Concurrently with the near total deterioration of the Florida real estate market encompassing most segments and categories, comes the push back against county property appraisers about their valuations and the resultant tax liability. Amidst loud and steady cries for reform the Florida legislature has recently considered several key issues that relate directly to property valuation.

There has been much made of the County Appraisers employing “highest and best use” as the basis for valuation for tax purposes. This resulted in cases such as “working waterfront” properties that argue that not every parcel is a site for a waterfront condominium and that the present less “valuable” use should apply. Many have rallied behind the idea including another group severely affected by the run-up in prices, the small motel and hotel properties which are often family owned and marginally profitable before any potential tax burden.

It is tempting and emotionally appealing to consider this change in the law but in principle, it is the wrong thing. We must drill deeper to unearth the root problem and consider how there may be other potential remedies. There are four classic tests of highest and best use that must be considered and while each is important they require total consideration to arrive at an informed decision.

• The proposed use must be legally permissible
• The proposed use must be physically possible
• The proposed use must be financially feasible
• The proposed use must be maximally productive.

The classic (and only partially true) statement often heard is “that use which results in the highest net return to the land”. It is a highest and best use as if vacant concept which is then considered in terms of the highest and best use as currently improved. The contemporary statement which most applies to the definition is “that use which results in the highest net return to the land in consideration of USE, USERS and TIMING (risk).” It is more than a subtle difference and one which is widely ignored by fee appraisers and county appraisers who fail to consider properly all of the four tests which in turn are supported by market analysis which is the “plasma” that sustains the organism.

Here are some examples based on recent cases with location and some details purposely omitted. In a local incorporated island community all land parcels west of the single service arterial are zoned for commercial use which among its permitted uses allows condominiums under certain physical guidelines. In this community are a number of locally owned or seasonal beach cottages much like the scenes I remember growing up in Sarasota. The lots are small and in many cases substandard in size allowing only conditional rebuilding if the structures are destroyed or severely damaged by an act of God. The property appraiser holds the view that since the land is zoned for commercial use now, even if the site is not large enough to support a multi-family structure, it may be combined with either contiguous parcels or worse, non-contiguous parcels to create a condo site.

This is an extraordinary set of assumptions under any conditions but in light of recent, current and likely continuing conditions the act strains credulity! First “assemblage” of land and/or improved parcels with attendant price influences is not a properly supported highest and best use. The only reason to assemble is when there is a market for the product that will ultimately be placed on the assembled site. This is such a key issue and it cannot be underscored enough, it’s about the TIMING requirement we discussed earlier.

The property appraiser used some sales of small residential properties that were “flips” and others where the implicit assumption on the appraiser’s part was that they were potential condo sites. More to the point at the time of the valuation there were (and more now) hundreds of unsold condominiums and even available vacant sites. Why would there be a market for the land when there is clearly no present market for the condos? This is the point where the issues become timing and risk as there needs to be a forecast of when there will be a market for the potential development and as always timing and risk are intertwined. The longer the holding period required to build the more risk that the outcome may not be as planned. Simply, the present worth of assumed future benefits.

The second example is similar in that as before, it’s a highest and best use problem (but then all of them are!). There is a slice of time in a rapidly escalating residential market, especially at the beginning stages, where there is unsatisfied demand because supply to match demand takes time, there is a lag. In that interim period there are “low hanging fruit” in the form of rental apartment projects that may for a time have a highest and best use as converted condos where they can be sold quickly. In my experience this has happened every time there has been a market surge and every time there have been unintended consequences. When the supply side catches up to current demand there exists a significant product differentiation. If you are a “user” or intended resident there may be better products with more features that are newer. If you are an investor there may be nobody to flip the speculative purchase to. If all sales are not consummated and closed there is the danger of becoming “fractured”, partly sold, partly not and among those two, partly rented.

In this case the appraiser has a “loophole”, once an apartment project is “declared” as a condominium the assessor in the next cycle can assess each unit separately as a “condo” unit. Let’s consider the aforementioned four tests; the use may certainly be legally permissible and physically possible (as improved) since it is basically the same as a rental project. There is just an aggregate change of ownership. The real problem is when the market never materializes or just disappears mid-stream! It is very likely in the case of a project never marketed that it is operated just as before, as a rental. Logically under highest and best use tests that is the highest and best use. In the case of the fractured or partially sold project it is a bigger mess to clean up. It should be valued both as a rental and as an unsold condo with market analysis of the product, timing and supply and demand required. This will be the present worth of future benefits as well.

Highest and best use cannot be determined without appropriate market analysis and value cannot be estimated without an appropriately supported highest and best use.

The most compelling contemporary question I hear is “are we at the bottom of the market”? There is a variety of opinion about this; some driven by a “positive attitude” because we need some good news, some which are darker and perhaps more pragmatic responses. I am an admirer of Lou Dobbs of CNN, he is by in large a practical thinker strong on basic rights and a keen observer not afraid to give his opinion. He has been predicting the economy (including housing) will begin a comeback before the end of the year. He criticizes both Obama and Bush for negative messages and offering little good news. The interwoven problems and solutions to the total economic health picture are beyond most of us but clearly there are key indicators in my bailiwick that give me a cautious view of when and how there will be a substantial recovery.

First, any recovery however that is measured, will not be uniform and across the board at the same time. Second, prices (not values) will not “return to their peak” anytime soon given that the peak was investor driven and not user driven. In addition to the hopefully soon to be flowing credit availability there is a single troubling wild card that cuts across every region and every property type. It’s fundamental that jobs are the key to all of the other systems. The alarming rise in unemployment will not change overnight and in spite of assurances to the contrary may not respond positively to stimulus attempts in the near term. Think about it, jobs create income which evolves into disposable income. Without adequate ability to repay from income there can be no housing mortgages, retail space becomes vacant (save for necessities) and office space exhibits shrinking occupancy.

I tend to agree with St. Pete Times columnist James Thorner in his May 1st column, “Rah-rah housing talk is wishful”. He provides an estimate that there are 35,000 unsold homes which for some period of time will be fed by further foreclosures. We in the Tampa Bay area and most of coastal Florida have been dependent upon in-migration of retirees and relocation of families coming primarily from the Midwest and Northeast. If that migration pattern is to continue (and there are signs that is dramatically changing) those folks need to sell their homes “up north” first. Almost every day the optimists (and some with rose colored glasses) point to the increase in home sales which has closely followed the slow to change price declines. It appears that there are certainly bargains, especially if you intend to live in what you purchase, but once again there are pockets of equity rich investors counting on the market being at or near the bottom in prices and are preparing for a renewal of flipping. However, once again the fundamental lack of credit and mortgages for many precludes fueling the cycle and at the end of the day it’s still about jobs, especially if you don’t have one!