Highest & Best Use: Turning Use-Case Logic into Defensible Value

The former New York headquarters of EY is being redeveloped into a mixed-use tower with about 1,250

Introduction

In commercial real estate, every property carries untapped potential that savvy developers and lenders strive to unlock. The principle of Highest & Best Use (HBU) serves as a guiding light in this pursuit – it demands that a property be put to its most value-maximizing use given all practical constraints. While location is paramount, failing to match a site with its optimal use can leave significant value “on the table”. HBU analysis provides a strategic framework to ensure the intended use of a property aligns with what the market values most, thereby producing a defensible and credible valuation. This article delves into the HBU concept and illustrates how use-case logic – evaluating various scenarios for a property’s use – can be turned into defensible value. We will explore early-stage feasibility screening to avoid costly missteps, outline a hierarchy of evidence that underpins robust HBU analysis, and highlight real-world case studies from the U.S. market. The goal is to elevate HBU from a routine appraisal requirement to a strategic tool for developers and lenders seeking to optimize returns in a dynamic real estate landscape.

Understanding the Highest & Best Use Principle

Highest and Best Use (HBU) is formally defined by the Appraisal Institute as “the reasonably probable and legal use of vacant land or an improved property that is physically possible, appropriately supported, and financially feasible, and that results in the highest value.” In simpler terms, HBU asks: What use of this property will generate the greatest overall benefit and value, given what is legally allowed and physically possible? This concept originated in early economic thought and has become a cornerstone of real estate appraisal and investment strategy. It recognizes that a property’s value is not static – it hinges on how that property is used at a given time. A change in use can dramatically alter value, for better or worse.

Four Key Criteria. In practice, determining HBU involves applying four criteria tests to potential uses of the property. The use must be: (1) Legally Permissible – allowed by zoning laws, deed restrictions, and other regulations; (2) Physically Possible – feasible on the site given its size, shape, topography, infrastructure, and other physical factors; (3) Financially Feasible – capable of yielding a return or profit that justifies the investment; and (4) Maximally Productive – among the feasible options, the use that produces the highest financial value or satisfaction. All four conditions should be met for a use to be considered the highest and best. Intuitively, these tests make sense: if a proposed use is illegal or cannot be built, it’s immediately disqualified; if it won’t be profitable, or if another viable option would be more profitable, then it isn’t the optimal use.

Relevance and Strategic Importance. HBU analysis is far more than an academic exercise – it is fundamental to sound real estate decision-making. Appraisers are required to analyze highest and best use as part of any market value appraisal, and differences in HBU conclusions often explain widely divergent appraised values in litigation or loan underwritin. For developers, identifying a site’s HBU helps target the right development concept – one supported by market demand and regulations – rather than forcing a project that leaves value unrealized. For lenders, understanding HBU is vital to assessing the true collateral value and viability of a project. A proposed development that is not the highest and best use of a site may struggle financially, putting a loan at risk. In short, HBU provides a strategic lens through which both developers and lenders can ensure that each dollar is directed to its “best use,” thereby maximizing returns and minimizing risk. As one industry expert put it, the HBU concept is “the economic foundation of the CRE investment business” and finding opportunities to convert properties to a higher and better use is a proven way to create value and profits.

Use-Case Logic for Defensible Valuations

At the heart of Highest & Best Use analysis is use-case logic – essentially, scenario planning for real estate. Rather than assume the current use or a single vision for a property, an analyst will brainstorm multiple potential use-cases (e.g. redeveloping an aging retail strip into apartments, or converting an office building to life-science labs) and then test each scenario against the HBU criteria. This process can be visualized as a funnel: start with many plausible uses and narrow them down, through analysis, to the one use-case that stands out as most supportable and value-maximizing.

From Scenarios to Value. Employing use-case logic means that valuation is evidence-driven. Each potential use-case is effectively a hypothesis that “If the property is used for X, it would be worth $Y.” Analysts gather data and make projections for each scenario – including construction or renovation costs, rental rates or sales prices, absorption timelines, operating expenses, etc. – to estimate the property’s value under that use. For example, consider a small commercial building currently used as low-rent retail. An HBU analysis might evaluate alternative uses such as office conversion or multifamily housing. One recent case study examined an old 1920s brick building whose current retail use was yielding modest value; by modeling a conversion to offices with higher market rents, the analysts found the office scenario would increase the property’s net present value from roughly $1.40 million to $1.49 million. Because the office scenario produced the highest value of all tested uses, it was deemed the highest and best use – a conclusion grounded in quantitative comparison of pro forma outcomes. This evidentiary approach turns use-case logic into defensible value: anyone reviewing the analysis (be it an investor, lender, or third-party appraiser) can see the rationale for value conclusion $1.49M, supported by market data and cash flow projections, rather than taking the value as a vague or speculative claim.

Credibility through Elimination. A key strength of the HBU approach is its power of elimination. Uses that don’t meet the criteria are systematically ruled out, lending credibility to what remains. For instance, in an HBU analysis of a newly upzoned residential lot, analysts might consider three development schemes – say, a single-family home, a duplex, or a triplex. If the triplex scenario turns out not to be financially feasible (e.g. because projected rent for a triplex would not cover its higher construction cost), it is eliminated from consideration. The remaining scenarios that pass the feasibility test are then compared for maximal productivity (which yields the higher land value or return). In this way, the final valuation rests on the best-supported use-case, with other options effectively disproven by the evidence. The result is a valuation outcome that is both highest and defensible – it represents the top end of what the property could be worth (if put to its best use), and it can be backed up by logical analysis and data. This methodology is especially important when justifying value to skeptical stakeholders or in court; as noted, many valuation disputes boil down to disagreements over HBU assumptions. By clearly showing why one use-case outperforms the alternatives, an analyst can defend the chosen valuation with confidence.

Early Feasibility Screening to Avoid Misallocation of Capital

One of the most practical applications of HBU analysis is in the early-stage feasibility screening of development projects and investments. Before committing significant capital – whether buying a property, funding a construction loan, or green-lighting a development within a firm – it is crucial to vet whether the project concept truly represents the site’s highest and best use. Integrating an HBU study at the front-end of the process can save developers and lenders from costly missteps by revealing misalignments between a proposed use and what the market or site will support.

Fail Fast (or Pivot) with Insight. Performing a preliminary HBU analysis early allows for a “fail fast” if the numbers don’t pencil out, or a strategic pivot to a better use-case. For example, suppose a developer is eyeing a Class B office building in an urban area with the idea of converting it to residential apartments. An initial highest and best use study might include a quick market analysis (are there enough renters to absorb new apartments and at what rent levels?), a regulatory check (is residential use allowed by right, or will it require a lengthy rezoning or variances?), and a high-level financial model. Northstar Project & Real Estate Services recently conducted exactly this kind of upfront HBU study for a prospective buyer considering an office-to-residential conversion in Boston. The study found that while zoning and market demand were favorable (residential use was permitted, and there was unmet demand for housing units), the projected Return on Cost for the conversion would not meet the investor’s required hurdle rate. In other words, even though the conversion was feasible, it wasn’t financially attractive enough. Armed with this insight, the buyer “did not elect to bid on the property” – thereby avoiding a potential misallocation of capital into a project with sub-par returns. For the cost of a study and some early due diligence, the investor saved millions by walking away from a deal that looked superficially enticing but failed the highest-and-best-use test.

Frameworks for Feasibility Analysis. To systematically integrate HBU thinking early, many developers and consultants employ feasibility screening frameworks. These often mirror the four HBU criteria and involve a multi-disciplinary check. A recommended practice is to start with a “Go/No-Go” analysis on basic legality and physical possibility: if a concept is not allowed by current zoning or cannot be built on the site’s footprint (say a high-rise on a tiny lot), it’s a “no-go” without expensive entitlement changes or site assemblage. Next comes a market feasibility screen – a cursory look at demand, supply, and pricing for the product type in question. This might involve consulting market comparables and absorption trends to ensure there is a market gap the project can fill. Finally, a financial feasibility screen is done by sketching a simplified pro forma: rough order-of-magnitude estimates of development cost, operating income, and exit value. Modern tools and platforms (including quick feasibility calculator software) can assist in running these numbers in minutes. The goal at this stage is not a pinpoint valuation, but to flag any scenario that fails to produce a positive net present value or an adequate return. For instance, if an initial discounted cash flow shows negative NPV, the project as conceived is not financially feasible and should be reworked or scrapped. By filtering projects through these screens, developers and lenders can focus resources only on those concepts that pass muster on all fronts. Such front-loaded HBU analysis ensures capital is directed to projects with credible underpinnings, rather than chasing ideas that sound good but lack defensible numbers.

A Structured Hierarchy of Evidence in HBU Analysis

Robust HBU analysis is underwritten by a structured hierarchy of evidence – a tiered approach to data-gathering and analysis that lends credibility to the final conclusion. Think of it as building a court case for a property’s optimal use: one must compile evidence from foundational facts up to financial figures, each layer supporting the next. By following a structured framework, analysts can demonstrate that the HBU conclusion isn’t based on a hunch, but on a convergence of proofs.

1. Site and Legal Foundations: The first tier of evidence concerns the property’s existing conditions and legal context. Analysts begin by thoroughly understanding the asset in its current state and any constraints or opportunities tied to it. This includes reviewing physical attributes (site size and configuration, topography, access to roads, availability of utilities, environmental issues) and the regulatory environment (zoning classification, allowable uses, density or height limits, any deed restrictions or easements). For instance, zoning ordinances and building codes might reveal that a taller structure or mixed-use development is allowed, opening possibilities; conversely, historic preservation status or restrictive covenants could limit alterations. These factors are non-negotiable filters – a use that clashes with legal or physical realities is ruled out or requires evidence of a plausible change (such as a likely zoning amendment). Thorough documentation at this stage – maps, title reports, zoning letters, site surveys, environmental assessments – forms the bedrock evidence for HBU. It answers the fundamental question: What uses are even possible here, before considering money?

2. Market and Demand Evidence: The second tier ascends to market research and demand analysis. Once we know what could physically and legally happen on the site, we ask: What does the market want or need, and at what pricing? Here, evidence is drawn from macro and micro market studies – demographics, economic trends, and comparable projects. Analysts look at supply and demand metrics for various use-cases: e.g. vacancy and absorption rates in the office market, rental rates for apartments, sales per square foot in retail, hotel occupancy and RevPAR, and so on. Comparable properties (recent developments or transactions) provide critical benchmarks: How much are similar land parcels selling for per acre for industrial use versus for residential use? What rents are achievable for a new multifamily project in this submarket, and is there unmet demand? A well-structured HBU study will include a review of market comparables and trends for each viable use alternative. For example, Northstar’s HBU analysis for a Boston office building gathered evidence like nearby residential rental rates (in $ per bedroom) and absorption projections to validate that a multifamily conversion could find tenants at sustainable rents. This market evidence establishes whether a proposed use is appropriately supported by demand. If the market data indicates, say, an oversupply of retail space but a housing shortage, that’s powerful evidence steering the HBU toward residential. In essence, this tier answers: What uses does the market reward most, and can this location competitively deliver that product?

3. Financial Feasibility and Returns: The third tier is the financial analysis, where the preceding evidence is translated into dollars and cents. This is often the most quantitative layer of evidence. Using inputs from the market research (pricing, absorption) and site studies (land area, allowable density), analysts construct pro forma financial models for the short-listed use scenarios. The models typically project development costs (land acquisition, hard and soft construction costs, financing), operating incomes and expenses, and eventual exit values or stabilized values. Key financial metrics – Net Operating Income (NOI), total project cost, return on cost (ROC), Internal Rate of Return (IRR), and Net Present Value (NPV) – are calculated to gauge each scenario’s profitability. A scenario is considered financially feasible if, for instance, its NPV is positive at a given discount rate or its IRR exceeds the required hurdle rate for that type of project. This stage provides concrete evidence to answer: Will this use not only pay for itself but yield a competitive return? The hierarchy of evidence comes into full view here, as all prior findings feed the financial model: legal and design constraints inform cost assumptions, market comparables inform revenue projections. The outcome might show, for example, that developing a boutique hotel on the site yields an expected IRR of 8%, whereas a multi-family project yields 12%. If the investor’s target is 10%, the hotel fails the feasibility test while the apartment project passes – a conclusion grounded in hard numbers. The financial evidence thus “locks in” the highest and best use by demonstrating which option leads to the highest residual land value or return once all costs and revenues are accounted.

4. Conclusion and Supporting Documentation: Finally, the analysis culminates in a comprehensive HBU report that synthesizes these evidence layers into a clear recommendation. This report typically includes a summary of the owner’s/developer’s goals, a digest of existing conditions findings, the market study results, outline designs or test-fits for prospective uses, cost estimates, and detailed financial feasibility workups. Crucially, it will present the recommended highest and best use (as vacant and/or as improved) and justify it with the compiled evidence: e.g., “Use A is recommended because it is legally permissible and fits the site, taps into unmet market demand as shown by comparable B and C, and generates an ROC of 12% versus 8–9% for other options.” By structuring the evidence in a hierarchy, the report builds an argument from the ground up – starting from factual constraints and ending in financial outcomes – which is highly persuasive. This level of documentation creates a defensible trail that lenders, investors, or regulators can audit. In effect, the hierarchy of evidence in HBU analysis mirrors the scientific method: starting with observations (site facts), forming hypotheses (use-cases), testing them (market and financial analysis), and arriving at a supported conclusion. The end result is an HBU determination that readers can trust, because each step is anchored in data or professional analysis rather than conjecture. As Northstar notes, the final HBU report becomes a “strategic tool for investment decisions, lender discussions, or partnership pitches,” precisely due to this rigorous evidentiary foundation.

Real-World Examples and Case Studies

The concept of highest and best use is not merely theoretical – it plays out vividly in the real estate market. Below are several real-world scenarios from the U.S. commercial real estate landscape that illustrate HBU in action, demonstrating how use-case logic has driven both value creation and prudent decision-making:

1. Office-to-Residential Conversions in Urban Cores: In recent years, many U.S. cities have witnessed underutilized office buildings, especially older ones, being reconsidered for residential use. The trend accelerated as remote work softened office demand, while housing demand in urban centers remained robust. A striking example is the conversion of 25 Water Street in Manhattan, a 1.1 million-square-foot vintage office tower, into over 1,300 residential rental units – the largest office-to-apartment conversion in U.S. history. The developers explicitly stated that “office was no longer the best and highest use” for this building given market conditions. Backed by data on local housing demand and the infeasibility of maintaining the property as offices, they reimagined the asset, even adding new floors within zoning limits once analysis showed the structural capacity to do so. The result has been strong leasing activity and a landmark example of adaptive reuse driven by HBU logic. On the flip side, not every office makes a viable residence. Industry research indicates that maybe only 10% of existing office buildings are good candidates for conversion, because many fail physical or financial tests despite the change in market demand. For instance, buildings with very large floor plates may not allow enough window access for apartments, or the cost to retrofit HVAC and plumbing could be prohibitive. The key takeaway is that where the four HBU criteria align – legal allowance, physical adaptability, market demand for housing, and profitable economics – office-to-residential conversions can unlock tremendous value. Where they don’t, attempts at conversion are wisely avoided. Thus, HBU analysis has been central to determining which offices get converted and which remain in their current use (or face other outcomes like demolition).

2. Repositioning Obsolete Retail Properties: Across suburban America, the decline of certain retail formats (like enclosed malls or strip centers in depopulating areas) has forced owners and lenders to confront harsh truths about highest and best use. A mid-2010s case in point is the wave of dead malls that found new life through conversion into distribution centers, offices, or mixed-use town centers. GlobeSt.com reported that many older suburban malls – once thriving retail hubs – saw their highest and best use shift to industrial or other uses as consumer behavior changed and e-commerce cut into physical retail sales. Examples include former malls repurposed as Amazon fulfillment centers or medical facilities. These conversions were driven by evidence that the properties’ large parcels and strategic locations (often near highways or population centers) were more valuable as logistics hubs or community college campuses than as half-vacant shopping centers. In one dramatic case, the site of the defunct Randall Park Mall in Ohio was redeveloped into an Amazon distribution warehouse, capitalizing on the site’s highway access and labor pool – a clearly higher use in the new economy. Such projects faced their own feasibility questions (zoning changes and community opposition had to be navigated), but from a pure valuation perspective, the numbers supported change. For lenders, recognizing the inflection point when a retail property’s HBU switches from retail to something else can be critical. Those who reappraised their collateral and worked with borrowers on repositioning strategies often recovered more value than those who held onto a failing status quo. As one commentary noted, seeking assets that can be “converted to a higher and better use” has become a savvy way to create value and profits in today’s competitive environment – a statement that perfectly describes the mall-to-warehouse trend.

3. Zoning Policy Unlocking New Uses: Sometimes, changes in public policy or zoning can suddenly alter the highest and best use of numerous properties, requiring rapid recalibration by owners and lenders. A notable case is Minneapolis’s elimination of single-family zoning in 2020 – the first major U.S. city to do so. By allowing duplexes and triplexes to be built on lots previously restricted to one house, the city unlocked additional housing density on thousands of parcels. For example, consider a small lot in Minneapolis that had a single-family home or even just a garage. Under the old rules, no further residential development was legally possible (the lot was too small for a second unit), so its HBU “as vacant” was effectively just a single-family residence and any extra land had minimal value. With the upzoning, that same lot could now host up to three units, dramatically changing its development potential and value. Appraisers in Minneapolis suddenly had to perform fresh HBU analyses “as vacant” and “as improved” for such parcels to determine what use (duplex? triplex? leave the current structure?) was now optimal. In one illustrative scenario, analysts found that a triplex plan on a small lot failed financial feasibility due to construction cost vs. rent mismatch, but a duplex plan would succeed, yielding higher land value than the original single-family use. The duplex, generating more rental income relative to cost, emerged as the highest and best use. This example underscores how feasibility screening (even if quick) must accompany newfound opportunities – just because a use is newly allowed doesn’t automatically make it the best choice without running the numbers. For lenders in Minneapolis, understanding these zoning changes was crucial: financing a project based on outdated single-family valuations could severely undervalue the collateral, while conversely, jumping into a three-unit development loan without checking feasibility could lead to backing an unsound project. The Minneapolis case demonstrates HBU as a dynamic concept – one that can shift overnight with legal changes, and one that requires stakeholders to continuously update their analyses to avoid mispricing assets or misallocating capital.

Each of these cases – urban office conversions, suburban retail redevelopments, and zoning-driven use changes – showcases HBU’s role as a strategic decision tool. In all instances, applying use-case logic (considering alternatives like apartments vs. offices, warehouses vs. retail, single-family vs. multiplex) and integrating feasibility checks early led to better outcomes: either seizing an opportunity for greater value or prudently steering away from a flawed investment. The common thread is that real-world validation backs the choices made. Whether it’s leasing data from a newly opened apartment tower in a former office or the sale of a converted mall-warehouse at a healthy price, these examples provide tangible evidence that highest and best use analysis, when done rigorously, translates to real value on the ground.

Conclusion

Highest & Best Use is far more than a box to tick in an appraisal report – it is a mindset and methodology that can elevate real estate strategy for both developers and lenders. By turning use-case logic into defensible value, stakeholders ground their decisions in analysis rather than speculation. The HBU approach forces a candid look at a property from all angles: what can be done, what the market wants, what yields profit, and ultimately what choice of action will optimize value. Embracing HBU as a strategic tool means asking the right questions early, integrating multidisciplinary evidence, and being willing to pivot when a cherished idea does not survive the gauntlet of feasibility. The payoff for this discipline is clear – from avoiding costly misinvestments to identifying golden opportunities that others overlook. In a rapidly changing market, where technology, demographics, and policies continually reshape demand, those who internalize the highest and best use principle will be better equipped to navigate uncertainty. Developers can design projects that truly fit their context and meet real demand, bolstering both community impact and financial success. Lenders can underwrite deals with greater confidence, knowing the proposed use is credible, supported by market evidence, and more likely to hold its value. In sum, HBU-oriented thinking aligns real estate vision with reality – ensuring that every project or loan is backed by the highest rationale and the best possible use of resources. As the cases discussed illustrate, leveraging HBU can transform dormant or misused assets into thriving ventures, and conversely, prevent enthusiastic plans from becoming expensive mistakes. In the end, Highest & Best Use is about maximizing value responsibly, a goal that lies at the very heart of commercial real estate success.

October 13, 2025 by a Collective of authors at MMCG Invest, HBU study consultants.

Sources:

• Appraisal Institute – The Appraisal of Real Estate, 15th Edition

• Uniform Standards of Professional Appraisal Practice (USPAP), 2024 Edition

• U.S. Small Business Administration (SBA) SOP 50 10 7.1

• The Appraisal Journal

• CCIM Institute – “Understanding Highest and Best Use”

• Northstar Project & Real Estate Services – “Highest and Best Use Studies” (2023–2024)

• Appraisal Buzz / PropStream Blog – “What Does Highest and Best Use Mean?”

• GlobeSt.com – various articles on adaptive reuse and conversions (2022–2024)

• Urban Land Institute – Emerging Trends in Real Estate 2024

• City of Minneapolis – Comprehensive Plan 2040

• CBRE Research / Cushman & Wakefield Market Reports (2023–2025)

• Harvard Joint Center for Housing Studies – America’s Rental Housing 2024

• Moody’s Analytics | REIS Commercial Data (2024)

• National Association of Realtors – Commercial Market Insights Q2 2024

• Buildium / Urban Institute – “Financial Feasibility Modeling for Small-Scale Developers”

• Journal of Property Investment & Finance – “Evidence Hierarchies in Real Estate Appraisal and Valuation”

• McKinsey Global Institute – “Reimagining Real Estate Value through Use-Based Redevelopment”

• Federal Reserve Bank of San Francisco – “Adaptive Reuse and Urban Land Productivity” (2023)

• MMCG Analytics Database (2025 Edition)