Highest and Best Use

The highest and best Use (HBU) in real estate is an important method to determine the best use for a piece of land. The method is based on the notion that the best use of the property is the project that leads to the highest implied land use. Thus, it is not the project that leads to the highest overall value that should be chosen, but rather the project that maximises the land value.

On this page, we discuss and illustrate the HBU approach. An Excel spreadsheet illustrates the approach and can be downloaded for free at the bottom of the page.

Highest and best use definition

As we already mentioned above, the HBU is the project that maximises the implied land value of a real estate project. That means that we evaluate potential projects and determine the implied land values. Then, we should choose the projects that leads to the highest implied land value. Note that this may mean that we are not choosing the project that leads to highest overall value. This is so important that we repeat it one more time. The most attractive project is not necessarily the one that maximises the overall project value.

It is also important to note that, when we calculate the value of the projects, we have to include the profit to the developer that handles the construction of the property.

Highest and best use example

The best way to understand this approach, is to have a look at a numerical example. Let’s consider a piece of land that can be used for two projects. The following figure reports the financials of both projects as well as the implied market value.

Highest-and-Best-Use

We observe that the project with the highest overall value does not have the highest land value. Thus, the project we should choose is the other one.

Summary

We illustrated a very straightforward method to choose among different projects that can be built on a piece of land. The highest and best use method is easy to apply and is an economically sound way to choose among different real estate projects.

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