Highest and Best Use is More Than Just a Check Box

This originally appeared over the Appraisal Buzz on Wednesday, December 3, 2014

http://appraisalbuzz.com/buzz/features/highest-and-best-use-is-more-than-just-a-check-box

As review appraisers, one of the issues that we see all the time is the failure to analyze highest and best use for a market value opinion related to mortgage lending appraisals. This makes sense to a large degree, because many appraisers believe that providing the “yes” answer relieves them of further analysis and communication. We wanted to address this topic and offer some insight as to why one may want to rethink their approach to this common issue. In that light, we thought that we would look at a key part of the valuation process, but one that often gets overlooked in residential reporting: Highest and Best Use. With the majority of reports being written on pre-formatted reports from Fannie Mae, many appraisers skip over this section as nothing but a box to check.

A required characteristic of any valuation professional is the ability to learn, and not just occasionally, but to continuously do so through one’s career. Look at any successful appraiser that you know; chances are that he or she makes time for classes. Many of the leaders in the profession are even known to write course work or review it for publication. So do not look at this article as us telling you that the sky is falling, but rather as a perspective that many of us have adopted in our evolution as valuation professionals. I know that we both will periodically look back at past work and reevaluate how we approached a specific problem. After all, as we learn and experience more, we learn new ways to do things or ways to improve upon what we already do. The goal is continual improvement.

As appraisers, we are by nature opinionated. We have a tendency to believe our way is the only way, or the best way, and although we may expect perfection, none of us come into the world knowing how to appraise. Appraisal learning is life-long, and perfection is not possible, although we strive for it by continuing to have an open mind to gaining new insights. The Uniform Standards of Professional Appraisal Practice (USPAP) even addresses that perfection is impossible to attain, and competence does not require perfection.1 The Standard Rule 1-1 (a) comment also addresses how the principle-of-change it continues to affect the way that appraisers perform their work.2 These items are under the development standard with which we all abide, and are the set up the point we are making – which is that none of us are perfect, and hopefully we all simply try and improve our skillset, each and every day.

The Valuation Process is an eight-step procedure that starts with the identification of the problem to solve; flows on to the determination of the appraiser’s scope of work; data collection and property description; followed by data analysis (see figure 1). Data analysis includes the market analysis as well as the Highest and Best Use Analysis – considering the land as vacant; what the ideal improvement would be, and the property as currently improved. Next, is the land value opinion; application of the approaches to value; reconciliation of the valuation approaches as well as a final opinion of value followed by the reporting of that defined value.

Clearly, the data analysis section requires a highest and best use analysis related to a market value opinion. This is also succinctly addressed in The Appraisal of Real Estate, 14th Edition on pages 42-43 for further reading.3

Figure 1: Courtesy of the Appraisal Institute (used with permission)

The 1004 form, which is the most common report form for residential mortgage assignments, specifically asks the question “is the highest and best use of the subject property as improved (or as proposed per plans and specifications) the present use?” followed by a check box for yes or no, and if no to describe (see figure 2).

Figure 2

4

As Standard 1-3 (b) in USPAP exhorts us to develop an opinion of highest and best use of the real estate when a market value opinion is developed (page U-19 2014-2015 USPAP), and Standard 2-2(a)(x) states specifically “when an opinion of highest and best use was developed by the appraiser, summarize the support and rationale for that opinion” (page U-24 2014-15 USPAP), checking the box without any further discussion is not adequate. Perhaps it is the lack of description in the box next to “yes” that throws appraisers off, but USPAP is clear that when it is developed, a summary for the opinion is required.5

To even start to address Highest and Best Use, the appraiser needs to have at least visited the zoning ordinance to not only understand what is an allowable use, but also what the minimum site size requirements are; what width is required; what the setbacks are, etc. Often we see zoning mislabeled, and more often than not, no information about what even the minimum site size is for the use. Without this basic information, it is not possible to start analyzing the highest and best use.

Discussing this issue with some appraisers online it was apparent that many do not believe any additional summation is required in the form other than checking the yes box, with the argument that as zoning is reported as either legal or not, meets the legally permissible criteria. That a house is built (or proposed) tests the physically possible criteria, and that reporting of functional depreciation in the cost approach or sales comparison approach addresses overall conformity and therefore financial feasibility, and that finally the remaining economic life provides for highest and best use as currently improved. While this may seem like a reasonable argument, we do not believe it is sufficient for a number of reasons, including it being nothing but an executive summary of real work and does not rise to the level of summation.

In addition, when doing work for a lender client, one must ask, “What is the purpose of this report?” The obvious answer is to determine market value, but the lender uses it as a risk assessment tool. They are trying to ascertain if the property is atypical to the market in any way and if so, how does that affect the value, and ultimately the ability to free them of the collateral in the event the loan goes sour. While an appraisal cannot answer that question in the entirety, it does help them assess their full risk by lending on a specific property.

Since the majority of appraisal work related to mortgage lending completed on form reports is for an improved property, much of the time the conclusion is that the highest and best use of the real property is that which is already in place. How difficult is it to flesh out a short paragraph related to this analysis? Given what we are seeing on a routine basis, it is apparently a monumentally difficult task given that it is rare for us to see anything beyond the “yes” check box.

What we are suggesting is that appraisers take a few extra minutes to summarize the highest and best use analysis. It can be done in as little as a sentence, but usually no more than a paragraph. One of the biggest reasons that we suggest it is that it will force you to slow down and look at your data. There have been instances where one of the authors has found out that some appraisals under review were in an illegal or a legal non-conforming use. During the review, it was discovered that the appraiser did not stop and do the analysis or did not really understand that they should look at it or report it. This puts a lender in a sticky position as they may have to shelf the loan and will not be able to sell it on the secondary or worse, have to buy it back.

In such instances, it may require several pages to support the highest and best use. Once it becomes something more complex, due diligence is paramount. The biggest reason appraisers should care about this is that it puts the appraiser in a more defensible position if something awry happens down the road with the loan. By attempting to address this directly up front you are less likely to be discredited for skipping or going too quickly through a section of the report.

One of the authors has done litigation review work where this specific issue was used by the attorneys as part of their strategy to discredit the appraisal report. In litigation, attorneys will often go to the fundamentals to challenge the appraiser’s work. To a judge or a jury it easy to make the connection that if the report is short on a fundamental concept then it is easy to assume it is also short on the section most scrutinize the heaviest, the sales comparison approach. We have both seen reports that have great sales comparison approaches, but little else in the way of a well-written report. Those are the reports that can hurt you in situations where you must defend your work.

So there you have it folks. A seemingly simple thing that really is not so simple. If anything, we hope this offers you something to think about when you are writing your reports and developing the analysis. We are sure this will create some interesting comments as well. Please feel free to share your thoughts as discourse helps us all learn more.

– See more at: http://appraisalbuzz.com/buzz/features/highest-and-best-use-is-more-than-just-a-check-box#sthash.kXUgU1Qb.dpuf

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About woody22911

I am a professional assessor/real appraiser by trade; I manage a staff of 13 people. I have a bachelor of science in business admin and an associates in culinary arts. I am looking into a masters in public policy/public administration. I am also a musician, a father to three kids and I attempt to write. I have Diabetes II as a result from a condition that causes my body to produce unusually high triglycerides. I have been hospitalized with acute pancreatitis four times over the last 15 years. This particular blog is an attempt to document my successes and failures to fix the problem through nutrition and activity.

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