There are several ways that real estate investors determine the value of a property. One common and simple approach is comparing the sale prices or rental rates of similar homes. Another is projecting the return on investment based on projected rental income compared to other investments, such as bonds. A third is the possible rental income relative to the initial investment. However, there is one method often overlooked by new or smaller real estate investors based on the property’s cost versus its highest and best use.

What is a property’s highest and best use? Essentially, it is the most reasonable and probable use of a property, which, when financially feasible, appropriate, and physically possible, brings the highest value. Moreover, in addition to being physically possible, it is important to determine if changes to the property’s use are legally permissible, determining zoning limitations, and the surrounding land uses. One example is discovering if it is legally and physically feasible to build a residential subdivision on land currently in use for agriculture. However, this process does not have to be this dramatic and can apply to smaller investors.

Another example is a large two-bedroom unit that could easily be transformed into a three-bedroom. This can potentially increase the unit’s rental rate and the property’s true market value. There is also the example of a residual property located in a predominantly commercial or industrial area. While the property’s existing market value may be equivalent to similar houses in other areas, the best use and therefore the highest value is working to convert the property and change the zoning.

The bottom line is that a serious real investor will work to squeeze the most value out of a property, and this includes determining its highest and best use. What brings the most profit? What will generate the greatest rental income, the best potential selling price, and the greatest return on investment?

Do you have questions? What haven’t we covered yet that is important to you? If you would like to talk about what “highest and best use” means for a real estate investor, or a related topic, please contact us.