A property's current use as a gas station generates $50,000 annual net income. Analysis shows the highest and best use as vacant would be for apartments generating $75,000 annual net income, but demolition costs are $40,000. Using a 10% cap rate, what is the highest and best use as improved?
Correct Answer
A) Insufficient information to determine
The apartment income gives a completed-property indication, not net conversion value. Construction, timing and other development costs are missing, so deducting demolition alone is insufficient for a highest-and-best-use conclusion. Current use can be valued from supplied NOI without proving it is maximally productive.
Why This Is the Correct Answer
Option A is correct because the $75,000 apartment income indicates the value of a finished project, not the land's net conversion value. Construction, timing and other development costs are missing, so deducting only the $40,000 demolition cost cannot support a highest-and-best-use conclusion.
Why the Other Options Are Wrong
Option B: Both uses have equal value
Option B, both uses have equal value, has no support; the figures given show different incomes, and the missing development costs prevent any finding that the values are equal.
Option C: Demolish and build the apartments now
Option C, demolish and build the apartments now, compares completed-project income with the existing use while ignoring construction and other development costs. Demolition is warranted only when land value as if vacant exceeds the value as improved, which cannot be shown here.
Option D: Continue as gas station
Option D, continue as a gas station, assumes the current use is most productive. The gas station can be valued from its $50,000 NOI, but that does not prove it is maximally productive without a full redevelopment analysis.
Finished value is not land value
Income from a completed new building must be reduced by all costs to create it before comparing with the existing use.
How to use: Use this when a highest-and-best-use question offers income from a proposed use but few cost figures.
Exam Tip
Check whether all development costs are given before choosing a redevelopment conclusion; missing construction cost is a sign that the data are insufficient.
Common Mistakes to Avoid
- -Treating completed-project income as land value
- -Deducting only demolition cost from the proposed use's value
- -Assuming the current use is the highest and best use because it produces income
Concept Deep Dive
Analysis
This question tests whether you recognize that highest-and-best-use conclusions require complete data. The apartment NOI reflects a completed project, but the stem gives only demolition cost and omits construction, timing and other development costs. Without those, you cannot compare the net value of redevelopment with the value of the existing gas station.
Background Knowledge
Highest and best use as improved asks whether the existing improvements should be retained, modified or demolished. Demolition is economically appropriate when the market value of the land as if vacant exceeds the current market value of the improved property. Redevelopment analysis must account for demolition, site preparation, construction and other development costs.
Real-World Application
An appraiser values a corner lot with an older gas station in an area where apartments are being built. Before concluding redevelopment is the highest and best use, the appraiser gathers construction costs, entrepreneurial incentive and lease-up timing for a new apartment building.
More Income Approach Questions
Market analysis confirms that seller financing at 3%, versus a 6% market rate, increased a comparable sale price. What adjustment removes that financing premium?
At the same effective date, reliable value indications support $800,000 for continued use of a property as improved and $500,000 for its cleared site. Immediate demolition costs $100,000. These are the only feasible alternatives, with no other costs or timing differences. Which alternative has the higher net value?
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Which proposed use cannot pass the legal-permissibility screen without evidence that the necessary permission is reasonably probable?
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