Highest and best use
A manual for a new model of value creation
Gabriel Townsend DarriauPERC498 2020Embedded Files
Real estate capital roams the city with an appetite for land value. It is highly mobile. Ironically, its method for extracting land value is to build immovable structures: that is to say, to extract value, value must be produced. This is capital investment.
In real estate, all land must be valued at its ‘highest and best use’. The notion is fundamental to the model of real estate development. Here, what is 'highest' and 'best' is determined by land's potential to return value on capital investment.
...
In the spring of 2020, a small-time local developer - HBU Immobilier - reflects on the model. They find inefficiencies and lost opportunities in it. They ask questions like: "If someone builds a modest structure on high-value land, how does real estate react? What other kinds of value are there and how does land respond to them? How does a memory or an experience create value in a real estate economy?"
In the summer of 2020, HBU builds a structure. They call it 'the pavilion'.
The pavilion is mobile: light, with a simple design, easy to build and unbuild - essentially the bare bones of a shed. The pavilion's purpose is to offer gifts to passers-by.
HBU believes in the principles of effective value capture, and so they set out into the city with the pavilion as their tool to improve under-developed private lands to their highest and best use. They pick out a site, set down the structure and operate it for a brief period.
As the pavilion makes its offerings to the public, HBU is careful to take note of the value generated, so that they can make informed speculations on the next site to tap.
What follows is a manual for a new model of value creation.
- The pavilion
HBU and its pavilion haunt the city, seeking to graft their project to valuable land. A sign hanging outside the pavilion advertises a gift: it could be a coffee, a smile, or a story. The gift is served to passers-by:
"Hello. What is this?"
“Hi! We're here activating this space's untapped value. Would you like a free coffee?"
"Sure! But I don't get it."
"We figure that this space has a lot more to give than it currently does. We think the land could benefit from being used to its fuller potential! Basically, we're trying to make something nice for the people who walk by here every day. Take a minute to enjoy the coffee. And let us know your feelings about the project before you leave!"
The pavilion taps a new kind of value. Land value is created by the market, who first perceives it, then consents to a price to represent it. The pavilion extracts this value encased in the land and, as it offers gifts, it transfers value back to the community who originally construed it.
2. Guest book
2. Guest book
But the developer is shrewd and knows the true worth of a gift. In reality, the pavilion generates as much value as it extracts. HBU can't let this value go uncaptured.
Real estate value is estimated according to the price that people are willing to pay. People perceive a property’s value in terms of utility, desirability, and scarcity and then identify a price point that reflects this perception [i]. In the pavilion’s case, where objects of value are given away for free, the developer would have no price point by which to observe value, and thereby evaluate the pavilion’s contribution to the site. HBU finds a solution quite easily though.
Once they've enjoyed the gift, visitors are invited to leave a note in a specially prepared 'guest book'.
The guest book captures value perception. As records of market perception in a real estate economy, the feedback written in the guest book is the raw data that HBU will use to estimate the value generated on site.
3. Sites
3. Sites
The clickable map below details proposed sites for the shed's itinerary through the city.
Any site is under-valued
Any site is under-valued
HBU installs the shed on a vacant lot: other than the pavilion, what else does the land have to give? The pavilion is likely to be the highest and best use that the land has seen in a long time.
But HBU is set on bigger targets: just because a property is already being used doesn’t mean it’s reached its full potential. After all, the shed isn’t strictly about activating undeveloped spaces. It’s about asking the question: what is 'highest and best'? The pavilion can just as well improve already-'improved' land.
Itinerancy
Itinerancy
Like the pavilion, many people drift, seeking, often with great difficulty, to make roots in a city bursting with value, but increasingly devoid of meaning. HBU shrewdly speculates on this quest for attachment by employing itinerancy itself. They pluck property value out of its static state. They make it flexible, experimental, searching.
4. "Highest and best use"
4. "Highest and best use"
Highest and best use is defined by real estate professionals as:
“The reasonable, probable and legal use of vacant land or an improved property, which is physically possible, appropriately supported, financially feasible, and that results in the highest value.” [ii]
In real estate economics, highest and best use is extremely useful for explaining the behaviour of players in the land market. It encapsulates the important idea that property investment should always seek the greatest return from the land. [iii]
The Sponge
The Sponge
A piece of land is a sponge. It absorbs and retains value. Capital investment, known as 'improvement', applies pressure, like a weight. The weight squeezes value out of the sponge. The more capital invested, the more weight pushes downward, and the more value is extracted.[iv]
However, the relationship between capital investment and value extraction is non-linear. If the first unit of capital invested squeezes out 5 units value, then the 1 millionth unit of capital may only squeeze out 2 units of value, and the 10 millionth may squeeze out only 0,5 units. There is an equilibrium to be achieved in the game of value extraction. The highest and best use of a piece of land is that which achieves the greatest value for the capital invested.
The pavilion's response
The pavilion's response
HBU asks: "why stop at the point of equilibrium? In the strictest terms, when conventional real estate says 'highest and best', it actually means 'optimal and most economical'... The current understanding of 'improvement' is shallow. What other kinds of investment can pursue value extraction well beyond the point where the building has been built?"
5. Evaluative method
5. Evaluative method
The collection of entries in the guest book is HBU's database. But it still can’t help them evaluate the pavilion’s worth. HBU needs to know the value in dollars. This is what will allow them to accurately compare the value created between sites. The value of the sites themselves is expressed in monetary terms, and so the gift value must be converted. HBU develops an evaluation model that allows them to crunch gift value into dollars.
The table above presents one possible model. Here, the base metric is positive/negative connotation in linguistic expression.
Each guest's entry in the guest book is broken into clauses.
Each clause is analyzed for positive or negative expression (e.g. "This is good" or "This is bad")
Each clause receives multipliers based on qualifiers present (adjectives or adverbs such as "amazing" or "horribly"). This results in the clause score.
The clause scores are added to get the entry score, which refers to the guest's full comment.
The entry score receives multipliers for the number of exclamation marks and other kinds of emphasis used.
The entry score receives a final multiplier based on the expected number of days that the memory of the experience will last in the guest's mind. This number is calculated from the entry score itself: the higher the score, the longer the staying power.
Under this model, for a hypothetical "Site 1" with 5 visitors, the value generated is evaluated at 669,00 CAD.
Affect and improvement
Affect and improvement
The 6th step in the manipulation of the guest book data is based on a premise: that the memory created for the guest continues to generate value beyond the moment that the gift is offered. Similarly, HBU believes that improved land isn't finished creating value. Improvement goes much further, beyond real estate production in the strictest of monetary terms. Private land is not at its highest and best. No land is off limits.
Endnotes
Endnotes
[i] Ozdilek, Unsal. Fondements pratiques de l’immobilier. Québec, Presses de l’Université du Québec, 2014.
[ii] “Highest and best use.” Duncan and Brown Real Estate Analysts, n.d., www.duncanbrown.com/highest-and-best-use.
[iii] Ozdilek, Unsal. Fondements pratiques de l’immobilier. Québec, Presses de l’Université du Québec, 2014.
[iv] Ozdilek, Unsal. DSR4980 : Éléments d’évaluation. 28 Jan. 2020, Université du Québec à Montréal, Montréal. Class lecture.
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