and Best Use...
While teaching, a student who has been appraising real estate
for years, recently asked “why business appraisers rarely
discuss the concept of “highest and best use”.
An excellent question.
“Highest and best use”
is the legally permissible application of an asset that will
yield the greatest economic benefit to its owner. If you own
vacant land, some potential highest and best uses might be
parking lot, apartment building, or oil well (if there are
proven reserves). A real estate appraiser will consider, assess,
and discuss these in every appraisal, usually at the very
beginning of their report.
This occurs because:
1. Most real estate appraisals involve “100% fee simple
interests”, meaning that they assume that the subject
property has a single (control) owner and that there are no
encumbrances (such as debt or other use restrictions). Control
owners are obviously free to seek the highest and best uses
of their properties, and the asset values reflect that freedom.
2. Many business appraisals involve minority interests. This
introduces three levels of complexity: the standard of value,
the premise of value, and the level of value. Each constrains
the ability of the minority owner to realize the “highest
and best use” value of the underlying business assets.
• The level of value:
Minority owners do not have the power to control how business
assets are deployed. Minority owners of
marginally profitable or money-losing businesses, except
in cases of shareholder oppression, cannot force the control
owner to (for example) reduce his/her compensation
in order to create more distributable earnings; i.e. to
create a higher and better use of the assets employed.
• The premise of value:
In the same vein, minority owners of such businesses cannot
owners to liquidate, even if a higher value could be obtained
compared to continuing in
• The standard
of value: Most business appraisals involve fair market
value – the value to any
willing buyer and seller – not the value to a strategic
buyer who might be able to pay a
higher price. Strategic or synergistic value is not part of
fair market value, and the minority
owner cannot force the control owner to seek such buyers in
order to realize that value.
Each of the three complexities - level, premise
and standard of value - is clear when valuing minority interests.
When valuing control (or 100%) interests, they are also relevant:
• Control ownership discretionary expenses
are “added back” (normalized), since a buyer would
not necessarily incur them. But there are more complications:
if the business is not operating
as efficiently as possible (based on benchmarking with its
peers), the appraiser will have
to assess whether such improvements are feasible and probable.
• The higher of going concern versus
liquidation value applies, since a rational control owner
would not want “lowest and worst use”.
• If the appraisal is for tax purposes,
the fair market value standard applies (no strategic buyers
are considered), but if the appraisal is for sale purposes,
strategic value becomes paramount.
The bottom line is: although highest and best use is a fundamental
concept for all appraisals, it is much easier to address in
real estate appraisals than it is in business appraisals.
Valuations play a part in all tax, transaction, and litigation
matters. For additional information or advice on a current
one, please do not hesitate to contact us. We Value Your Business!