Highest and best use

Highest and best use is the use of a non-financial asset by market participants that would maximise the value of the asset or the group of assets and liabilities (eg a business) within which the asset would be used.


Here is the way real estate manager use this definition, which should be within IFRS because these are the market participants.

A property must be appraised in terms of its highest and best use.

The definition of highest and best use is as follows:

The reasonable, probable and legal use of vacant land or an improved property, which is physically possible, appropriately supported, financially feasible, and that results in the highest value.

When a site contains improvements, the highest and best use may be determined to be different from the existing use. Implied in this definition is that the determination of highest and best use takes into account the contribution of a specific use to the community and community development goals, as well as the benefits of that use to individual property owners.

An additional implication is that the determination of highest and best use results from the appraiser’s judgment and analytical skills; that is, the use determined from analysis represents an opinion, not a fact to be found.

In appraisal practice, the concept of highest and best use represents the premise upon which value is based. In the context of most probable selling price, another appropriate term to reflect highest and best use would be the most probable use.

Any determination of highest and best use includes identifying the motivations of probable purchasers. The motivations are based on perceptions of benefits that accrue to property ownership. Different motivations influence the highest and best use and are significant to an appraiser’s conclusions about the highest and best uses of any parcel of real estate.

The benefits of investment properties that are not owner-occupied relate to net income potential and to eventual resale or refinancing. The highest and best use decision for investment property is often influenced by the income tax and inflation hedge aspects of the existing or proposed improvements.

Determination of the type and intensity of the improvement to be placed on the investor’s land often requires an after-tax return analysis of various alternatives. Land or improved property that has resale profit as its principal potential benefit is purely speculative. The price such land commands in the market reflects the real motivation of the purchaser/speculator.

This portion of the appraisal process is based on the definition of highest and best use supplied previously. From this definition, it is obvious that market value of the land or site and of an improved property are both estimated under the assumption that potential purchasers will pay prices that reflect their analysis of the most profitable use of both land, as vacant, and property, as improved.

A use must meet four criteria as follows:

  1. Physically Possible
  2. Legally Permissible
  3. Financially Feasible
  4. Maximally Productive.

Once the highest and best use has been determined, the appraiser can then apply the appropriate approaches to value.Market-corroborated inputs

Example – Highest and best use vs intended use

An entity acquires a research and development (R&D) project in a business combination. The entity does not intend to complete the project. If completed, the project would compete with one of its own projects (to provide the next generation of the entity’s commercialised technology). Instead, the entity intends to hold (i.e., lock up) the project to prevent its competitors from obtaining access to the technology. In doing so, the project is expected to provide defensive value, principally by improving the prospects for the entity’s own competing technology. To measure the fair value of the project at initial recognition, the highest and best use of the project would be determined on the basis of its use by market participants. For example:

  1. The highest and best use of the R&D project would be to continue development if market participants would continue to develop the project and that use would maximise the value of the group of assets or of assets and liabilities in which the project would be used (i.e., the asset would be used in combination with other assets or with other assets and liabilities). That might be the case if market participants do not have similar technology, either in development or commercialised. The fair value of the project would be measured on the basis of the price that would be received in a current transaction to sell the project, assuming that the R&D would be used with its complementary assets and the associated liabilities and that those assets and liabilities would be available to market participants.
  2. The highest and best use of the R&D project would be to cease development if, for competitive reasons, market participants would lock up the project and that use would maximise the value of the group of assets or assets and liabilities in which the project would be used. That might be the case if market participants have technology in a more advanced stage of development that would compete with the project if completed and the project would be expected to improve the prospects for their own competing technology if locked up. The fair value of the project would be measured on the basis of the price that would be received in a current transaction to sell the project, assuming that the R&D would be used (i.e., locked up) with its complementary assets and the associated liabilities and that those assets and liabilities would be available to market participants.
  3. The highest and best use of the R&D project would be to cease development if market participants would discontinue its development. That may be the case if the project is not expected to provide a market rate of return if completed and would not otherwise provide defensive value if locked up. The fair value of the project would be measured on the basis of the price that would be received in a current transaction to sell the project on its own (which might be zero).

If the highest and best use in this example was (a), then that is the value that the entity must ascribe to the R&D project, even though its intended use is to lock up the project.

The fair value of the in-process research and development project in the above example above depends on whether market participants would use the asset offensively, defensively or abandon it (as illustrated by points (a), (b) and (c) in the example, respectively). If there are multiple types of market participants who would use the asset differently, these alternative scenarios must be considered before concluding on the asset’s highest and best use.

The place of highest and best use in IFRS 13:

IFRS 13 fair value is exit price


Highest and best use

Highest and best use

 

Annualreporting provides financial reporting narratives using IFRS keywords and terminology for free to students and others interested in financial reporting. The information provided on this website is for general information and educational purposes only and should not be used as a substitute for professional advice. Use at your own risk. Annualreporting is an independent website and it is not affiliated with, endorsed by, or in any other way associated with the IFRS Foundation. For official information concerning IFRS Standards, visit IFRS.org or the local representative in your jurisdiction.

Something else -   IFRS 13 Adjusted net asset method

Leave a comment