AN UNDERSTANDING OF REASONABLY PROBABLE THAT IS PROBABLY REASONABLE

Charles Johnstone, M.I.M.A., Principal, Expert Witness Services, Property Tax Complex, Ryan

Haydn C. Johnstone, AACI, P.App, Director, Property Tax, Ryan

We know that market value is most often defined as the most probable selling price. We also know that Highest and Best Use is the reasonably probable use of the real property that is, physically possible, legally permissible, financially feasible, and maximally productive, and that results in the highest value. How do these concepts fit together? Is it reasonable that the most probable selling price would be the highest value? Hot off the press is the latest update to the Appraisal of Real Estate - the 4th Canadian Edition for those keeping count - which provides the definition for Highest and Best Use at 17.1 as described above. Nothing startling there; however, flip the page and you find: the Most Probable Use is defined as “[t] he use to which a property will most likely be put to based upon market analysis and the highest and best use conclusion. The most probable use is the basis for the most probable selling price of a property (17.2).” You also find that the Most Profitable Use is “[h]ighest and best use in the context of investment value” not market value. Let us explore these concepts a bit further.

The latest edition of the Appraisal of Real Estate references reasonably probable; however, no definition is provided. This is likely because reasonably probable can mean many things depending on the scope of the assignment. That said, we have found that by providing a base level or foundation of our understanding of the term, that we have gained a better appreciation for it. Going to the root of the two words:

Reasonable is defined as, “being in accordance with reason; having the faculty of reason; or, possessing sound judgment.”

Whereas, probable is defined as, “supported by evidence strong enough to establish presumption but not proof; or, likely to be or become true or real.”

While the wording may seem arbitrary, it is much more nuanced. What is possible may not be probable. Really, it could be simplified down to “could” versus “likely.” When you buy a lottery ticket, it is possible that you will win but it’s not probable. This adds some complexity to HBU, where the use with the highest value could be possible, but not probable (unlikely). The key is, we are not trying to determine what the highest value could be without constraints, we are trying to determine the highest value the market would likely achieve and how it might go about doing this. We are attempting to replicate market behaviour, and therefore, we must understand the constraints the market itself faces. As valuers, if we are not replicating reality, we are fabricating fantasy.

With that in mind, when combined we can synthesize our understanding of reasonably probable to:

A conclusion of the property’s use supported by sound appraisal judgment and market evidence, which is strong enough to establish the likelihood of becoming true or real.

There is still room for professional judgment. Take for example, the complex world of assessing or valuing redevelopment lands. If we are to replicate market behaviour, does the market behave through the lens of the most probable use1 or the most profitable use2? How is this perceived in assessment? Perhaps a summary from the recent IMA/AAA “Canadian Assessors Summit” will provide some insight on this topic.

The stage was set by asking the participants to imagine they were on an assessment appeal tribunal and tasked with determining the correct market value of an estate home of historical significance close to the downtown core. The 3,500 square foot home is situated on 1.5 acres of land. The subject property is zoned residential, but the community plan shows the local area has been designated mixed-use high-density and nearby properties have been developed as such. However, there is also an historical society that strongly opposes redevelopment for potential heritage-designated properties including the subject property.

Assessor focuses on HBU: As my evidence has been presented, based upon the nearby sales, it is at least 51% probable that this site can be redeveloped to a new mixed high-density use based upon the designated land use. I interviewed nearby purchasers, looked at development cost and sales potential, and estimated that it is in fact profitable to redevelop the subject. While I do acknowledge the possible heritage constraints, it is still reasonable to value the future redevelopment potential of this property. I have provided four similar redevelopment potential lands in the vicinity and have shown them to be selling for $2,000,000 per acre. Further to this, the Act requires market value and that is based upon the highest and best use as of the valuation date. My sale comparables are properties of similar size and land use designation as the true value is in the land’s development potential and not in the current use. The correct assessment for the property based on its HBU is $3,000,000, calculated as 1.5 acres at $2mil an acre. I requested that the Tribunal not speculate on the possibility of a heritage designation for this property when I have provided sound evidence that redevelopment is reasonably probable as the value of the land exceeds the value of the current use and any developer would not see the value in the estate.

Owner focuses on MPU: I have no intention to sell or redevelop the property, it is an historical estate, and it is well-maintained to the original specifications as drafted by a famous architect. The market would appreciate the true value of historical significance. I have provided articles and documents showing there are strong political pressures to designate this property as heritage, with an active local lobbying group. It is not speculation that a heritage designation is imminent, it is self-evident and plastered all over the news. The greatest value can be achieved through preservation. I have also presented evidence challenging the absorption targets, impact of tightening lending policy and rising interest rates, and increasing construction costs, which have softened the real estate market making any redevelopment in the current market speculative. The current use requires no speculation, as the property is going to remain a house for the indefinite future and should be assessed as such. I agree with the assessor that without constraints and without the change in the market, there may have been a possibility of redevelopment at some future date; however, as of the valuation date there was no probability of it. I have provided the board with sales similar estates in the vicinity to capture only the value of the current use. I have also provided the board with court decisions stating that assessors should not speculate on future changes to the property. The sales and assessments indicate that the value of the subject property in its MPU should be set at $1.5mil to achieve a fair and equitable assessment.

It is unlikely that both could have a 51% chance or greater of occurring, so we asked the participants – the newly assigned Board members – to provide their thoughts on which was more correct for assessment purposes. The results were about 50/50, with a slight edge to the most probable use. Our surprise(d) guest of honour, whom we sprung the challenge of rendering a decision on-the-spot as the case study’s arbitrator, provide sound guidance (as they are a respected Member in this realm) suggesting in this instance, the value would be somewhere between the two (purposely curated) polar opposite HBU and MPU stances. The decision rendered was the market would appreciate the existing use while inherently understanding that there is some additional value in the future development potential or location, being more proximate to downtown and higher-density uses.

All of this to say that even when our understanding of reasonably probable is probably reasonable, the greatest minds in valuation and assessment – yes you, the participants – were almost evenly split. Each assignment comes down to judgment, expertise, and a proper highest and best use analysis. The most probable use will define the most probable user which identifies what is comparable. To select sales before determining the most probable use, is to put the cart before the horse. Alongside this, the analysis should provide the timeframe of the redevelopment or maintenance of the current use. While this in no way is profound, the conclusion is “be transparent and use your discretion.”