THE REASONABLY PROBABLE STANDARD IN HIGHEST AND BEST USE ANALYSIS Implications for eminent domain

BY ROBERT M. GREENE, CRE, MAI, SRA, Ph. D

An easily overlooked portion of the definition of highest and best use is the three-word phrase, “reasonably probable use.” The most recent edition of The Dictionary of Real Estate Appraisal defines highest and best use as “The reasonably probable use of property that results in the highest value.” This standard became common during the late 1970s and early 1980s, and its adoption paralleled the change of market value definitions from “highest price” to “most probable price.” Since then the phrase has been widely adopted in the literature of real estate valuation and eminent domain case law. (For a complete history, see Nichols on Eminent Domain, the legal profession’s basic compendium on eminent domain.)

32 Right of Way MARCH/APRIL 2019 A Countermeasure should be considered to the extent a property’s potential for such use The reasonably probable standard, affects its market value.” when properly applied, is an effective countermeasure against valuation The Appraisal Institute defines based upon speculative uses that highest and best use as the unreasonably inflate the estimate of reasonably probable and legal use market value. For example, a hayfield of vacant land or an improved located on the edge of town might property that is physically legally be developed with a high-rise possible, appropriately supported, office tower or a regional shopping financially feasible and that results center with correspondingly high in the highest value. In practice, land values, but is either of those reconciliation of the Appraisal uses reasonably probable? Institute definition with the Yellow Book guideline is best accomplished Less understood but equally through thoughtful consideration important is that the reasonably of what the market is advising probable standard is also concerning the reasonably probable a countermeasure against use. undervaluing that same hayfield based upon its current or previous A Protocol for Evaluation use as a hayfield. The reasonably probable standard protects equally Challenges in applying the against the speculation of excess reasonably probable standard optimism and the speculation of arise in the case of properties excess pessimism. Speculation itself undergoing transition. Examples is not bad; it is the very nature of include transitional properties real estate investment. However, if that lie immediately outside the appraiser relies on evidence of an existing boundary (such as reasonably probable use provided by city limits or an urban growth market participants, the appraiser boundary) or properties in evolving is not speculating at all. Instead, the neighborhoods that have retained appraiser is evaluating the credibility an outdated zoning. This includes and the creditability of the market industrial zoning in an area indicators. where surrounding zoning and development (often redevelopment) Reviewing Definitions are commercial or mixed-use commercial and residential. The Uniform Appraisal Standards for Because the evaluation of highest In the valuation of properties in Federal Land Acquisition (UASFLA and best use that is different from relatively stable markets, reasonably or “Yellow Book”) is sometimes a property’s previous or existing probable use is easily ascertainable. thought to be antagonistic toward use falls upon the appraiser, the However, in markets that are the concept of speculation, but that following provides some guidelines undergoing transformation, the is not actually the case. Although and procedures for consideration of estimation of reasonably probable the current edition acknowledges reasonably probable use. use presents a unique challenge to that “a property’s highest and best the appraiser, who must expand use is ordinarily its existing use on Organizing a clear and logical his or her investigations and make the date of value,” it goes on to say analysis of reasonably probable use judgments—based on market that “courts describe this precept as can benefit from grouping the issues evidence—beyond the scope of work a presumption in favor of a property’s into categories: physical factors, of the everyday assignment. The existing use; others simply regard an legal factors and feasibility issues. following provides some background existing use as ‘compelling evidence In the normal order of highest and and suggests a possible protocol for of highest and best use when a best use analysis, physical and legal assignments where the reasonably different proposed use is asserted.’” factors precede feasibility analysis. probable standard requires special Yellow Book concludes, however, But in the case of transitional care, research and judgment. that “any reasonably probable use properties, feasibility issues

MARCH/APRIL 2019 Right of Way 33 (changes in demand and the profitability on site, the costs and feasibility of of alternative uses) are the driving providing them—including their factors that create changes in reasonably cost, the length of time required to probable use. make them available and any other obstacles to their development—need • Feasibility to be considered in the valuation. It should be remembered that If a deduction is to be made in the feasibility is the true engine of valuation or in the feasibility analysis, reasonably probable use. It is it needs to include hard costs, soft the motivation of possible profit costs and appropriate recognition of that puts pressure on the market risk in accounting for delays. to change a neighborhood or a property from one kind of use • Legal Factors to another. There is a spectrum Legal factors include any legal In my experience, of levels of feasibility analysis. requirements that may be Inferred analysis, which relies on impediments or enablements to the most extrapolating trends from general a proposed use. This analysis, market data, is more common however, is not strictly a legal and is often adequate in stable criterion. Attorneys and government common failure markets. However, fundamental bureaucrats may adopt the most analysis—which quantifies pessimistic outlook in analyzing demand and supply in light of legal issues. In times of transition, in the analysis projected and quantified data for however, a strong motivation market trends such as population for change is revealed by good growth, household and per-capita fundamental market analysis. “This is of reasonably income, and other economic the way we’ve always done it” is not a and demographic factors—is the valid argument. most persuasive kind of feasibility probable use analysis. Fundamental analysis An analysis of reasonably probable is best explained in Stephen F. use should also consider the arises when an Fanning's classic text, Market experience and testimony of typical Analysis for Real Estate: Concepts purchasers for the property type and and Application in Valuation and use in question. This may include appraiser fails to Highest and Best Use. developers, brokers and investors, who should be interviewed and In stable markets, most appraisers whose observations should be carefully consider rely on inferred analysis. The scrupulously transcribed, accurately appraiser surveys surrounding recorded and cited in an appraisal properties and makes an inference report. To repeat, buyers and sellers— the likelihood of that the kind of use available for the typical buyers and typical sellers for subject property will be consistent the type of property in question—are with nearby and surrounding uses. the ones who determine what use is change. reasonably probable. In areas of transition, however, the uses of surrounding properties are In my experience, the most common in the process of becoming obsolete. failure in the analysis of reasonably Therefore, a fundamental demand probable use arises when an appraiser analysis will provide sound support fails to carefully consider the for reasonably probable use. likelihood of change. The appraiser assumes that because the change has • Physical Factors not yet happened, he or she must A reasonably probable use must treat it as though it cannot happen. It meet all the criteria of what is is the responsibility of the appraiser, physically possible, including size, however, to make an informed and shape, topography, availability of educated estimate of that likelihood. utilities and location. If a proposed The source of that judgment—and the use will require utilities or other research it requires—is the subject of amenities not presently available the next section of this article.

34 Right of Way MARCH/APRIL 2019 Because the reasonably probable • On the demand side, a typical standard is frequently associated purchaser has similar options. with issues of speculation, it is The would-be buyer can useful to consider a court case make a lower offer and if that is approvingly cited in the the seller declines, the buyer Uniform Appraisal Standards for can: 1) withdraw the offer; or Federal Land Acquisition. “While 2) raise the offer. In no case market participants may speculate, is a purchaser obligated to appraisers cannot. The finder of fact purchase. must not, itself, speculate, i.e., guess, about potential end uses or markets However, in eminent domain cases, when the speculation is so remote the self-correcting mechanisms of or improbable that one would not the market place are suspended. invest his money in it.” (Fla. Rock The appraiser’s assessment of Indus., Inc. v. United States) reasonably probable use—and the value appropriate to that use—is The important point here is an important safeguard available to that market participants are the the property owner and also serves ones who determine what is as protection for the condemnor. For more information, please visit reasonably probable. The appraiser’s In short, the appraiser’s proper www.appraisalfoundation.org responsibility is to evaluate the observance of the reasonably market evidence. A rigorous probable standard is a protection for application of a thoughtful protocol all parties participating in this effort for estimating reasonably probable to estimate market value for just use, including research into the compensation. J thinking of the relevant market Finally, the last step in estimating participants, can provide an reasonably probable highest and best efficacious framework for insulating use is to analyze which one or more the appraiser from charges of of the possible uses that have passed inappropriate speculation. the tests of physical possibility, legally permissibility, and feasibility is the most profitable use. In transitional In Summary areas, this requires fundamental supply and demand analysis. Eminent domain requires special attention to the reasonably probable Who Decides? standard because condemnation short-circuits some of the How does the appraiser assess what protections for the property owner is reasonably probable and, more that are inherent in an otherwise importantly, who determines what free and open market. is reasonably probable? Because feasibility in a changing market is • If a property owner has an driven by its participants—buyers, unreasonably high estimate of sellers, developers and investors— the value of his or her property, they are the ones the appraiser should he or she can offer it on the consult. They should be interviewed market on that belief. If there Robert M. Greene is the Chief Appraiser (with their interviews transcribed) are no offers or if the offers are for the State of Washington Department of Natural Resources, which oversees more and their experience, opinions and unacceptably low, the property than five million acres. Prior to his present judgments should be included, owner has three choices: 1) position, he was the President of G&A considered and evaluated in the lower the asking price; 2) Valuation, Inc.,Director of Litigation Support appraiser’s analysis and conclusions. decline the offer and wait for a Services for Integra Realty Resources— Those sorts of interviews are not better one; or 3) take it off the Portland, Director of the Real Estate always conducted by appraisers in market. In no case—except for Advisory Group for the Chicago office of the ordinary course of business, but duress, which is excluded in Stout, Risius, Ross, Inc., and an appraiser in the offices of MaRous and Company. From they are essential to establishing estimates of market value—is 1983 to 1996, he owned and operated Robert reasonably probable use for properties a property owner compelled M. Greene and Associates, a real estate undergoing transition. to sell. appraisal firm in Kalamazoo, Michigan.

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