As improved, a retail building is worth $1,200,000 in its current use. Renovating it would cost $250,000 plus $50,000 of rent lost during the work and would raise its value to $1,560,000. Converting it to medical office would cost $600,000 and would raise its value to $1,850,000. Assuming equal risk and timing, what value, net of required investment, does the highest and best use as improved indicate?
Correct Answer
C) $1,260,000
Each alternative is measured net of the investment it requires: continued use $1,200,000; renovation $1,560,000 - $250,000 - $50,000 = $1,260,000; conversion $1,850,000 - $600,000 = $1,250,000. Renovation produces the highest net value, $1,260,000. Keeping the current use gives $1,200,000, choosing conversion for its highest finished value gives $1,250,000, and leaving out the lost rent gives $1,310,000.
Why This Is the Correct Answer
Option C is correct because renovation nets $1,560,000 - $250,000 - $50,000 = $1,260,000, which beats conversion at $1,850,000 - $600,000 = $1,250,000 and continued use at $1,200,000. With equal risk and timing, renovation is the course of action that adds the most value.
Why the Other Options Are Wrong
Option A: $1,200,000
Option A, $1,200,000, keeps the current use without testing the alternatives. Renovation adds $60,000 of value after all its costs ($1,260,000 - $1,200,000), so continued use is not the best course.
Option B: $1,250,000
Option B, $1,250,000, is the conversion net value ($1,850,000 - $600,000), chosen because conversion has the highest finished value. After costs it falls $10,000 short of renovation's $1,260,000.
Option D: $1,310,000
Option D, $1,310,000, deducts only the $250,000 construction cost from $1,560,000 and leaves out the $50,000 of rent lost during renovation. Including it gives $1,260,000.
Every alternative pays its bill
Before comparing alternatives, subtract each one's full bill, including rent lost while the work is underway.
How to use: Use this rule on as-improved questions that compare keeping, renovating, converting or replacing a building.
Exam Tip
Look for hidden costs such as lost rent, carrying costs or demolition, and deduct them before ranking alternatives.
Common Mistakes to Avoid
- -Choosing the alternative with the highest finished value
- -Leaving out income lost during construction
- -Assuming the current use without testing alternatives
Concept Deep Dive
Analysis
The question tests the as-improved comparison of continuing, intensifying and changing a use. Each alternative must be stated net of every cost it requires, including income lost during the work. With equal risk and timing, the highest net value marks the highest and best use as improved.
Background Knowledge
The highest and best use as improved asks whether the existing use should continue, be intensified or be changed, and whether improvements should be modified or replaced. The course producing the highest risk-adjusted return is the highest and best use, and alternatives requiring physical changes must account for the investment they need.
Real-World Application
An investor considering a dated strip center asks an appraiser whether a facelift or a medical-office conversion makes more sense. The appraiser nets each plan's costs, including vacancy during construction, and finds the facelift adds slightly more value.
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