Land and Special-Purpose Properties: Highest and Best Use Thinking

Land as a Property Type: Value Comes From What It Can Become

Land is different from buildings because most of its value is tied to future potential, not current income or current improvements. Two parcels with the same size can be worth very different amounts if one can support a profitable use (for example, a small apartment building) and the other cannot (for example, due to no road access or wetlands restrictions). When people say “location matters,” land is where that idea shows up most clearly: access, allowable uses, and constraints shape what can be built and how easily it can be used.

Common Land Categories (and What Buyers Usually Care About)

• Raw land: Land with little to no improvements (often no utilities, no grading, no driveway). Buyers focus on access, utility availability, zoning, and the cost to make it buildable.
• Infill lots: Vacant or underused parcels inside an already-developed area (near existing streets and utilities). Buyers focus on zoning fit, neighborhood compatibility, setbacks, parking rules, and construction logistics (tight sites, neighbors, permits).
• Agricultural land: Land used for crops, grazing, orchards, or similar. Buyers focus on soil quality, water rights/availability, drainage, access for equipment, and whether non-farm development is allowed or restricted.
• Development parcels: Larger sites intended for subdivision or major projects. Buyers focus on entitlement risk (rezoning/approvals), infrastructure capacity, environmental studies, and absorption (how fast units/lots can sell).

Plain-Language Factors That Control Land Value

Access (Can You Legally and Practically Get There?)

Access means a legal and usable way to reach the property from a public road. A parcel can look “close to the street” but still have problems if it lacks legal frontage or an easement. In practice, land with uncertain access can be hard to finance and expensive to develop.

• Public road frontage: Often the simplest and most valuable.
• Easement access: A legal right to cross another property. It can be fine, but lenders and buyers will want it clearly documented and adequate for the intended use (width, maintenance, emergency access).
• Physical access constraints: Steep slopes, seasonal flooding, or a narrow approach can make access “legal” but not practical.

Utilities (What Services Are Available and What Will They Cost?)

Utilities are services like water, sewer, electricity, gas, and internet. The key question is not only “are they nearby?” but also “what does it cost to connect and what capacity is available?”

• Water: City water connection vs. well. Wells require drilling and water quality/quantity considerations.
• Sewer: City sewer vs. septic. Septic requires suitable soils and space for a drain field; some lots cannot support it.
• Electric: Extending lines can be costly, especially over distance.
• Stormwater: Many jurisdictions require on-site detention or specific drainage solutions, affecting buildable area and cost.

Zoning Sensitivity (What Are You Allowed to Do?)

Zoning is a set of rules that controls land use and building form. It can determine whether a parcel can be used for a single home, multiple units, retail, industrial, or agriculture. It also controls details that change value even when the “use” seems allowed.

• Use permissions: What categories are allowed (residential, mixed-use, commercial, etc.).
• Density/intensity: How much can be built (units per acre, floor-area ratio, lot coverage).
• Setbacks and height limits: How close to property lines and how tall.
• Parking and access rules: Can reduce usable building area.
• Discretionary approvals: Some projects require hearings or special permits, adding time and uncertainty.

Environmental Constraints (What Limits the Buildable Area or Adds Risk?)

Environmental constraints are conditions that can restrict building, increase costs, or create liability. They range from obvious (wetlands) to less visible (contaminated soil).

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• Wetlands/floodplains: May reduce buildable area and require permits or elevation.
• Steep slopes: Increase grading costs and can trigger engineering requirements.
• Protected habitat/trees: Can limit clearing and site layout.
• Contamination: Prior industrial use can require testing and cleanup before redevelopment.

“Highest and Best Use” (HBU): A Practical Way to Think About Land Value

Highest and best use is the most valuable use of a property given real-world constraints. It is not “the biggest building you can imagine.” It is the use that passes four tests. If a proposed use fails any test, it is not the highest and best use.

A helpful way to apply HBU is to treat land as an input into a project and ask: what use leaves the most value for the land after paying all development costs and required profit? This is often called a simplified residual land value approach.

Simple Residual Land Value Formula (Learning Version)

Residual Land Value ≈ Completed Value (or Sale Proceeds) − Total Project Costs − Required Profit

This is not a full appraisal model; it is a practical decision tool. You can use it to compare two possible uses under the same assumptions.

Step-by-Step Case Vignette: Two Possible Uses for One Parcel

Scenario: You are evaluating a 1.2-acre infill parcel near a busy corridor. The parcel is currently vacant. It has street frontage and electricity at the street. Water and sewer are available but require connection fees. The site has a small low area that will need drainage work.

You will compare two potential uses:

• Option A: Build 6 townhomes and sell them individually.
• Option B: Build a small neighborhood retail building and lease it, then sell the stabilized property.

Use simplified assumptions to decide which option is likely the highest and best use.

Step 1: Legally Permissible

Given assumptions:

• Zoning allows residential up to 8 units per acre and allows neighborhood retail with a conditional use permit.
• Height limit: 35 feet.
• Parking rules: retail requires more on-site parking than residential.

Check:

• Option A (6 townhomes): 6 units on 1.2 acres = 5 units/acre, within the 8 units/acre limit. Likely permitted by right. Pass.
• Option B (retail): Allowed but needs a conditional use permit (public process, time risk). Still legally possible. Pass, but higher entitlement risk.

Step 2: Physically Possible

Given assumptions:

• Buildable area is reduced by drainage work and required setbacks.
• Townhomes can fit with internal drive and required parking.
• Retail parking layout is tight; may require shared access agreement with a neighbor (assume possible but not guaranteed).

Check:

• Option A: Fits on site with standard layouts. Utilities can be connected. Pass.
• Option B: Building fits, but parking is the limiting factor; depends on a shared access/parking arrangement. For this exercise, assume you can secure it. Pass (with site-planning sensitivity).

Step 3: Financially Feasible (Simplified Numbers)

Now estimate residual land value for each option. Use the same structure: estimate completed value (or sale proceeds), subtract costs, subtract required profit. The option that can “pay more for the land” is usually more financially feasible and more productive.

Option A: 6 Townhomes (For-Sale)

Assumptions:

• Expected sale price per townhome: $450,000
• Total sale proceeds: 6 × $450,000 = $2,700,000
• Hard construction costs: $1,500,000
• Soft costs (design, permits, engineering, insurance): $250,000
• Utility connection + drainage/site work: $220,000
• Financing/holding/marketing: $180,000
• Required developer profit (risk/effort): 15% of sale proceeds = 0.15 × $2,700,000 = $405,000

Residual land value estimate:

Completed Value (Sales)                 $2,700,000  −  Hard Costs                            1,500,000  −  Soft Costs                              250,000  −  Utilities + Site/Drainage                220,000  −  Financing/Holding/Marketing              180,000  −  Required Profit                          405,000  --------------------------------------------------  Residual Land Value (Option A)            $145,000

Interpretation: Under these assumptions, the townhome project can support paying about $145,000 for the land (before considering negotiation, contingencies, or surprises). If the seller wants much more than that, the project becomes hard to justify.

Option B: Small Retail (Lease, Stabilize, Sell)

Assumptions:

• Retail building size: 8,000 sq ft
• Stabilized net operating income (NOI): $180,000/year
• Market cap rate at sale: 7.0%
• Estimated sale value when stabilized: $180,000 ÷ 0.07 ≈ $2,571,000
• Hard construction costs: $1,280,000
• Soft costs: $260,000
• Utility connection + drainage/site work: $260,000 (more paving/parking)
• Leasing/tenant improvements and commissions: $220,000
• Financing/holding during lease-up: $240,000
• Required developer profit: 18% of sale value (higher risk due to leasing and approvals) = 0.18 × $2,571,000 ≈ $463,000

Residual land value estimate:

Completed Value (Stabilized Sale)       $2,571,000  −  Hard Costs                            1,280,000  −  Soft Costs                              260,000  −  Utilities + Site/Drainage                260,000  −  Leasing/TI/Commissions                   220,000  −  Financing/Holding                        240,000  −  Required Profit                          463,000  --------------------------------------------------  Residual Land Value (Option B)           ($152,000)

Interpretation: With these assumptions, the retail option does not support paying for the land at all; it is short by about $152,000. That does not mean retail is “impossible,” but it suggests at least one assumption must improve for it to become feasible (higher NOI, lower costs, lower cap rate, reduced parking costs, or a lower required profit).

Step 4: Maximally Productive (Choose the Best Feasible Use)

Both options were assumed legally permissible and physically possible. Financially:

• Option A (townhomes) produces a positive residual land value ($145,000).
• Option B (retail) produces a negative residual land value under the stated assumptions.

Result: Under these simplified assumptions, Option A is the highest and best use because it is financially feasible and yields the highest (and only positive) residual land value.

Practice: What Would Change the Answer?

To build “highest and best use thinking,” try adjusting one variable at a time and re-check feasibility:

• If retail NOI increases to $220,000, sale value becomes $220,000 ÷ 0.07 ≈ $3,143,000. Does Option B become feasible?
• If the townhome sale price drops to $420,000 each, what happens to Option A’s residual land value?
• If the conditional use permit adds 9 months of holding costs, how much additional cost would you assign, and how does that affect Option B?
• If soils require a more expensive drainage solution, which option is more sensitive to that cost increase?

These “what-if” checks mirror how real land buyers and developers think: land value is not fixed; it is the leftover value after a realistic use is tested against rules, site constraints, costs, time, and risk.