In-depth treatment of these issues is beyond the scope of this book, but the following is an introduction. The effect that environmental issues can have on the value of land should not be underestimated, and wetlands are one of the more prevalent environmental detriments to land development.
Contamination is another environmental issue that can not only diminish the value of land but due to liability issues may actually render it worthless.
Eminent domain valuations for partial takings of land require a special type of government-mandated valuation process. That process can result in a value that is much different from other market value appraisals.
Wetlands can be a major obstacle to development, and hence the valuation, of all types of land. For this reason, the appraiser should be familiar with wetlands and have experience in valuing them if they are part of the appraisal under review. One legal definition of wetlands can be found in the Emergency Wetlands Resource Act of 1986, which states:
Wetland: Land that has a predominance of hydric soils and that is inundated or saturated by surface or groundwater at a frequency and duration sufficient to support, and under normal circumstances does support, a prevalence of hydrophytic vegetation adapted for saturated soil conditions.
To understand the basis that the government uses to intervene in the wetlands issue, the act goes on to say this:
Overview
The purpose of the Act is to promote wetlands conservation for the public benefit and to help fulfill international obligations in various migratory bird treaties and conventions. The Act authorizes the purchase of wetlands from Land and Water Conservation Fund monies. The Act also requires the Secretary of the Interior to establish a National Wetlands Priority Conservation Plan, requires the states to include wetlands in their Comprehensive Outdoor Recreation Plans, and transfers funds from import duties on arms and ammunition to the Migratory Bird Conservation Fund.
Findings/Policy
Congress finds that: wetlands play an integral role in maintaining the quality of life; wetlands provide essential habitat to a major portion of migratory and resident fish and wildlife; migratory bird treaty obligations require federal protection of wetlands; wetlands, and the fish, wildlife, and plants dependent on wetlands, provide recreational and commercial benefits, including contributions to a commercial marine harvest valued at over $10 billion annually, support for the nation’s annual fur and hide harvest, and wetland-related recreation activities that generate billions of dollars annually; wetlands enhance water quality and supply by serving as groundwater recharge areas, nutrient traps and chemical sinks; wetlands provide a natural means of flood and erosion control by retaining water during periods of high runoff; wetlands are only a small percentage of the U.S. and continue to disappear; certain activities of the federal government have altered or assisted in the alteration of wetlands; existing federal, state, and private cooperation in wetlands conservation should be strengthened.1
Based on the act, there are essentially three characteristics necessary to categorize land as wetlands. However, it should be noted that biologists and others often disagree about what constitutes a wetland and that frequently there are legal disputes regarding them. And the reason for these legal disputes is clearly understood in light of the fact that land can lose a huge amount of its value if it is classified as wetlands. Often the fact that wetlands exist on a property is not in dispute, but the extent of the wetlands, and consequently the boundaries of them, bring about litigation.
The three basic characteristics that lead to land being classified as wetlands are evidenced by the following:
1. Hydrology. Hydrology refers to the presence of water on land.
2. Hydric soils. These are soils that show evidence of water saturation. When soil is underwater for prolonged periods, the lack of oxygen produces anaerobic conditions that often change its color. The wetlands biologist will dig a hole in the ground to examine the soil underneath and examine it for signs of saturation.
3. Wetlands plants. Also called hydrophytic vegetation, these are plants that grow in the soil and conditions found on land that is periodically inundated with water.2
According to Cowardin et al., there are five basic types of wetlands environments: palustrine, lacustrine, marine, estuarine, and riverine.3 The following are brief and noncomprehensive definitions of these types of wetlands.
Inland properties are generally considered palustrine wetlands because they are swamps and bogs and other wet areas that are not connected to the wetland systems.
Lacustrine wetlands are generally associated with lakes and dammed bodies of water such as reservoirs.
Marine wetlands are found along ocean shorelines.
Estuarine wetlands are found between marine wetlands and uplands; they are generally marshy areas and swamps near the ocean.
Riverine wetlands, as the name implies, are found near rivers, creeks, and manmade waterways.4
Requirements for permits are quite complex, and they also are constantly changing. The information supplied here is very superficial and should not be relied upon except as a general introduction.
Basically, there are two different permits that one must obtain to fill wetlands, but the permits can vary according to agricultural and other aspects. The nationwide permit is necessary if areas as small as one-tenth of an acre are to be filled. An individual permit is necessary for filling larger areas. The amounts that trigger the need for permits have changed over the years, and the restrictions keep getting tighter.5
In order to develop a property with wetlands, it is sometimes possible for a developer to mitigate some of the wetlands. In other words, if the developer wants to build on an area that is wetlands, he or she might mitigate the area by creating new wetlands or restoring or enhancing existing wetlands. This might occur on the same property that is under development. For instance, if the property is a five-acre parcel and one acre is wetlands but that acre is in the most usable portion, the developer might create wetlands on other acreage to mitigate for it.
The rules are constantly changing, and mitigation ratios may also vary according to whether the developer is creating, restoring, or enhancing the mitigated areas. The ratio could be up to 1:8, or some other number. In the past, mitigation could be performed on a distant site, but with the newer rules, property has to be mitigated with property in the same watershed, the borders of which are generally outlined by the Army Corps of Engineers.6
Mitigation banks have been established in some areas where developers can purchase mitigation credits for their property. Sometimes, banks are started by developers for their own projects, or they may be established by entrepreneurs who sell the credits for a profit. The sale prices from mitigation banks can be helpful in determining the value of wetlands. However, sales of this nature can be complicated, and if they are used in the appraisal, they should be reviewed carefully.
There are various theories regarding the best valuation methods for wetlands, but the sales comparison approach is generally the most accurate. Wetlands that can be further enhanced are usually sold for mitigation purposes, and the price of those sales should have been considered and examined by the appraiser to determine the value of the wetlands under valuation. The circumstances of the sale are of paramount importance. Supply and demand can vary depending on what is available at a given time.
If land is purchased to create wetlands, then the value of the land in such a situation may not be usable as a wetlands comparable because it was purchased as uplands. If there are enough wetland sales in a certain area, a pattern should develop that should form a range for valuing the subject property. The appraiser will probably use a sales grid, which will be constructed as it would be for any other land sale analysis, and a conclusion should be drawn after the sales are analyzed and reconciled.
Appraisers normally have a statement in their appraisals that protects them from liability regarding contaminants on the property they are appraising. It might be similar to this:
The appraiser is not qualified to detect hazardous waste and/or toxic materials. Any comment by the appraiser that might suggest the possibility of the presence of such substances should not be taken as confirmation of the presence of hazardous waste and/or toxic materials. Such determination would require investigation by a qualified expert in the field of environmental assessment. The presence of substances such as asbestos, urea-formaldehyde foam insulation, or other potentially hazardous materials may affect the value of the property. The appraiser’s value estimate is predicated on the assumption that there is no such material on or in the property that would cause a loss in value unless otherwise stated in this report. No responsibility is assumed for any environmental conditions, or for any expertise or engineering knowledge required to discover them. The appraiser’s descriptions and resulting comments are the result of the routine observations made during the appraisal process.
For industrial properties, certain industries tend to be contaminated with chemicals associated with the products they produce. For instance, trichloroethylene (TCE) was used for many years as a degreasing agent, and it may be present at certain types of plants, such as paper mills. A company under valuation may not want to know if contamination exists because that knowledge can force them to clean it up. Consequently, property can be contaminated, making it a risk for a lender, and the lender may never know about it. The reviewer would be wise to ask questions if the appraisal is for an industrial facility.
Residential and commercial sites may also have contamination. Gasoline stations may have buried tanks that have leaked. Dry cleaning establishments may have used chemicals that have polluted the ground, and homes with buried heating oil tanks may also have issues.
If a company’s property is possibly contaminated, the reviewer might want to ask it to conduct an environmental assessment report to determine if it is contaminated, and if so, to what extent the contamination exists. The American Society for Testing and Materials (ASTM) has set certain standards for different phases of testing. The following is an example of what is performed for a typical Phase I through IV report. Please note that the following information is introductory and basic. More detailed information is required for an in-depth understanding of these reports.
The first phase is an initial review to determine whether there is a reason to suspect contamination. This environmental assessment is a due diligence screening tool designed to make a basic assessment, using research and observation, to determine potential environmental contamination associated with real property. It usually includes the following activities:
• Inspection of the property, including all structures, to identify possible sources of contamination, such as asbestos, electrical equipment containing polychlorinated biphenyl (PCB), and/or chemical spills
• Inspection for leaking storage tanks, old waste disposal areas, chemical containers that have been stored on the property, and other visible sources of potential contamination
• Investigation of past chemical spills or disposal of hazardous substances, legal or illegal, by observing soil stains or disturbed vegetation
• Contact with people familiar with the property and data sources so the investigator can discover its history to identify past events or uses that may have contaminated the property
• Search of available government records on the property to identify possible sources of contamination on or near the site; search of databases that reveal properties in the vicinity that have been identified as contaminated
• A 50-year or longer title search for previous owners and uses of the property, which may reveal usage that could have caused contamination
• Search for historical aerial photographs of the site to determine past uses and evidence of contaminating activities such as waste disposal
The second phase is a physical investigation to determine whether there is contamination. This phase differs from Phase I in that the site is actually tested. It generally follows Phase I if Phase I reveals a need for further testing. It is also aided by Phase I since Phase I directs what is tested and what tests need to be performed:
• Surface and subsurface soil sampling. This may require boring holes and taking samples at different levels in the soil.
• Groundwater sampling. Drilling wells may be required to determine whether water is contaminated at any level. Monitoring wells are often installed on sites that are contaminated.
• More extensive testing of the site depending on conditions. The chemical constituents chosen for analysis should correspond with the potential contaminants for the site. In other words, it is difficult to test for every type of chemical, so the testing should be for chemicals related to the use of the land.
This phase is to determine the type and extent of the contamination. Studies need to be conducted before the cleanup process can begin:
• Before the cleanup process can begin, studies need to be conducted to find the geographic location of the contamination.
• It must be determined whether the contamination is still spreading (through groundwater, for instance). A remedial action plan (RAP) must be developed, studied, and approved by the controlling regulatory agencies.
In this phase, the process of cleanup and remediation begins. This is the actual cleanup of the toxic material. It may not rid the property of all contamination because doing so may be impossible. Rather, the goal is to clean up the site to the extent that the governmental regulatory agencies’ requirements are met.
Remediation may be in situ (within the site) or ex situ (outside of the site). In situ cleanups are generally less expensive, but they may be less successful than ex situ. An example of an in situ cleanup is treating the soil to rid it of a toxic chemical. In an ex situ cleanup, the soil is taken from the site and dumped in an approved toxic waste disposal site.
Changes in technology have had a mixed effect on the detection and remediation of contamination. Micro-technology—micro-separation devices with micro-sensors—can now be used to detect contamination plumes. This means that contamination that might have escaped detection in the past can now be identified. This adds to the burden of remediation, but it also allows for more precise cleanup, which can save costs because noncontaminated areas can be more easily distinguished. The point is, as technology changes, the cleanup process is affected.
Different types of contamination affect property values differently. There are many types of chemicals that can contaminate a property, as well as various ways in which a property can become contaminated. For instance, chemicals such as arsenic can be found at aluminum plants, and trichloroethylene (TCE), a degreasing agent, can be found in paper mills. Chemicals vary in their toxicity, and some are easier to clean up than others. The more dangerous chemicals can be more expensive to clean up, depending on their molecular structure and other properties.
The diminution in value depends on how the contamination affects the site. For instance, the presence of asbestos in a building may entail the removal of it or the sealing and containment of it, and when that is accomplished, the contamination issue should be resolved. The expense of the work may not be certain, but it will be within a range of cost that can be reasonably estimated, and when the cleanup is accomplished, the property will not be stigmatized.
In comparison, a site with contaminated soil has more risk because the extent of the contamination is not known until the cleanup begins. Estimates can be made, but they will not be as certain as those for an asbestos cleanup. Moreover, the site may continue to suffer from the stigma of contamination because there may be a lingering question about whether the cleanup was complete. Soil testing has its limits, and it is possible to miss an area that needs cleaning.
A site with contaminated groundwater poses an even higher risk. Water is difficult to clean, and it can travel to other sites, increasing the liability aspect of a cleanup. Monitoring wells may help to determine the condition of the groundwater, but no one knows the exact route that water takes under the earth, so contamination can seep into areas that cannot be anticipated. Remedial work is also more questionable with groundwater contamination because methods vary in expense and effectiveness. The property may continue to be stigmatized for a long time into the future because of the seriousness of this type of contamination.
The results of the report investigations will determine if there is contamination, but it will not necessarily be accompanied by a cost to cure. An environmental engineer typically makes this estimate, and it will probably state cleanup costs based on the assumed amount of contamination. If groundwater is the issue, the estimate will likely include projected future costs, including monitoring wells and other expenses. In any event, often the full extent of the contamination cannot be known until the cleanup begins, so a specific estimate is rare at this stage.
If there is a cost-to-cure estimate, the figure that results when that amount is subtracted from the market value of the property as clean will not necessarily be the market value for the property as contaminated. The time and effort to clean the property and the cost of borrowing the funds to clean it will also have to be considered. Moreover, accurate estimates can rarely be made for cleanups, and they often cost more than anticipated.
There is another aspect of the contamination issue that should be considered in reviewing the appraisal, even if the property has been cleaned: stigma.
Stigma is defined by The Dictionary of Real Estate Appraisal as “an adverse public perception regarding a property; the identification of a property with some type of opprobrium (environmental contamination, a grisly crime), which exacts a penalty on the marketability of the property and hence its value.”7 Merriam-Webster’s Collegiate Dictionary defines it as follows: “1 (a) archaic: a scar left by a hot iron; brand. (b) a mark of shame or discredit; stain. (c) an identifying mark or characteristic; specifically: a specific diagnostic sign of a disease.”8
Stigma as it relates to real estate is defined as follows: a characteristic of real property that is detrimental to its market value, based on perceptions about the property. Stigma includes, but is not limited to, the following items:
• Fear of current and future liability
• Concern that the cleanup is not complete
• Inability to finance property (Lenders are leery.)
• Problems for public relations (For instance, does the company want to be known as being located on a previously contaminated site, even if it is now clean?)
The reviewer should understand that stigma, in the case of environmental contamination, should be separated from the specific cost to cure. The cost to cure can be more easily measured than stigma, and stigma is an additional loss in value that is not inherent in the cost to cure.
The stigma affecting a site, and the potential liability due to the ramifications of the contamination, may be affected by the circumstances of the contamination. Many sites became contaminated with chemicals that were legal to use years ago but have since been banned. Some chemicals may still be in use, but they are now subject to strict methods of disposal, whereas in the past they were simply dumped on the ground or into a river.
Sites with contamination from such uses, where the law was not broken, may be less prosecutable and less risky regarding liability claims than sites that have become toxic due to illegal conduct. For the same reason, the stigma associated with a legally contaminated site is often diminished compared to that associated with a site subject to criminal activity.
Property may be contaminated without that problem being noted in the appraisal. In fact, most appraisals specifically state that the subject property is being appraised as if it is free of contamination and that the appraiser is unqualified to detect contamination and will be held harmless of any liability should the site prove to be contaminated. There are certain properties that are more likely to be contaminated than others, such as gasoline stations, dry cleaners, and most industrial plants, and specific chemicals may be associated with certain industries. To determine if a site is contaminated, an environmental assessment should be conducted.
Sites that are certified to be clean but were previously contaminated may still suffer from a loss in value due to the stigma associated with the property. Stigma is not the only issue with these sites. Often there is uncertainty that a site has been thoroughly cleaned, even if it has been certified as such. There may be significant risk and liability associated with a contaminated site or with a site that has been cleaned up, and the valuation of it requires an appraiser who is a specialist.
An in-depth treatment of eminent domain valuations is beyond the scope of this book, but the following is an explanation of how eminent domain appraisals differ when compared to typical market value appraisals. Eminent domain is the right of the government to take private property for public use. It is further defined in The Dictionary of Real Estate Appraisal, as follows:
The right of government to take private property for public use upon the payment of just compensation. The Fifth Amendment of the U.S. Constitution, also known as the takings clause, guarantees payment of just compensation upon appropriation of private property.9
Eminent domain rules for takings for the federal government may vary from the rules for state governments. The federal government publishes a document titled Uniform Appraisal Standards for Federal Land Acquisitions, which is often referred to as the Yellow Book. It is a guide to appraisers on how eminent domain property should be valued. The definition of market value from the federal book is as follows:
Market value is the amount in cash, or on terms reasonably equivalent to cash, for which in all probability the property would have sold on the effective date of the appraisal, after a reasonable exposure time on the open competitive market, from a willing and reasonably knowledgeable seller to a willing and reasonably knowledgeable buyer, with neither acting under any compulsion to buy or sell, giving due consideration to all available economic uses of the property at the time of the appraisal.10
However, in comparison, the definition of market value for eminent domain takings for the state of California is this:
The fair market value of the property taken is the highest price on the date of valuation that would be agreed to by the seller, being willing to sell but under no particular or urgent necessity for so doing, nor obliged to sell, and a buyer, being ready, willing, and able to buy but under no particular necessity for so doing, each dealing with the other with full knowledge of all the uses and purposes for which the property is reasonably adaptable and available.11
Consequently, it is extremely important for the appraiser and reviewer to know what laws the eminent domain takings fall under. If a property is being taken in California by the federal government, the definition will be different than if the same piece of property is being taken by the state of California. The main difference here is that the federal government pays based on the most probable sale price, whereas the state of California pays on the highest sale price.
The differences between the federal rules and the rules of each state should be understood and quoted in the appraisal. The federal government requires that the definition for market value be included as well as other statements, and state governments also require this information.
However, a major difference that may not be apparent, or stated clearly enough to understand for a reviewer not familiar with such appraisals, is the requirement that the appraiser find the larger parcel. This is extremely important if the taking is for a partial acquisition—that is, if the government is taking only a portion of a parcel of private land and not the whole parcel. The following is a quote from the federal book that explains this requirement in regard to ownership:
B-11. Partial Acquisitions. When the United States acquires only part of a unitary holding, federal law requires that compensation be made not only for the property interest acquired but also for the diminution, if any, in the value of the remainder directly caused by the acquisition and/or by the use to which the part acquired will be put. This diminution in the value of the remainder is often and “somewhat loosely” referred to as severance damage. When the remainder is specially benefited as a result of the government’s project, the value of the remainder will reflect that fact, which will result in a lessening of the compensation paid to the landowner.
It is essential to a partial taking and to the application of the rules on severance damages and special benefits that the land acquired be part of a unitary holding (a “whole”), commonly referred to as the larger parcel. It is often difficult to determine what constitutes the whole property comprising the part acquired and the remainder, in particular when there are vast acreages or non-contiguous parcels involved. Because of this difficulty, tests have been established to determine the larger parcel. First, there must be a unity of ownership in all parts of the whole. Second, there must be a unity of highest and best use for all parts of the whole.12
Note that at first these paragraphs may seem to refer to extra compensation only when there is damage to the remaining property with a partial taking. However, special attention should be paid to the statement, “When the remainder is specially benefited as a result of the government’s project, the value of the remainder will reflect that fact, which will result in a lessening of the compensation paid to the landowner.” This means that in a partial taking, if the remainder is benefited in the appraiser’s judgment, the compensation will be diminished. But it is also applied in another manner, and this is why the determination of the larger parcel is so important to the government: the compensation will be based on the total value of the parcel from which the land is taken.
For example, if land is being taken by the government to widen a freeway, and there are two landowners who are both giving up two acres of land, the compensation may be different for each landowner even if the land being taken is essentially the same in value.
Let us suppose that landowner 1 has 200 acres and landowner 2 has 4 acres. If the total value of land for landowner 1 is $400,000, then landowner 1 would get $4,000 for the 2 acres, or $2,000 per acre. If the total value for landowner 2 is $40,000, then landowner 2 will get more than landowner 1. The reason is that the appraiser may figure that a 4-acre parcel will sell for $40,000 or $10,000 per acre. Therefore, if landowner 2 is diminished by 2 acres, the loss would be $20,000. Consequently, landowner 1 will get $2,000 for the 2 acres being taken, whereas landowner 2 will get $20,000.
That is the explanation as to why there is a vast difference between the compensation for these two landowners. However, the value could be more drastic in another scenario. If the government finds out that the landowner with 200 acres also has a contiguous tract with 800 acres, the compensation might then be determined based on the market value of a 1,000-acre tract. That amount might be $800 per acre, so now the compensation to landowner 1 totals $1,600, compared to landowner 2, who is getting $20,000.
The key to this is how the appraiser determines what the larger parcel is because, in a partial taking, that factor can have a significant effect on the value of the taking. This determination is complicated by various rules, which are beyond the scope of this book, but suffice it to say, it is important for the reviewer to know and understand the basic concept. The larger parcel issue is a consideration for an eminent domain appraisal that would not be an issue in a typical appraisal.
In a normal sale, if a neighbor wanted to buy 2 acres from landowner 1, the landowner would research prices and sell it for the going price for 2 acres, and would not base the sale amount on the amount of land that he or she already owns. Likewise, an appraiser hired to value the 2-acre parcel would not consider what the 2 acres were being taken from; the appraiser would be concerned with only the value of the property being sold.
The process is explained in a slightly different way in the following instructions for the appraiser from the Uniform Appraisal Standards for Federal Land Acquisitions. In this note, the appraiser finds that the 10-acre parcel is the larger parcel and not the 200-acre parcel:
For instance, if an appraiser determined that the larger parcel was a 10-acre tract out of a total ownership of 200 acres, the unit (e.g., per square foot; per acre) value may well be different for the smaller tract, and the appraiser would utilize comparable sales similar in size to the 10-acre larger parcel, rather than sales similar in size to the entire 200-acre ownership.13
Since these rules can be complicated, it is advisable for the reviewer to get professional help from an appraiser and/or an attorney who specializes in eminent domain if there is a question about the valuation. It should be remembered not only that the federal rules are complex but also that the state rules may vary from the federal rules.