Highest and best use, site valuation, and the three approaches to value

Start with the use

Highest and best use is the reasonably probable use that is legally permissible, physically possible, financially feasible, and maximally productive. Test all four, not just which proposal promises the most revenue. Zoning and private restrictions affect legal permissibility; size, shape, access, and soil affect physical possibility. Feasibility asks whether expected benefits justify costs. Maximum productivity selects the feasible use producing the highest value. Analyze land as though vacant and the property as improved; an existing building may warrant continued use until redevelopment benefits exceed demolition and redevelopment costs.

Value the site

Site valuation commonly compares sales of similar vacant sites, adjusting for location, size, utilities, access, and permissible use. Compare on a suitable unit, such as price per square foot. When vacant sales are scarce, extraction subtracts the depreciated value of improvements from an improved property's sale price; allocation estimates land value using a supported land-to-total-value ratio. These methods require market support.

Three approaches

The sales comparison approach uses recent comparable sales and the principle of substitution. Adjust each comparable to the subject: subtract for a comparable's superior feature and add for an inferior feature. Do not adjust the subject to match the sale.

The cost approach estimates site value plus current replacement or reproduction cost of improvements, less accrued depreciation. Replacement supplies equivalent utility; reproduction creates a duplicate. Depreciation includes physical deterioration, functional obsolescence within the property, and external obsolescence caused outside it. Land is valued separately and is not depreciated in this calculation. This approach can be especially useful for newer or special-purpose improvements.

The income approach converts anticipated benefits into value. In direct capitalization, value equals annual net operating income divided by the capitalization rate. Net operating income reflects vacancy and operating expenses, but excludes mortgage debt service and income taxes. For example, $60,000 divided by 0.06 indicates $1,000,000. A gross rent multiplier instead uses gross rent, not net operating income; match monthly or annual rent to the multiplier's basis.

Reconcile the evidence

Weight each applicable approach according to the property and the quality of its data; reconciliation is not an automatic arithmetic average. Income evidence often matters most for investment property, while comparable sales often matter most for owner-occupied houses. These are appraisal principles, not guarantees that one method will dominate every assignment. Federal appraisal law applies in New York to federally related transactions: 12 U.S.C. § 3331 describes written appraisals under uniform standards by competent, supervised individuals. Section 3350 defines a written appraisal as an independent, impartial, date-specific value opinion supported by relevant market analysis.