Highest and Best Use

Highest and best use is a real estate appraisal concept that determines the most valuable use for a property — the use that would produce the greatest return. It is the foundation of property valuation and is directly constrained by zoning regulations, which dictate what uses are legally permissible on any given parcel.

The Four Tests of Highest and Best Use

1. Legally permissible: The use must be allowed under current zoning, or there must be a reasonable probability of obtaining the necessary approvals
2. Physically possible: The site must be physically capable of supporting the use (size, shape, topography, soil conditions)
3. Financially feasible: The use must generate sufficient revenue to justify the cost of development
4. Maximally productive: Among all uses meeting the first three tests, the highest and best use is the one that produces the greatest residual land value

How Zoning Controls Highest and Best Use

Zoning is the primary legal constraint on highest and best use. A parcel zoned for single-family residential has a very different highest and best use than the same parcel zoned for mixed-use or commercial. When zoning changes — through rezoning, overlay districts, or comprehensive plan amendments — the highest and best use changes with it, and the property's value adjusts accordingly.

Why This Matters for CRE

Understanding highest and best use is essential for identifying mispriced properties. When a parcel's current use does not match its highest and best use under current zoning, it may be undervalued. More importantly, when zoning changes create a new highest and best use that exceeds the current use, the resulting value gap represents a development or investment opportunity. Tracking zoning decisions that change the highest and best use of properties — especially rezoning from lower- to higher-intensity uses — is one of the most direct paths to identifying undervalued real estate.

What to Watch For

• Zoning-value mismatches: Properties being used below their zoning potential (e.g., a parking lot in a high-density commercial zone)
• Pending rezoning applications: Approved rezonings change the highest and best use calculation immediately
• Comparable sales analysis: What are similar parcels with the new zoning classification selling for?
• Infrastructure improvements: New roads, transit, or utilities can change what is physically possible on a site