Eminent Domain and Fair Market Value in a Depressed Real Estate Market (2014)

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8 for a public use. In Kirby Forest Industries, Inc. v. United States,60 the Court agreed that the standard for determining just compensation does not always indemnify the owner for his loss. Particularly when property has some special value to its owner because of its adaptability to his particular use, the fair-market-value measure does not make the owner whole. …We are willing to tolerate such occasional inequity because of the difficulty of assessing the value an individual places upon a particular piece of property and because of the need for a clear, easily administrable rule governing the measure of “just compensation.”61 Thus, “current compensation rules exclude whole categories of damages caused by government takings of private property.”62 Under the Fifth Amendment as construed by the courts, the government is not constitutionally required to compensate a property owner for attorney’s fees, relocation costs, or the cost of replacement property that exceeds the fair market value of the property that was taken.63 Fair market value, moreover, excludes “consequential damages and compensation for any of the real but subjective harms suffered by the property owner.”64 An owner typically may not recover damages that are common to other property owners in the same community.65 Many other items are not compensable because the doctrine of fair market value also does not include a landowner’s more personal or subjective losses.66 Scholars have addressed whether the principle of just compensation is one that is fairly derived and applied, particularly in regard to takings of private homes or takings of property belonging to low income persons or to members of minority groups. Scholars emphasize that takings law 60 467 U.S. 1, 104 S. Ct. 2187, 81 L. Ed. 2d 1 (1984). 61 Id., 467 U.S. at 10, n.15, 104 S. Ct. 2194 n.15, 2194, 81 L. Ed. 2d at 10 n. 15 (1984) (citations omitted). 62 Christopher Serkin, The Meaning of Value: Assess- ing Just Compensation For Regulatory Takings, 99 NW. U. L. REV. 677, 678–79 (2005) (footnotes omitted), here- inafter referred to as “Serkin.” 63 Katrina Miriam Wyman, The Measure of Just Compensation, 41 U.C. DAVIS L. REV. 239, 254-255 (2007), hereinafter cited as “Wyman.” 64 Serkin, supra note 62, at 678-679 (footnote omit- ted). 65 Harris County Flood Control Dist. v. Glenbrook Patiohome Owners Ass’n, 933 S.W.2d 570, 578 (Tex. App. 1996). 66 Brock L. Toll, The Implications of Eminent Do- main in a Post-Kelo World, at 86 (2007) (citation omit- ted), hereinafter referred to as “Toll,” available at: http://business.uni.edu/economics/Themes/toll.pdf. generally “impose[s] significantly unequal burdens on citizens.”67 However, much of the recent debate has focused on the meaning of public use in the Fifth Amendment to the U.S. Constitution and in state constitutions, while the meaning of just compensation has “remain[ed] somewhat in the shadows of the takings debate.”68 As discussed in Section VI, some commentators argue that a property owner’s additional “economic losses can be easily compensated in eminent domain cases.”69 IV. THE DETERMINATION OF FAIR MARKET VALUE A. Introduction Fair market value is what a person who is willing but not required to buy a property would pay a seller who is willing but who is not required to sell it, taking into consideration the highest and best use to which the property may be put.70 Nevertheless, as the courts have stated, “[m]arket value is nothing but a hypothetical concept….”71 Indeed, the methods traditionally used to value property may produce quite different valuations of the same property.72 The fair market value approach itself has been attacked on the grounds that the approach renders an unjust outcome and is even inconsistent with property law.73 According to the Supreme Court, “when market value has been too difficult to find, or when its application would result in manifest injustice to [the] owner or public, courts have fashioned and applied other standards….”74 Although “[t]here is 67 John Fee, Eminent Domain and the Sanctity of Home, 81 NOTRE DAME L. REV. 783, 803 (2006), herein- after referred to as “Fee.” 68 Fegan, supra note 49, at 269. 69 Toll, supra note 66, at 86. 70 County of Ramsey v. Miller, 316 N.W.2d 917, 919 (Minn. 1982). 71 United States ex rel. Tenn. Valley Auth. v. Powelson, 138 F.2d 343, 345 (4th Cir. 1943). 72 4 Nichols on Eminent Domain § 13.01[10]. 73 Fegan, supra note 49, at 277. 74 United States v. Commodities Trading Corp., 339 U.S. 121, 123, 70 S. Ct. 547, 549, 94 L. Ed. 707, 712 (1950); see also Kirby Forest Indus., Inc. v. United States, 467 U.S. 1, 104 S. Ct. 2187, 81 L. Ed. 2d 1 (1984).

9 no precise and inflexible rule for the assessment of just compensation,”75 “the dominant consider- ation always remains the same: What compensation is ‘just’ both to an owner whose property is taken and to the public that must pay the bill?”76 Consequently, some courts have stated that “market value should not be the sole means of valuation in eminent domain cases.”77 There are four basic methods used to derive a valuation that satisfies the just compensation requirement: comparable sales, income capitalization, reproduction or replace- ment cost, and development cost.78 Although not discussed further in the digest, the development cost approach is based on the price a developer- purchaser would be warranted in paying for land given its cost of development and probable sales proceeds, but the land must be ripe for development.79 In a generally depressed real estate market, one issue is whether there are conditions that militate against using the comparable sales approach to value property and whether other methods of valuation or adjustments may be or should be utilized to determine value so as to avoid altering the traditional rules of valuation used in eminent domain cases yet produce a fair and equitable valuation. B. Comparable Sales The fair market value method based on comparable sales to determine property value, discussed throughout the digest, is the lodestar of valuation methods when a public agency takes 75 Township of Manchester Department of Utilities v. Even Ray Co., Inc., 315 N.J. Super. 122, 135, 716 A.2d 1188, 1195 (N.J. Super. Ct. App. Div. 1998). 76 United States v. Commodities Trading Corp., 339 U.S. 121, 123, 70 S. Ct. 547, 549, 94 L. Ed. 707, 712 (1950); see also Kirby Forest Indus., Inc. v. United States, 467 U.S. 1, 104 S. Ct. 2187, 81 L. Ed. 2d 1 (1984). 77 Township of Manchester Department of Utilities v. Even Ray Co., Inc., 315 N.J. Super. 122, 136, 716 A.2d 1188, 1195 (N.J. Super. Ct. App. Div. 1998). 78 County of Ramsey v. Miller, 316 N.W.2d 917, 919, 922 (Minn. 1982). 79 Deborah Dyson, Eminent Domain: Just Compensa- tion, MINNESOTA HOUSE RESEARCH (August 2006), here- inafter referred to as “Minnesota House Research,” available at http://www.house.leg.state.mn.us/hrd/pubs/ ss/clssedjust.pdf. The valuation methods are discussed in the Dictionary of Real Estate Appraisal, 4th ed. (2002). property in eminent domain.80 The comparable sales value is determined by “comparing the property to similar properties that have been sold recently and then applying appropriate units of comparison to adjust the sale prices.”81 The comparable sales approach is used to value improved properties, as well as vacant land.82 However, at a time of a severely depressed real estate market, some sales of comparable property may include sales that were involuntary and not at arm’s length because of government intervention or foreclosures and sales by institutional investors and speculators, sales that arguably must be excluded because they are not comparable sales.83 C. Income Approach Another accepted method of valuation is the income capitalization approach to determine the fair market value of income-producing property. The income method calculates just compensation by assessing “the present value of the future revenues for the useful life of the business based on past performance.”84 When property is taken that is a unique business property, a court may allow a jury to consider lost profits caused by the taking “because the income approach necessarily takes into account what future earnings would be were the property interest not extinguished….”85 Although typically used for commercial property, the income method may be used for any property that is capable of or actually producing an income.86 The approach may serve as an alternative when comparable sales are not available. Indeed, it has been noted that [t]he income approach is employed for any property, such as an apartment building, whose value is primarily dependent upon the amount of cash generated by its on- going operations. This method is generally regarded as a check on the accuracy of comparable sales, and is used instead of comparable sales where insufficient sales data 80 4 Nichols on Eminent Domain § 13.01[9] (stating that the courts have equated just compensation with a property’s fair market value at the time of the taking). 81 Minnesota House Research, supra note 79. 82 Id. 83 Joseph T. Waldo & Stephen J. Clarke, Preventing A Down Real Estate Market From Affecting Valuation in Condemnation Cases, at 58 (July 2010), hereinafter referred to as “Waldo & Clarke.” 84 Minnesota House Research, supra note 79. 85 Housing Authority of Atlanta v. Southern Ry. Co, 245 Ga., 170 at 231, 264 S.E.2d at 176. 86 4 Nichols on Eminent Domain § 13.01[12].

10 exist in the relevant market. This method is also dependent upon the existence of reliable and relatively consistent income and expense data going back several years prior to the taking.87 In its response to the survey, Arizona noted that the income approach is “impossible to do with vacant land or agricultural land where rents are too low.”88 Connecticut advised that “[w]hen appraising a multi-use or multi-occupied property…the income approach may be utilized, or considered by the courts during the reassessment process.”89 The department agreed that the income approach “sometimes” is an alternative but commented that “[o]wner-occupied single family residential properties typically do not generate revenue.” Florida confirmed that that some property owners had used the income method. Nevertheless, the experience of the remaining transportation departments responding to the survey was that property owners had not attempted to rely on an income approach as an alternative to valuation in condemnation cases during the financial crisis.90 D. Reproduction or Replacement Approach The reproduction cost less depreciation method estimates the current cost to construct a reproduction of or replacement for the existing structure, deducts depreciation from the total cost, and adds the estimated land value.91 If during a depressed real estate market the use of the comparable sales method is not appropriate, an alternative is the depreciated replacement or reproduction cost method.92 87 Timothy S. Hollister and Allison M. McKeen, Cur- rent Issues in Just Compensation, GEORGETOWN LAW CENTER, at 11 (2005) (citing Correira v. New Bedford Dev. Auth., 375 Mass. 360, 377 N.E.2d 909, 911 (1978) (emphasis supplied)). 88 Response of Arizona DOT. 89 Response of Connecticut DOT. 90 Arizona DOT; Arkansas State Highway and Transportation Department; California DOT; Connecti- cut DOT; Idaho Transportation Department; Oregon DOT; Utah DOT; and Wisconsin DOT. 91 Minnesota House Research, supra note 79. 92 Del-Mar Redevelopment Corp. v. Associated Ga- rages, Inc., 726 S.W.2d 866, 869 (Mo. Ct. App. 1987) (stating that “[o]ur courts have also approved two other methods for arriving at fair market value: “cost of re- placement” and “capitalization of income”); City of Boulder v. Orchard Ct. Dev. Co., 527 P.2d 931, 933 (Colo. App. 1974) (stating that “evidence of elements of damages, such as cost of restoration and estimates of replacement value, are admissible if ‘they would have a Replacement value may be used when market value is not readily available, or where otherwise uncompensable consequential damages would be extremely high. More generally, courts can award replacement value when awarding fair market value would result in manifest injustice, making the denial of replacement value itself a valuation mechanism because of courts’ wide discretion.93 The replacement cost method may result in a market value that differs significantly from a comparable sales approach to fair market value94 and may exceed any other measure of the value of the property.95 A Missouri court has stated that the replacement value method may not be the “most accurate approach to valuation” but that the method is “an accepted method of determining [the] fair market value of condemned property.”96 However, the replacement value method also has been called the “non-fair market method of valuation.”97 In Louisiana [r]eplacement costs are those expenses arising from the cost of replacing structures due to the expropriation of property on which the original constructions were situated. Traditionally, this kind of incidental damage was denied because it did not pertain to the market value of the property itself. Thus, any additional costs to replace the building at current market prices were borne by the owner.98 However, Louisiana courts have “granted replacement costs when the court has determined that they are necessary in order to compensate an owner to the ‘full extent of his loss.’ By doing so, courts have shown a clear departure from the ‘res’ theory of awards and have shifted their focus more to the personal loss an owner experiences from the taking.”99 The Louisiana Supreme Court bearing on and influence opinion as to value’”) (citation omitted)). 93 Serkin, supra note 62, at 702-703 (footnotes omitted). 94 4 Nichols on Eminent Domain § 13.01[13]. 95 Serkin, supra note 62, at 702 (footnote omitted). 96 Del-Mar Redevelopment Corp. v. Associated Ga- rages, Inc., 726 S.W.2d 866, 869 (Mo. Ct. App. 1987) (citing State ex rel. State Highway Commission v. Jasper, 544 S.W.2d 554, 555 (Mo. en banc 1976); 5 Nichols on Eminent Domain § 20.1, at 20–21 (3d ed. 1985)). 97 Department of Transportation v. Bales, 197 Ga. App. 862, 400 S.E.2d 21, 24 (1990). 98 Tracy Lee Howard, Compensating an Owner to the Full Extent of His Loss: A Reevaluation of Compensable Damages in Louisiana Expropriation Cases, 51 LA. L. REV. 821, 830 (1991), hereinafter cited as “Howard.” 99 Id. (footnote omitted).

11 has held that when using the replacement value approach “it is not constitutionally significant that the award…will exceed the market value of the property used in their business operations.”100 In City of Renton v. Scott Pacific Terminal,101 the court held that the replacement cost of improvements may be introduced into evidence whether or not there is a market value upon which to base an opinion as to the value of the property.102 The court stated that the majority rule in the state of Washington is that evidence of cost of reproduction of structures less depreciation may be introduced whenever the structures are well adapted to the land upon which they stand. The proper measure of just compensation is the value of the land with the buildings upon it, and the owner therefore receives nothing for the buildings unless they increase the market value of the land.103 Furthermore, the court stated that [t]he reproduction cost of the structure on another comparable parcel of realty is not the sole measure of compensation but it is a factor to be considered in determining fair market value of the property as a whole. When the cost of reproduction (or the original cost) is considered as an element in determining market value, a proper deduction must be made for depreciation. Depreciation is not limited to physical wear and tear but it includes economic and functional obsolescence.104 The replacement cost approach is used to value unique or special use properties, such as properties for which no market exists (e.g., schools, churches, train stations).105 Unique properties are those that are not of a type generally bought or sold in the open market.106 A unique property “must be valued by something 100 State ex rel. Department of Highways v. Constant, 369 So. 2d 699, 702 (1979) (holding that landowners were entitled to recover replacement costs of construct- ing a new loading and parking area for their marina business operations). 101 9 Wash. App. 364, 512 P.2d 1137 (Wash. Ct. App. 1973). 102 Id., at 369-370, 512 P.2d at 1141-1142. 103 Id. 104 Id., 512 P.2d at 1141-1142. 105 Township Dept. of Util. v. Even Ray Co., 716 A.2d 1188, 1195 (N.J. Super Ct., App. Div. 1998); State ex rel. Mo. Highway and Transp. Comm’n v. Roberts, 926 S.W.2d 18, 21 (Mo. Ct. App. 1996); Housing Authority of City of Atlanta v. Southern Ry. Co., 264 S.E.2d 174, 175 (Ga. 1980)). 106 Housing Authority of Atlanta v. Southern R. Co., 245 Ga. 229, 230, 264 S.E.2d 174, 175 (1980) (ques- tioned by, followed by Buck’s Service Station, Inc. v. Department of Transportation, 191 Ga. App. 341, 381 S.E.2d 516 (1989)). other than the fair market value standard;” otherwise, a property owner will not secure just and adequate compensation.107 The damages sustained by the taking of a unique property may be “measured by a variety of non-fair market methods of valuation, including the cost and income methods.”108 Indeed, an expert may testify that under the circumstances a unique property has no market value.109 In a North Carolina case, the court held that “testimony [on the replacement cost for a replacement church building] was proper and directly relevant to the determination of the property’s fair market value immediately before and after the taking.”110 In a New York case, the court held that greenhouses on a property were unique and therefore the replacement cost method was the appropriate method to value the condemned property, including a residence located on the property because it was an “integral part” of the nursery complex.111 On occasion the courts also have permitted a “hybrid appraisal technique,” one that considers the characteristics inherent in a property that may produce a significantly higher valuation.112 For example, in situations in which property has particular value because of an easement or because the property is deemed to be unique for some other reason the property may warrant an alternative method of valuation to accommodate the distinction.113 Unique properties can best be described as “properties without compare.”114 One of the proposals for reforming the methods of determining just compensation is to “provide property owners with the replacement value of 107 Id. 108 Id. 109 Id. 110 Department of Transportation. v. Marston Baptist Church, Inc., 676 S.E.2d 313, 315 (N.C. Ct. App. 2009); see also State Department of Highways v. Baddock, 160 So. 2d 279, 280 (La. Ct. App. 1964). 111 In re County of Suffolk, 47 N.Y.2d 507, 512, 514 (1979). 112 London Bridge Resort, Inc. v. Mohave County, 200 Ariz. 462, 27 P.3d 819 (Ariz. App. 2001) (valuation of time-share interests with a hybrid method); 4 Nichols on Eminent Domain § 13.01[15]. 113 Housing Authority of City of Atlanta v. Southern Ry. Co., 264 S.E.2d 174, 175 (Ga. 1980). 114 Duvall, Richard O. & Black, David S., Methods of Valuing Properties Without Compare: Special Use Prop- erties in Condemnation Proceedings, THE APPRAISAL JOURNAL (Jan. 2000).