Highest And Best Use

VALUATION GUIDANCE REGARDING BUFFER LAND AT QUARRY OPERATIONS.

By Gary R. Loke

Highest and best use (H&BU) analysis is a founding principle in real property valuation. When applied to the valuation of land at the buffer area of a construction aggregates operation, it triggers interesting and relatively complex matters for consideration.

Base-level understanding about the current user and the user’s competitive market, expected economic mine life and land-reversion scenarios, along with competitive land uses in the market area, make supportable valuation at the buffer a challenge that often requires understanding well beyond that used in valuing land with more traditional uses. This article presents a conceptual framework to assist in dealing with this challenge.

The current market value of any land parcel is the collective assessment and agreement point of the willing market buyers (who have purchasing power) and a willing seller, neither under duress. Market participants gauge the future benefits to be derived from use of the parcel, as well as its potential linkage to other assets or benefits, from their own perspectives of self-interest.

Unlike in more general real property valuation settings, comparable transactions of buffer land are typically nonexistent. While such analysis may become relatively involved and complex, highest and best use analysis, coupled with other foundational real property principles, are key to properly considering and determining supportable land values at the buffer.

According to the Appraisal Institute’s “The Appraisal of Real Estate,” highest and best use is defined as “The reasonably probable use of property that results in the highest value.” The concept is further described as follows:

To be reasonably probable:
The use must be physically possible (or it is reasonably probable to render it so).
The use must be legally permissible (or it is reasonably probable to render it as so).
The use must be financially feasible.

Uses that meet the three criteria of reasonably probable uses are tested for economic productivity, and the reasonably probable use with the highest value is the highest and best use. A practical summary about it follows:

“In the real estate arena, the highest and best use of a specific parcel of land is not determined through subjective analysis by a property owner, developer, real estate agent or appraiser; but rather, it is a use shaped by the competitive forces within the market where the property is located.”

H&BU is correctly applied by considering the situational contexts of “as if vacant” and then “as improved.” In an effort to focus on the buffer area as defined herein, this article focuses on a mining land assemblage “as improved,” that is, already improved to the H&BU considering a single economic unit centered on active mining, with all operating permits in place, remaining reserve life with some duration, and an active market for construction aggregates exists in the addressable market.

H&BU is one step in the critical thinking process wherein market values are concluded. While often considered in typically real property valuation settings, it is also properly applied in many other appraisal assignments where real estate contributory value and earning power is an important element of overall value, whether of equity, total invested capital or a financial interest.

Such contributory value, gauged using H&BU analysis, is relevant when separately valuing mineral reserves or interests. Some examples where H&BU and non-mineral buffer land may be key matters in a larger context valuation setting include the following:

Reserves valuation for allocating partial interests or purchase price.
Valuing total stockholders’ equity.
Buy-sell agreements.
Estate and succession planning.
Mine site reversion analysis.
Life-of-mine planning shifts.
Valuations of business enterprise.
Condemnation.
Real property tax assessment.
Shareholder dissent matters having focus on excess land versus buffer adequacy.

In applying H&BU in these settings, other principles and concepts for consideration in real property valuation include interim use, consistent use, assemblage/plottage and practice guidance about special-use properties.

Interim Use

Mining use of land is sometimes considered to be an interim use, defined as “The temporary use to which a site or improved property is put until a different use becomes maximally productive.” The extent of post-mining reclamation efforts, driven by any or all the following factors, may be pivotal to whether a mining use becomes an interim use or a terminal use.

The legal requirements are:

Economic redevelopment.
Hydrologic and geologic factors.
Scale and geometry of past surface mining.
Cost of infill and grading.

Consistent Use

“The Appraisal of Real Estate” presents the concept consistent use as follows:

“The concept that land cannot be valued on the basis of one use while the improvements are valued on the basis of another use.”

Under this concept, the highest and best use of an improved property shifts to the highest and best use of the land “as vacant” once the land value, plus the cost of demolishing and removing the improvements, exceeds the value of the property as improved.

Plottage and Assemblage

Plottage is the increment of value created when two or more sites are combined to produce greater utility. Assemblage is the combining of two or more parcels, usually but not necessarily contiguous, into one ownership or use; [it is] the process that creates plottage value.

Special-Use Properties

Mining operations are a prime example of special-use properties. The intricacies of discerning the highest and best use of special-use properties are noted in “The Appraisal of Real Estate” as follows:

“The highest and best use of a special-use property as improved is probably the continuation of its current use if that use remains viable and there is sufficient market demand for that use. If the current use of a special-purpose property is physically, functionally or economically obsolete and no alternative uses are feasible, the highest and best use of the land might be realized by demolishing the structure and selling the remains for their scrap or salvage value, if possible.”

Functioning buffer land, including an issue of its scale, is integrated with all special-use mine property, and certainly is a prerogative of control by ownership and adherence to setbacks. Such holdings may have strategic market value not highly evident to market participants nor appraisers. Well-supported analysis of the facts and circumstances, including meaningful insights gained from research, due diligence, and industry practice experience, leads to reasonable value conclusions.

Highest and Best Use as Improved

The highest and best use of a property as improved is the use that should be made of a property as it exists. The use must also be currently viable, and reasonably expected to remain so, and yield the highest economic return. The initial analysis must therefore focus on the H&BU of the overall economic unit, and not on just a land parcel (or group of parcels) that encompasses control of the minerals.

In situations of long-term control via ownership or lease of land with relatively scarce construction aggregates in reserve, aggregate-producing properties – especially those near large user bases and/or major transportation arterials – will not likely be challenged by other land uses. In situations where this is not true, or a combination of factors exists, H&BU analysis of the economic unit may indicate that an alternative use is best to be considered in the valuation. Thus, H&BU as improved depends on many factors, but mainly on the relative value of the assemblage as one economic unit in comparison to other uses as contemplated through H&BU, with appropriate consideration of interim use, consistent use, plottage and assemblage, and guidance about the nature of special-use properties.

Mining Buffer Adequacy, Highest and Best Use, and Valuation

The issue of highest and best use analysis has heightened importance in a contentious setting where buffer acreage adequacy is in play. Assuming that the H&BU conclusion indicates that the economic unit is not being challenged, an issue remains if all buffering land is truly required, or has the potential to be considered surplus land or excess land for current or future development.

Surplus land is land that is not currently needed to support the existing use but that cannot be separated from the property and sold off for another use. Surplus land does not have an independent H&BU and may or may not contribute value to the improved parcel.

Excess land is land that is not needed to serve or support the existing use. Excess land has the potential to be sold separately and must be valued separately. If buffer land is found supportably to be excess, its value would be additive such that it could be sold for cash at the appraised amount and its sale would not harm the overall on-going business.

In considering the adequacy of buffer acreage for valuation purposes, minimization may only be taken to the mine plan’s required setback distances set by local zoning ordinances. These legal boundaries are generally established in the mutual interest of the miner and the neighbors to insulate and establish a barrier from activities associated with surface mining.

The land use just beyond this insulating acreage becomes a matter of valuation comparison as to market needs and pricing of nearby land for other uses. A mine owner’s motivation may be to own the buffer simply to insulate the property from externalities in the form of potential challenges (and related cost avoidance) from neighbors who may bring complaints and potential legal action against the business, including jeopardizing the permit or important future permitting actions.

Summary

When the value of a property “as improved” is greater than the value of a site in a vacant state, the highest and best use of the property is usually the “improved” property. Conversely, once the value of the vacant site scenario is greater than the improved (including all costs for legally obligated restoration efforts in a mining setting), H&BU analysis would usually call for the improvements to be demolished or transformed to make way for the incrementally better economic alternative.

Generally, valuation service providers cannot purport to provide engineering-based land-use studies, nor do they typically challenge an operator’s engineering-based or otherwise practical determination of whether to extend its control over land areas that may provide incremental buffering utility to a current mine plan or a future one. In arriving at a value opinion for a mining business property, including the contributory value of non-mineral buffer land, an appraiser often must have a practical understanding of the issues of mining buffer, current and/or foreseeable development patterns near the mining site, local issues and other guidance.

One must also be aware of market tendencies and preferences of mine operators to control more acreage versus less for buffering and/or mine planning purposes, and recognize the need for balance in relations between the community and mine operators. It is from this general perspective, as well as taking into account characteristics and practice guidance about H&BU as improved, along with principles of interim use, consistent use, plottage and assemblage, and special-use properties, that one appropriately considers the supportable value of buffer land, and whether surplus land and/or excess land value exists.

Gary Loke is a director in the Energy and Mining Practice at Duff & Phelps. He provides direction and technical support for special-purpose, large multiproperty and multidiscipline engagements.