The recent vote by the New York City Council approving construction of 15 Penn Plaza, a 1.3-million-square-foot office building on the site of the Hotel Pennsylvania in Manhattan, is most likely the final chapter of this storied hotel’s economic life. The approved development plan, similar to the seven new skyscrapers that are proposed in New York City during the next decade, is reflective of the forever evolving highest and best use of real estate.
During 2008, the interim highest and best use of the property evolved to the continued use of the site as a functionally and physically obsolete hotel until such time when a proposed redevelopment of the site again became financially viable. It now appears the economic feasibility of tearing down the Hotel Pennsylvania and developing a major office building on the site will once again turn positive in the near future.
Highest and best use often is identified as the key concept supporting real estate use and value decisions. The highest and best use of a specific parcel of land is not determined through subjective analysis but rather, it is a use shaped by the competitive forces within the market where a property is located.
The exact definition of “highest and best use” varies, but it generally is the most probable use of land or improved property that is legally possible, physically possible, financially feasible (and appropriately supportable) from the market and which results in maximum profitability.
An analysis of highest and best use involves two considerations:
1. The most likely and profitable use of the site "as if vacant" under the requirements set forth above.
2. If a property is "already improved," “highest and best use” is the use that should be made of the property to maximize value for non-income producing properties or, maximize net operating income on a long range basis for investment properties. In cases where capital expenditure is necessary to renovate or improve an income producing property, these costs must provide a sufficient rate of return (to the owner) for the total amount invested in the site and building improvements.
The highest and best use as vacant land may be the same or different as the highest and best use as improved.
If a property is located in an area zoned for commercial use, the maximum productivity of the land as though vacant will likely be based on commercial use. If, however, the competitive level of demand is greater for say, residential or multi-family use, then the highest and best use of the property as improved would be for residential use. If market preference conflicts with zoning, and consequently violates the legal permissibility test, a developer will consider if there is sufficient profit incentive to justify the added legal costs, extended time frame, and potential neighborhood opposition before obtaining a zoning change and developing the site.
As long as the value of a property "as improved" is greater than the value of the site as "if vacant," the highest and best use is typically the "improved" property. Once the value of the vacant land exceeds the value of the improved property (including demolition costs), highest and best use usually dictates that improvements be demolished.
The recent Great Recession has resulted in a dramatic resetting of commercial real estate values as well as new development and redevelopment construction costs. This phenomenon, along with a bottoming out of the market, has investors now looking to deploy the tremendous amounts of stockpiled equity capital that has recently been raised, to effectuate the highest and best use of a variety of real estate assets throughout the nation.
As debt becomes more readily available, all types of real estate transaction activity will continue to increase. Such deals will include the development of myriad new real estate projects, as well as the re-development of older assets that are ripe for investment of capital expenditures to extend the economic life of existing improvements. Similar to perceived value of an asset, the highest and best use of property is dynamic and changes and evolves over time, sometimes overnight. Clearly, the highest and best use of a proposed hotel site situated in lower Manhattan was dramatically different on 10 September 2001 when compared to 24 hours later.
Daniel Lesser serves as the senior managing director-industry leader of the Valuation & Advisory Services Hospitality & Gaming Group at CB Richard Ellis. For eleven years prior to joining CBRE, Mr. Lesser founded and led the Hospitality & Gaming Group at Cushman & Wakefield. Mr. Lesser was a member of the original team at HVS International when it was founded. He can be reached at 212.207.6064 or Daniel.lesser@cbre.com.
The opinions expressed in this column do not necessarily reflect the opinions of HotelNewsNow.com or its parent company, Smith Travel Research and its affiliated companies. Columnists published on this site are given the freedom to express views that may be controversial, but our goal is to provoke thought and constructive discussion within our reader community. Please feel free to comment or contact an editor with any questions or concerns.