The real estate market moves in cycles. When times are good, new projects are easy to justify—whether the land use is residential, commercial, or something else. But when the economic times are uncertain, the best use of a property is not always clear. In the Houston area, where the local economy has been adversely affected by low oil prices, land owners and developers are still moving forward… but cautiously. Projects currently underway are being closely scrutinized while future planned developments are being re-evaluated. Determining the highest and best use for an undeveloped (or under-developed) property is always important, but in a challenging local real estate market, it is absolutely essential.
By definition, the highest and best use of undeveloped (or under-developed) is made up of the four following criteria:
1. Physically possible
2. Legally permissible
3. Financially feasible
4. Maximally productive
1. Physically possible
2. Legally permissible
3. Financially feasible
4. Maximally productive
The first three criteria typically act as constraints, limiting the number of options for a property. After these options have been narrowed down, the final criterion, productivity, is largely a function of market support. In essence the question is, under current market conditions what type(s) of development are feasible and will bring the most value to the property owner?
The research process which answers this question focuses primarily on the economic demand in the area surrounding the property. First, market areas are delineated for each potential land use. Population characteristics, employment activity, mobility patterns, and other demographic trends are carefully analyzed and related to each land use. Next, it’s important to provide a clear picture of the competition for each land use, with a focus on performance levels which can help determine the level of existing demand (i.e. occupancy, inventory, rents, lease rates, etc.). Several sources are utilized to gather this information including real estate publications, reporting services, field visits, customer/client surveys, and interviews with industry professionals. With the level of demand quantified, the return on investment and rate of absorption for each potential land use can then be estimated and compared.
The research process which answers this question focuses primarily on the economic demand in the area surrounding the property. First, market areas are delineated for each potential land use. Population characteristics, employment activity, mobility patterns, and other demographic trends are carefully analyzed and related to each land use. Next, it’s important to provide a clear picture of the competition for each land use, with a focus on performance levels which can help determine the level of existing demand (i.e. occupancy, inventory, rents, lease rates, etc.). Several sources are utilized to gather this information including real estate publications, reporting services, field visits, customer/client surveys, and interviews with industry professionals. With the level of demand quantified, the return on investment and rate of absorption for each potential land use can then be estimated and compared.
An example of how drive times can be used to create market areas for comparison.
While real estate market cycles are often expected, even the most experienced practitioners are not able to predict when they will start, how long they will last, and how severe they will be. As uncertainty grows, confidence in demand for certain types of development wains. The golden rule for a successful project is usually location, location, location. But in uncertain times, the highest and best use of the property must also be considered.
About the Author: Kent Dussair founded CDS in 1971 for the purpose of providing professional market and economic research and consulting services. With over 50 years of professional experience, Kent continues to help CDS implement and evaluate effective qualitative research.
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