient use is considered to be the one that provides the highest residual value of the land.

The residual value of land can be found by determining the value of the proposed use (land and improvements) and deducting the cost of creating the improvements.

EXAMPLE 2

It is required to determine the most efficient use of a free land plot, for which there are two possible options for building a plot: construction of a residential building with a total area of \u200b\u200b220 sq.m. or 176 sq.m.

It is assumed that the sale price of a plot with a large house can reach $ 150,000, and with a smaller one - $ 120,000. At the same time, construction costs, taking into account the developer's profit, are $ 500 / sq. M.

To select the most effective use, we define using economic methodland cost for different building options:

The most effective use of the two options considered is the construction of a residential building with a total area of \u200b\u200b220 sq. M, since during its implementation a high cost of land is achieved

Alternatively, the value of land can be calculated by capitalizing income attributable to land. Basically, this land income is the residual income after operating costs and income related to improvements have been deducted from income from all real estate. Although the capitalization of residual income is usually not a very convincing indicator of the value of land per se, this valuation procedure is very useful in analyzing the most efficient use because it provides a basis for comparing alternative uses in order to identify the most productive one.

EXAMPLE 3

It is required to determine the most effective use of a vacant land plot with an area of \u200b\u200b2000 sq.m located in a residential area with an active rental market.

Market research revealed the following comparable data:

for rent payments:

Apartment with a total area of \u200b\u200b54.5 square meters with 1 bedroom $ 500 per month;

An apartment with a total area of \u200b\u200b72.7 square meters with 2 bedrooms $ 650 per month;

Apartment with a total area of \u200b\u200b100 square meters with 3 bedrooms $ 725 per month.

by construction cost:

Apartment with a total area of \u200b\u200b54.5 sq.m with 1 bedroom $ 495 per sq.m

Apartment with a total area of \u200b\u200b72.7 sq.m with 2 bedrooms $ 440 per sq.m

Apartment with a total area of \u200b\u200b100 sq.m with 3 bedrooms 385 USD per sq.m

It is known that net operating income is 60% of potential gross income, and the rate of return on land improvements is 12%.

To select the most effective use of a free land plot, we will determine the residual value of the land using the income distribution method.

The most efficient use of a vacant land plot is the construction of a 6-apartment (two-bedroom) residential building, as it provides the highest land value.

Consider another example, when the value of land can be calculated by capitalizing the income attributable to land, but for different functional uses of the land.

EXAMPLE 4

It is required to determine the most effective use of a free land plot, for which there are three possible options for building a plot: construction of a residential building, an office building and a retail store.

Market data analysis shows that the use of the land:

Construction of a residential building, the cost of which will be 1,021.6 thous.

dollars, will allow you to get a real gross income of 250 thousand dollars with operating costs of 120 thousand dollars;

Construction of an office building, the cost of which will be 928.0

thousand dollars, will allow you to get a real gross income of 200 thousand dollars with operating costs of 80 thousand dollars;

The construction of a retail store, which will cost $ 817.3 thousand, will generate an actual gross income of $ 180 thousand at an operating cost of 69

thousand USD

Assume that for all use cases, the building being constructed has the same economic life (20 years) and an equal rate of return (10%).

To select the most efficient use, we will use the income distribution method to determine the cost of land for each of the use cases. At the same time, let us take into account that the return of invested funds in land improvements (construction) is due to a limited period of the economic life of buildings, while this period is infinite in relation to land.

Calculations show that the most efficient use of the site would be to locate a retail store, which provides the largest return on land.

Thus, the most efficient use will not necessarily mean the most expensive construction or the one that will generate the largest gross or even the largest net operating income. Most likely, such a relationship between these variables, which provides the maximum income from land (return on capital invested in the development of the site) determines the most efficient use.

In conclusion, it should be noted that the potential most efficient use of land as vacant is usually long-term use and is expected to be sufficient for the normal life of improvements, the duration of which will depend on the type of building, quality of construction and other factors.

Similar information.

The option for the most efficient use of the property being appraised must meet four criteria - these are:

Legal admissibility;
... physical feasibility;
... financial security;
... maximum productivity.

The sequence of consideration of these criteria in the analysis of various options for the use of real estate to select the most effective usually corresponds to the above. Legal admissibility and physical feasibility are considered first, then financial security and maximum productivity are assessed. This sequence of the analysis procedure is due to the fact that the most effective use case, even with the necessary funding, is not feasible if it is legally prohibited or its physical implementation is impossible.

Legal admissibility.

The validation of the legal admissibility of each considered use case is carried out in all cases first. However, one should not confuse the option of optimal use of the property with the legal requirement to use the property for its intended purpose.

The appraiser reviews specific restrictions, zoning codes, building codes and regulations for the protection of historic buildings, as well as environmental legislation that may be specific to potential uses. The choice of the most efficient use of real estate can be influenced by the existence of long-term lease agreements. During the remaining lease term, the use of the property depends on the terms of the lease. If the most efficient use of the property is constrained by the existence of a lease, this should be reflected in the valuation report.

For example, if a property is limited by a land lease that expires in more than 12 years, then it may not be economically viable to construct a new building that has an economic life of 40 years.

In addition, it is necessary to take into account possible restrictions that may be included in the contract for the acquisition of real estate. These restrictions may relate to some areas of use, specify the location of buildings on the land plot, the parameters of buildings, the type of building materials used. If restrictions on the title deed conflict with more general legal regulations such as building codes, then the maximum restriction is usually taken into account.

Building codes can constrain the development of more efficient structures on land if they increase building costs to meet technical regulations. This ultimately hinders the development of the territories. In some areas, building codes are used to reduce new construction and restrict growth. The current land use rules are aimed at protecting the environment. Appraisers should take into account the standards for the purity of air, water, as well as public opinion about the proposed development projects.

Example. Construction of buildings of a certain number of storeys, fire breaks, insolation requirements.

A use case that is legally prohibited on the date of assessment can be considered at further stages of the analysis only if the assessor intends to make changes to the existing norms. However, the likelihood of changes in legislation, building codes, zoning rules, etc. is never 100% certain.

Physical feasibility.

The choice of the most efficient use case for real estate should be based on its physical feasibility. Physical feasibility criteria - size, shape, area, design, ground conditions and access roads to the site, and the risk of natural disasters (such as floods or earthquakes) - affect the intended use of the land. The ultimate usefulness of a land plot depends on its size and shape. Some options give the greatest effect only on the basis of using an area of \u200b\u200ba certain size. In this case, it is necessary to determine the possibility of expanding the existing land plot, since some plots may not have the potential to increase. The shape of the plots affects the final productivity, since the costs of building an irregularly shaped land plot can be higher, which further reduces their utility, compared to plots with flat sides. Similarly, the presence of access roads to the site and utilities increases its final productivity, since savings on its development are achieved. Thus, the free capacity of treatment facilities limits the physical dimensions of the proposed efficient development option. The topographic or soil characteristics of the land plot are reflected in the functional usefulness of the site. The negative aspects identified by the appraiser make it difficult to build up or increase the development costs. Since all the plots on the market compete with each other, the assessed plot may not be unsuitable for the most efficient use, as it is inferior to other plots typical of the area.

In the process of analyzing the physical feasibility of an effective use case, it is necessary to consider the state of buildings and structures to determine the possibility of its further operation on a new basis. If buildings need to be rescheduled to ensure optimal use, the costs involved should be calculated and compared with the final return. Typically, the cost of renovating an object depends on the physical condition and location of the property.

Financial security.

The next stage in the selection of uses is financial security analysis. An option is considered financially viable if it provides operating income equal to or greater than operating costs, financing costs and the required capital recovery scheme. Thus, all uses that can generate positive returns are considered financially feasible. If the type of use does not imply the receipt of regular income from operation, then in the course of the analysis those options are selected that create real estate at a cost equal to or greater than the cost of construction or reconstruction of the facility for this new type of use. The appraiser must compare the capital gains or income from the use of the property against the capital expenditures incurred. If the income is less than or only slightly higher than expenses, this type of use is deemed unfeasible in financial terms.

To assess the uses that generate regular operating income, for each of them the evaluator calculates the total net operating income, the individual rate of return on capital invested, the amount of income attributable to land. If the net income meets the required return on investment and provides the required rate of return on the land, this use is financially feasible. Obviously, the identification of financially feasible uses is based on an analysis of demand, supply and location.

Maximum productivity.

Maximum productivity is the highest value of the land plot as such, regardless of whether it is vacant (actually or conditionally) or built-up. Thus, the implementation of this criterion presupposes, out of all legally permitted, physically realizable and providing a positive amount of income options, the choice of the type of use that provides the maximum value of the basis of real estate - a land plot. The potential for the most efficient use of land reflects a long-term, carefully designed and rather specific land use program associated with the normal life of buildings and structures. The service life depends on the type of building, the quality of construction work and other factors.

The maximum productivity of a land plot is determined by correlating the amount of its income with the capitalization rate required by the market for a given type of use. However, depending on the selected real estate use case, the method for determining the value of land can be different. The choice of the method depends on the degree of reorientation of the actual purpose of the appraised real estate, the level of risk of the considered option, the required rate of return and the period of capital reimbursement, the timing of the proposed use of the real estate. The type of use that provides the most profitable land is the most efficient. All the methods used for determining the value of a land plot in order to select the most effective option are based on the so-called residual technique. Income from land is considered as the balance between the total income generated by real estate and those amounts of income that are provided by attracting labor force, capital, fixed assets (functioning buildings and structures). The value of a land plot, in turn, represents the difference between the total value of the entire property and the residual value of buildings or the cost of their construction.

The best way to use real estate can either be achieved on the basis of existing buildings, or involve the construction of fundamentally new improvements, which requires the consideration of the land plot as free. Based on this, appraisers apply two techniques when analyzing the best use of real estate:

The most efficient use of the site as undeveloped;
... the most efficient use of the site as built-up.

There are the following main reasons for determining the most efficient use of land as undeveloped:

1. Allocation in the value of real estate only the value of the land.
2. Using the comparable sales method for valuing built-up land.
3. Calculation of the loss in value due to external obsolescence.
4. Assessment of the real value of land as part of the property, which is not optimal for this site.

The analysis of the most efficient use of the built-up area is done for two reasons:

1. Identification of the type of use of the property that provides the highest total return on capital invested.
2. Identification on the market of real estate objects of the same purpose with a comparable level of efficiency of use.

Let us consider the difference between the most efficient use of a land plot without buildings and a property with buildings on the example of industrial property with toxic emissions. The area in which the analyzed object is located, according to its natural characteristics, is developed as a suburban residential area. The maximum efficiency of using a plot without buildings will most likely be based on the use as a residential cottage. In this case, the costs of demolition and disposal of the existing facility will arise. In practice, the potential property owner will only redevelop the site if the residual value of the buildings is low.

Depending on how close in time it is to the valuation date the selected use case requiring a new building is located, the existing use may be considered as intermediate. So, if, according to the plan for the expansion of urban land, cottage construction reaches the analyzed land plot in five years, and the time required for the demolition of existing buildings and the construction of a new cottage is one year, the four-year operation of the existing industrial property is considered as an intermediate use. However, if the competitive level of demand is higher for industrial use, then it is likely that the most efficient use of this property may be to maintain the existing use with the necessary conservation work at the appropriate cost.

The theory of real estate appraisal requires an analysis of a plot of land on the assumption that there are no buildings on it, even if the site is built up, in order to determine how much the current use is in demand, whether it should be continued or replaced.

The method of determining the best and most effective use of the appraised real estate as an undeveloped land plot is based on the assumption that it has no buildings, or can be freed from buildings as a result of their demolition. As a result, the cost of land is determined based on the choice of possible use cases that ensure the profitability of real estate, and the selection of parameters of real estate in accordance with a specific purpose.

The option of using a plot of land as undeveloped has two main types:

1. Use of a plot of land for speculation, that is, for selling it without improvement to an investor, who subsequently, in accordance with the requirements of the market or his own preferences, will develop it. This option is applicable when real estate markets are oversaturated.

2. Development of a land plot with new buildings and structures, including:

Development without intermediate use, if a new use option is being considered that is accepted by the market at the analysis date;
- development with intermediate use assumes the temporary preservation of the existing use case, until the new option is demanded by the market, based on the forecast of the market situation;
- division or unification of a land plot to achieve the most efficient use;
- development of the site with new buildings similar in purpose and physical parameters to the existing object.

The most common situation in real estate appraisal based on undeveloped land is its conditional undeveloped. This is due to the fact that there is a building on the analyzed site, which affects the value of the object. In this case, the choice of the option for the most effective use of the site as undeveloped takes the form of investment planning at the decision-making stage.

In this case, the appraiser needs to answer a number of questions:

1. How can a land plot be used if it is not actually built up or can be freed from existing buildings?
2. What type of building or other structures that provide the selected use case can be built on the land based on its physical and other characteristics and in what time frame?
3. Should the existing use be considered as an intermediate use?

For example, if construction work is required to achieve the most efficient use of land, the appraiser should determine:

Demolition costs of existing buildings;
- the type of the most efficient use of the real estate object (office, hotel, warehouse, etc.) that meets the current market standards and includes elements at the most affordable prices;
- characteristics of the optimal buildings that should be erected to maximize the potential characteristics of the site (number of storeys, the optimal area of \u200b\u200bthe functional unit, the number of these units, etc.);
- the level of rent and operating costs;
- the cost of buildings under construction, taking into account financing costs.

Acceptance of the most effective use of a land plot as built-up involves the preservation of existing buildings on the analyzed plot. The option of using a plot of land as built-up has two main types:

1. preservation of the existing purpose of the appraised property;
2. change of the existing purpose of the appraised property.

In both cases, the necessity and possibility are considered:

Maintaining the existing volume and quality of services provided by real estate;
... carrying out construction work on the reconstruction of buildings to improve their class and change the rental rates;
... carrying out construction work to expand the area due to an additional extension or the construction of additional floors;
... reduction of existing areas due to partial demolition.

The appraiser, comparing the existing use case of the buildings located on the land plot with the optimal building option, should receive an answer to the following questions:

1. Is it advisable to continue to operate the building in its current state?
2. Which variant of building reconstruction to choose: reconstruction, expansion, partial demolition?
3. How and in what time frame will the costs be recouped?

The most optimal option for using the buildings will ensure the maximum value of investment-attractive real estate, taking into account the rate of return determined in accordance with the risk of the selected option. It is clear that the risks of maintaining the existing way of using the property and the different redevelopment options will not be the same. In the assessment report, it is necessary to separate the most efficient use of the site as undeveloped from the most efficient use of the site as built-up. The assessment report should clearly identify, explain and justify the purpose and conclusion for each use.

2. Real estate appraisal

2.7. Features of land valuation

2.7.3. Analysis of the best and most efficient land use

When assessing a land plot, it is necessary to determine the option of its best and most effective use, which is determined by the interaction of a number of factors.

The analysis of the best use includes the study of alternative uses (development, development) of the land plot and the choice of the optimal one. This takes into account the prospects of the location, the state of market demand, the cost of development, the stability of the estimated income, etc.

When assessing the value of an object consisting of a land plot and buildings, great importance is attached to the analysis of the best use, firstly, of the alleged vacant land plot and, secondly, of the land plot with existing improvements.

An analysis of the alleged vacant land plot is a necessary step in determining its value, and it is based on establishing the most profitable land use option.

Analysis of a land plot with existing improvements involves making a decision on the demolition, modernization or preservation of the improvements on the land plot in order to ensure maximum profitability of the object.

The probable and most profitable use of the site provides its highest value. Use cases must be legal, physically acceptable, and cost effective.

Let's name the main factors that determine the optimal use of land:

1) location - a factor that has a major impact on the value of a land plot (taking into account the prospects of the location, transport accessibility, the nature of the environment);

2) market demand - a factor reflecting the ratio of supply and demand in the market;

3) financial feasibility - the ability of the project to provide income from the use of the land plot, which would be sufficient to reimburse the costs of investors and ensure the receipt of the expected profit;

4) physical suitability of the site - the prospect of creating improvements - size, topography, soil quality, climate, geotechnical and hydrogeological characteristics of the site, existing zoning, environmental parameters, etc .;

5) technological feasibility and physical feasibility - analysis of the ratio of quality, costs and timing of the project, the likelihood of natural disasters, the availability of transport, the ability to connect to utilities, taking into account the size and shape of the site, for example, the size may be small for the construction of an industrial facility;

6) legislative (legal) admissibility - compliance of the option of using the land plot with the current legislation. It is revealed as a result of an analysis of building, environmental standards, restrictions on the number of storeys, the presence of temporary bans on construction in a given place, difficulties in the area of \u200b\u200bhistorical urban development, possible changes in regulations, compliance with zoning rules, negative moods of the local population;

The variant of the most effective use of the improved real estate can be achieved either on the basis of existing buildings, or it can involve the construction of fundamentally new improvements, which requires the consideration of the land plot as conditionally free. The theory of real estate appraisal assumes the analysis of a plot of land on the assumption that there are no buildings on it, even if the site is built up. The method of determining the most effective use of the assessed built-up real estate as an undeveloped land plot is based on the assumption that the plot has no buildings or can be freed from buildings as a result of their demolition. As a result, the cost of land is determined based on the choice of possible use cases that ensure the profitability of real estate, and the selection of parameters for real estate in accordance with a specific purpose.

On this basis, appraisers investigate two situations when analyzing the most effective use of real estate:

1) the site is considered as undeveloped, free from improvements;
2) the plot is considered as built-up.

To calculate the value of the site as undeveloped and suitable for development according to the scheme of the most efficient use, the evaluator should disregard any existing structures and determine the ideal type of structures that can be built. The land is then rated as undeveloped in the most appropriate way.

There are three main reasons for determining the most efficient use of land as undeveloped:

Allocation of the value of the land plot separately in the value of real estate (for example, when applying the cost approach);
- to establish analogues when evaluating undeveloped plots using the comparable sales method (SME);
- calculation of the loss in value due to external obsolescence.

For an already built-up site, the judgment about the most efficient use can be reduced to one of the following conclusions: a) the site must be released from the existing development, deducting the costs of demolition from the estimated income from its more advantageous use;
b) the object must be reconstructed (repaired) in order to generate more income;
c) buildings (structures) should be used for a different purpose;
d) the object should be used for its current purpose without any alteration.

Since the demolition of buildings is still an extreme measure that the investor may have to resort to, because this path usually involves high costs and greater risk (usually income-generating objects are not demolished), the appraiser needs to calculate the optimal use of the site while maintaining the existing buildings. At the same time, having studied market trends, the appraiser can recommend replanning, repurposing, adding to the building or continuing to use it as it was.

The appraiser, comparing the existing use case of the buildings located on the land plot with the optimal building option, should receive an answer to the following questions:

1. Is it advisable to continue to operate the building in its current state?
2. What type of building construction to choose: reconstruction, expansion, partial demolition?
3. How and in what time will the costs be recouped?

The analysis of the most efficient use of the built-up area is carried out for two reasons:

Establishing the type of use of the property that provides the highest total return on capital invested;
- identification on the market of real estate objects of the same purpose with a comparable level of efficiency of use, including the establishment of analogues for the assessment of built-up real estate objects using the comparable sales method (SME).

The most optimal option for using the buildings will ensure the maximum value of investment-attractive real estate, taking into account the rate of return determined in accordance with the risk of the selected option. It is clear that the risks of maintaining the existing way of using the property and the different redevelopment options will not be the same.

In the assessment report, it is necessary to distinguish conclusions about the most efficient use of the site as undeveloped from its NEI as built-up. The report should clearly identify, explain and justify the purpose of the analysis and the conclusion for each identified use.

Special situations in the analysis of NEI

In practice, in the process of considering and identifying the most effective use, it is necessary to take into account special considerations due to the specifics of a particular property. This could be due to a stand-alone, intermediate, legally inappropriate use; multi-profile use of real estate, etc. In this case, the methods of analysis of the most effective use have to be adjusted.

For example, in an area zoned for single-family residential buildings, the best use of a vacant lot might be to build a department store. Of course, this option is only possible if there are no shops in the area, and market analysis shows the feasibility of such commercial use. But such use may be one of a kind, since the construction of the second, third stores will be economically unjustified.

Let us group the variants of special situations arising in the analysis of NEI and consider them in more detail.

Surplus land. It is possible that when determining the most effective use, it will become clear that part of the territory is redundant, i.e. exceeds the economic size of this use case. In this case, it would be appropriate to estimate the excess part of the territory separately, setting its boundaries.

Unique (single) use. Although the most effective use usually has analogues in the district, there are certain types of property that have only one type of use. Sometimes the best use of such property is to continue its current use. For example, it is practically impossible to convert a steel plant for another use.

But a unique use is also possible as the best. Calculating it is not an easy task for an evaluator, requiring particularly convincing argumentation and careful analysis. This may be the first international business center in the region, an amusement park such as Disneyland, or the Yellow Submarine Rock Club youth hotel in a decommissioned Navy submarine.

Temporary (intermediate) use is the current best use, which is likely to change in the future.

In a broad sense, an intermediate use is any current use if:

A) does not correspond to the best use;
b) provides a cost excess of the object as a whole over the cost of the site as undeveloped.

Intermediate use of the undeveloped area is possible. For example, a section of an urban area can be temporarily used as a paid parking lot, although its best use is as a supermarket, which can be built in a year or five years, when a new area is populated nearby or a metro station opens. In anticipation of the development of roads and other infrastructure, favorable financing conditions, settlement of the microdistrict and other conditions, the site may be occupied by hangars (warehouses) or workshops, or vegetable gardens, or garages, or a market, etc.

Use that is not the most effective. What if the NEI of a piece of land as undeveloped differs from the current use of the object?

Valuation theory and practice states that when evaluating a property, improvements should be assessed on a use that is consistent with the NEI of undeveloped land.

Use for special purposes. As a rule, NEI of special purpose facilities with improvements - continuation of their current use, if such use is viable. Use for multiple purposes (complex). Quite often, the most efficient use is a multi-purpose use in which the site will be used for more than one purpose. For example, on a large plot, it is advisable to build a shop, residential buildings, a parking lot, etc. In such cases, the contribution of each use should be evaluated separately.

The best and most effective use is often complex. This applies to both the land plot and the building. For example, a hotel building may have a restaurant, a bar, or a shop. A multi-storey building can house shops, offices, and apartments. The value of these individual elements, as calculated by the appraiser, should not exceed the value of the entire object.

Legally inappropriate use. Suppose that the use of the property for a certain period of time was in full compliance with the current laws and regulations, but they have changed, and the current use is in conflict with the new provisions. This use is called legally inconsistent. When evaluating land with such use, it should be taken into account that current use can provide increased income due to higher intensity of use and, therefore, has a higher value than the comparison object corresponding to zoning. Therefore, a usage adjustment should be made when applying the sales comparison method.

NEI analysis methods

If the land plot is regarded as undeveloped, then, depending on the assessment of the capitalization ratio, three methods can be applied.

The first method assumes that the capitalization ratios for land and buildings are different.

1) Determine the cost of building a conditionally free land plot with buildings and structures of a certain purpose, taking into account market demand and supply;
3) make amendments taking into account the load factor and losses during collection of payments;
4) determine the possibility of obtaining and the amount of other income;
5) estimate the actual gross income;
6) calculate operating costs;
7) calculate reserves for capital expenditures;
8) calculate net operating income;
9) calculate the capitalization ratio for buildings;
10) estimate the income generated by the constructed buildings and structures;
11) determine the income attributable to the land;
12) calculate the capitalization ratio for the land plot;
13) estimate the value of a land plot by capitalizing the income brought by land.

The second method also characterizes the land plot as undeveloped, but the capitalization ratios for buildings and land are the same.

To obtain a conclusion about NEI, you must:

1) determine the cost of building a conditionally free land plot with buildings and structures of a certain purpose, taking into account market demand and supply;
2) calculate potential gross income;
3) make amendments taking into account the load factor and losses during collection of payments and the amount of other income;
4) estimate the actual gross income;
5) calculate operating costs and capital expenditure reserve;
6) calculate the total net operating income;
7) calculate the total capitalization ratio for the appraised property;
8) evaluate real estate by capitalizing the net operating income generated by real estate;
9) estimate the value of the land plot as the difference between the estimated value of the property and the cost of improvement.

The third method assumes that the land plot is considered undeveloped and the market price of the sale of the property for the intended purpose is known.

To obtain a conclusion about NEI, you must:

1) determine the market value of a finished property for a specific purpose, which can be built on the analyzed land plot;
2) calculate the cost of construction and add the developer's profit;
3) estimate the value of the land plot as the difference between the selling price of the real estate object and the total costs.

If the land plot is considered built up, then two methods are used.

The first method - the land plot is considered as built-up, the buildings require some improvements.

In this case, the following calculations must be performed:

1) calculate the net operating income generated by real estate;
2) determine the overall capitalization ratio;
3) assess the value of real estate by capitalizing net operating income;
4) calculate the cost of improving the facility;
5) calculate the increase in the value of real estate, taking into account the improvements made.

The second method - the land plot is considered as built up, but does not require restructuring.

To obtain a conclusion about NEI, you must:

The application of the above methods of analysis of the NEI of real estate is associated with a large volume of calculations, therefore, in the Russian appraisal practice, the method of qualitative analysis of possible options for using the appraised real estate is used. This method is based on a qualitative assessment, expressed in points, of the parameters of the property being appraised in terms of their compliance with the possible options for using the property.

A qualitative use-case analysis method includes:

1) analysis of the territorial real estate market to identify competitive use cases;
2) an assessment of the parameters of the object from the point of view of their suitability for each considered option;
3) preparation of a reasoned opinion on the most effective use of the appraised real estate.

The use case with the highest total score is considered the most effective.

The standard best practices analysis discussed above applies to all types of real estate. However, in the process of considering and identifying the most effective type of use, it is necessary to read out the specifics of a particular property. In this case, the considered methods of the NEI analysis may need to be adjusted.

Topic 3.2 Analysis of the best and most efficient use of land as free. Analysis of the best and most efficient use of land as improved

Topic 3.1 Concept of the best and most effective use

Section 3. Analysis of the best and most efficient use of real estate

The procedure for identifying and justifying the alternative use of property that ensures the most productive use is usually called analysis of the best and most efficient use of real estate (NINEIN).

NiNEIN - ϶ᴛᴏ probable use of vacant land or property with improvements, ĸᴏᴛᴏᴩᴏᴇ:

1) Is legally permitted (ᴛ.ᴇ. complies with legal regulations, including zoning and environmental protection regulations, town planning regulations);

2) Physically feasible (the size and shape of the land plot, its transport accessibility, utilities, existing buildings allow the chosen use case to be implemented);

3) Financially sound (use of the property provides income in excess of capital costs, operating costs and financial obligations);

4) Provides the highest real estate value or yield.

The NiNEIN analysis is carried out, firstly, for a plot of land as free and, secondly, for a plot of land with existing improvements.

There are the following main reasons for NNEI's definition of a piece of land as undeveloped:

1. allocation in the value of real estate only the value of the land plot;

2. the use of comparable sales methods for valuing built-up land;

3. calculation of the loss in value due to external obsolescence;

4. assessment of the real value of land in the composition of the property, which is not optimal for this site.

The NNEI analysis of the built-up area is done for two reasons:

1) identification of the type of use of the property that provides the highest return on capital invested;

2) identification on the market of real estate objects of the same purpose and with a comparable level of efficiency of use.

When making the final choice, NiNEIN is guided by the provisions:

If the value of the property with improvements is greater than the value of the plot without improvements, then NINEI will use the property with improvements;

If the cost of a vacant plot exceeds the cost of a property with improvements, then NINEI will use the land as vacant.

There are 2 basic options for using a plot of land as undeveloped:

1. Use of a plot of land for speculative purposes.

2. Development of a land plot with new buildings and structures, including:

Development without intermediate use. If a new use case is being considered, accepted by the market on the date of analysis;

Development with intermediate use. Assumes the temporary preservation of the existing use case until the moment the new option is demanded by the market, based on the forecast of the market situation;

Division or consolidation of land plots to achieve NINEI;

Development of the site with new buildings, similar in purpose and functional parameters to the existing object.

The main task of this analysis is to answer the following questions:

If the land is or will be free, then how should it be used?

What type of building or structure should be built and when?

Should an existing use be considered as an intermediate use?

For the first question, it is extremely important to analyze not only the current state of the market, but also to predict its changes for the future, since the cost is determined by the potential of the land plot. It is necessary to take into account that the functional zoning may change, there may be a transfer to another category of land, etc.

In addition to the nature and timing of the improvements, the specific type of improvement should also be identified.

Often the built-up area is analyzed as if it were free. In this case, the task of the analysis is to determine the effectiveness of the current use and associated further use. As if a vacant site is considered from the point of view of building a building similar to the existing one.

The criterion for the NNEI of a land plot as vacant is the maximum residual value of the land.

The option for using a plot of land as built-up has 2 main types:

1. Preservation of the existing purpose of the appraised property;

2. Change of the existing purpose of the appraised property.

In both cases, it is considered:

It is extremely important to maintain and maintain the existing volume and quality of services provided by real estate;

Conducting construction work on the reconstruction of buildings to improve their class and change the rental rates,

Conducting construction work to expand the area due to additional construction or construction of additional floors;

Reduction of existing areas due to partial demolition.

The main task of this analysis is to answer the questions:

1) Is it advisable to continue to operate the building in its current state;

2) Which restructuring option to choose (reconstruction, expansion or partial demolition);

3) How and in what time frame will the costs be recouped.

NINEI property as improved - ϶ᴛᴏ using it if there are existing improvements. The analysis should provide recommendations for the further use of the property.

The criterion of the NNEI property as improved is the maximization of the property value at a suitable long-term rate of return and the amount of risk.

In practice, if options do not involve the cost of reconstruction and modernization, then they can be compared directly with each other on the basis of the present value of future income.

In the event that the costs of conversion or reconstruction are required, the comparison of options can be made on the basis of the net present value or the internal rate of return of the reconstruction project of each option.

Topic 3.3 Finding options for the best and most effective use of real estate

In the conditions of the formation and development of the economic market in Russia, the search for new ideas and options for the use of real estate becomes especially important in assessing the market value.

Most of the objects for which it is required to determine the market value, in the current functional purpose, do not provide their owners with adequate utility determined by the average market level of profit.

Practical experience shows that in the overwhelming majority of cases, only a new functional purpose, reflecting the current needs of market demand, allows a particular object to successfully compete in the real estate market. It is in this regard that the analysis of NINEIN in Russian conditions becomes the main element of the market value assessment procedure, largely determining the value of the final result.

The first step in the analysis of NINEI real estate is to search for possible options for functional use, which can significantly change the positioning of the object of assessment in the real estate market.

For a targeted search for real estate use cases, you can apply the methodology developed in investment analysis for similar purposes. The essence of the methodology is essentially that the alternative use should be determined based on the existence of the following basic assumptions:

1) the presence of minerals or natural resources;

2) the possibilities of the existing structure of agriculture;

3) the possibility of changing the structure of supply and demand as a result of the influence of demographic or socio-economic factors;

4) the possibility of using the export-import and investment policy of the state;

5) experience of using real estate in other countries with similar conditions;

6) opportunities for diversification of existing business:

7) the possibility of expanding the scale of production.

Despite the fact that such a classification is of an enlarged nature, it allows you to analyze the options for using real estate quite effectively.

Topic 3.2 Analysis of the best and most efficient use of land as free. Analysis of the best and most efficient use of land as improved - concept and types. Classification and features of the category "Topic 3.2 Analysis of the best and most efficient use of land as free. Analysis of the best and most efficient use of land as improved" 2017, 2018.