Eminent Domain and Fair Market Value in a Depressed Real Estate Market (2014) / Chapter Skim
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Legal Research Digest 62 NATIONAL COOPERATIVE HIGHWAY RESEARCH PROGRAM October 2014 TRANSPORTATION RESEARCH BOARD OF THE NATIONAL ACADEMIES EMINENT DOMAIN AND FAIR MARKET VALUE IN A DEPRESSED REAL ESTATE MARKET This report was prepared under NCHRP Project 20-6, "Legal Problems Arising Out of Highway Programs," for which the Transportation Research Board is the agency coordinating the research. The report was prepared by Larry W
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CONTENTS I Introduction, 3 II.
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3 EMINENT DOMAIN AND FAIR MARKET VALUE IN A DEPRESSED REAL ESTATE MARKET By Larry W Thomas, The Thomas Law Firm, Washington, DC I
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4 responses are discussed throughout the digest and summarized in Appendix B
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5 values recorded in the second quarter of 2006.17 The decline in the value of residential property from mid-2007 to March 2009 was an estimated $5.9 trillion.18 Housing values that had peaked in the first quarter of 2006 finally reached bottom by the first quarter of 2012 at about 57 percent of their peak values. 19 By the fourth quarter of 2012, housing values had recovered only to around 62 percent of their 2006 highs.20 In the fourth quarter of 2009, at the apex of the financial crisis, approximately 24 percent or 11.3 million home mortgages were "underwater;"21 that is, the values of properties were less than the outstanding balances of the mortgages secured by the properties.
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6 Financial institutions suffer losses when governments condemn properties having under- water-mortgages. When a government takes a mortgaged property by eminent domain, the mortgagee (i.e., the lender or financial institution)
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7 On the other hand, it is reported that because of the crisis some states benefited because of the decreased cost of materials.45 The lower cost for land acquisition is said to have assisted some states in reducing costs and in being able to resume some suspended projects.46 For example, although revenue decreased to $4.1 billion from $4.7 billion in 2008, the Colorado Department of Transportation reported that its costs of materials decreased, thus allowing the department to narrow the gap between revenue and expenses. For one transportation project in Colorado, estimated construction costs dropped almost half a billion dollars between 2008 and 2009.47 III.
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8 for a public use. In Kirby Forest Industries, Inc.
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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 developerpurchaser 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.
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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]
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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.
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12 their property if it is higher than the property's fair market value."115 Commentators have argued that a valuation that is higher using the replacement value method should be used when a comparable sales valuation would be insufficient to permit an owner after the taking to buy comparable housing in the community.116 One writer argues that "replacement value could be paid either in-kind (i.e., by guaranteeing the expropriated owner similar property…) , or in cash (i.e., by paying compensation sufficient to allow the property owner to buy similar housing)
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13 Even though the courts have been consistent in finding that the comparable sales approach is usually the best evidence of market value, some courts have stated that they are not "wedded" to any particular formula or method to determine just compensation. Other courts have held that "the determination of what would be fair compensation in each case is not a matter of formulas or artificial rules; it is a matter for discretion and sound judgment based on the facts peculiar to each case."125 Related to the issue of avoiding manifest injustice in condemnation cases is the question of who should bear the economic burden that resulted from the financial crisis.
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14 tax."139 The tax would be "a fixed monetary amount that each institution would owe, to be paid over some specified period and subject to rules limiting the impact on net earnings."140 The foregoing articles do not resolve the issue of manifest injustice to institutions and property owners who had no role in the financial crisis and no control of the causes of their losses, including those incurred when properties were taken by eminent domain at a time of severely depressed property values.
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15 Island,155 Justice O'Connor stated in a concurring opinion that [t] he concepts of "fairness and justice" that underlie the Takings Clause, of course, are less than fully determinate.
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16 should be considered in determining just compensation.162 The Oregon DOT reported that in one of its circuit court cases, the issue of "normalized value" was argued but that the court excluded the appraisal theory at trial. However, "[s]
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17 however, abandoning the underlying and accepted rules of valuation.176 On the other hand, some legal commentators have argued that it is both inappropriate and unlawful to consider the value of the property in a depressed real estate market, for the simple fact that the property owner would not have voluntarily sold the property in such a market. In a down real estate market, a property owner who had no compulsion to sell would simply retain the property until real estate prices leveled out or increased, or the owner might borrow against the property if in need of liquid assets (i.e., cash)
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18 Indeed, the court's rules for determining valuations at a time of extraordinary economic circumstances when "there is no real market as of a particular date" required a finding of value that excluded conditions that could produce a value that is too low or too high.188 The Court of Appeals stated that "‘[f] air market value' means neither panic value, auction value, speculative value, nor a value fixed by depressed or inflated prices.
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19 with the requirement that property must be valued as of the date of its taking for a commissioner to decide not to consider speculative value or a market that was not "normal" and not error for a commissioner to define a normal market as one that is neither "depressed" nor "inflationary."198 The commissioner had considered the market at the time of the taking to be inflationary or speculative because of "federal activities in the Richmond area…."199 The Virginia court quoted an Oregon case, Public Market Co.
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20 of the purchase, courts will allow [evidence of] purchase price paid."208 E
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21 market.216 Utah also stated that its policy was not to include sales that were not conducted at arm's length.217 Sales at auctions may not necessarily be evidence of market value. In Tremblay v.
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22 rate of return…."231 The court agreed that "[c] ost, reproduction cost, and use value constitute evidence which may be considered in determining fair market value."232 However, the court held that "[t]
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23 departments reported that their ability to value properties had been affected by such interventions or actions. For example, Arizona stated that its ability had been affected "to the extent government regulations force banks to sell REO property without market exposure."244 4.
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24 There are four occasions when the project influence rule may be asserted. The first occasion is when "the improvement's exact location is known from the outset, the property that will serve as the site of the improvement will not be subject to any rise or fall in values."252 The second occasion is when the location of a project is unknown.
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25 The Colorado Court of Appeals affirmed the trial court's application of the rule.261 The Fowler court explained that the rule promotes fairness in valuing property by preventing a windfall to the property owner based on speculative potential enhancements in value while, at the same time, protecting the property owner from the injustice of assessing against it a diminution in the property's value caused by the same project for which it is being taken.262 The Fowler court observed that regulatory actions that affect the value of a property as a result of the project, "such as rezoning or the imposition of use limitations" may not be taken into account when determining the value of the property.263 In Missouri Highways and Transportation Commission v. 1811 North Broadway, LLC,264 the court held that "[i]
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26 also selling at a depressed price.274 As a Connecticut court stated when refusing to permit a valuation as of any date other than as of the date of taking, if a property owner desires "to purchase other land in place of that taken he could buy a much more desirable property for the same money in a time of general depression than he could when values were at a higher level."275 There are other counterarguments or issues that condemnors may raise; for example: whether public funds may be used to place a property owner in a better economic situation by providing resources to purchase a comparable replacement property less the debt owed on a property that is worth less than the balance of the mortgage; and whether adjusting the principles of just compensation amounts to rewarding property owners, banks, and speculators for engaging in what was essentially irresponsible behavior, such as the issuance of loans exceeding the value of a property or the use of no-document or sub-prime loans.
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27 to an award equal to the opportunity cost of his contribution to the condemnor's project…."286 Although the value of the gain to the condemnor and the loss to a property may be equivalent in some or even most cases, particularly at the time of a severely depressed real estate market the difference in value between the two measures may be substantial.287 A property owner's compensation presumably would be higher if a decision on the value of the property and the compensation due to a property owner is based on the value of the government's gain because of the use for which the property was taken, for example, for commercial development.288 It appears that most courts have not allowed evidence of the value of the gain to the government so as to permit a property owner to recoup losses relating to a particular use of the property that are reflected in a strict interpretation of fair market value.289 Indeed, as discussed in Section VI.F, depending on the circumstances, the law also disfavors allowing property that is taken to include value attributable to the project's influence on the property.
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28 The court agreed that the values of the property were adjustable because the highest and best use of the property was for a residential subdivision. However, usually it is necessary to discount a property's highest and best use valuation because of costs that would be attendant to the property's development.297 Although development costs may be deducted, in contrast to what a real-world buyer would consider, the courts usually do not deduct the cost of any risks or delays associated with development that would decrease the value of the property being taken.298 Thus, there is the possibility with this approach to valuation that a property owner's recovery could be greater than a private seller's sale proceeds for the same property.299 There is some authority holding that temporary difficulties in the market may warrant valuing a property based not on its current use but on its highest and best use.
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29 waive its rights if the owner withdraws the funds as allowed by the statute.308 As for the first question, the argument of Azusa Pacific University (University) was that the date of valuation should be the date the trial on just compensation commenced.
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30 action."322 If so, "a landowner is entitled to ‘precondemnation damages' caused by "government conduct that occurs prior to the filing of an eminent domain case."323 In State ex rel.
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31 Distributive justice, also referred to as comparative justice or efficiency maximization, is based on principles of equity and fairness.336 The distributive justice approach to just compensation is founded on the belief that "resources should be divided to secure the greatest overall utility to society as a whole….
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32 For Utilitarians, the amount and purpose of compensation for a taking, therefore, should equal the amount necessary to avoid these demoralization costs.351 Although the above approaches have been argued to be applicable principally to cases of regulatory takings, the approaches' underlying principles also have implications when property is taken by condemnation. As discussed below, the URA352 addresses some of the concerns expressed in the three views on distributive justice by providing additional compensation and by seeking to preserve home ownership.353 A policy founded on equity and fairness also evokes principles of environmental justice.
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33 domain cannot be exercised without first providing for just compensation to the owner for the interference with his exclusive rights."364 It is not clear that such a statute, however, would require the payment of compensation for a property owner's subjective losses in connection with a taking. One source reports that several states now require payments for intangible losses, such as owner's sentimental attachments to property.365 For example, one commentator notes that in Louisiana Resources Co.
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34 at a price far above its fair market value."381 When a homeowner receives only fair market value, the owner may lose any "contract purchase equity" existing at the time of the taking, leaving the homeowner "with nothing but the possibility of a deficiency judgment after applying his or her award to the debt still owed to the seller."382 To some extent, however, the issue has been addressed by FHWA's waiver, necessitated by the financial crisis and underwater mortgages, of the usual method for calculating Replacement Housing Payments under the URA.383 C Additional Losses or Values that May Be Compensable As noted in Section VIII.B., even though the courts refer to just compensation as full indemnification, there are losses peculiar to homeowners as well as businesses that are not compensable in eminent domain.
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35 personal property."398 One writer argues that more compensation should be paid precisely because the property is a home,399 for example, by paying "an additional…percent of market value for every year the owner has lived in the home."400 One writer argues that just compensation must be "the amount of compensation required to make the owner indifferent to the land acquisition at issue (not indifferent to the government's choice to use eminent domain as the means of acquisition) , accounting for the owner's reasonable subjective value."401 Another approach is to "require a higher measure of direct compensation when government takes land for private redevelopment than when it retains the land for direct public use."402 For example, it has been suggested that a legislatively approved schedule is a way to increase the amount of compensation in excess of what would be awarded based on a property's fair market value to compensate in an objective way for the loss of subjective home ownership values.403 Some propose something on the order of a surtax whereby a condemnee may receive, for instance, 150 percent of fair market value as compensation.404 Reformers also have proposed that a premium be added to compensate for emotional damages, perhaps adjusted for the number of years a property owner has lived in the home.405 One proposal that would result in additional compensation involves the use of a percentage premium plan (PPP)
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36 there is some evidence that distributive justice principles have influenced legislatures to enact laws that authorize additional compensation to cover certain losses suffered because of a taking.419 No transportation department responding to the survey reported that during the real estate crisis its agency or the courts in its jurisdiction had permitted the use of distributive justice principles when determining just compensation such as by allowing compensation for an owner's subjective or sentimental loss (e.g., the taking of an owner's home or of a family homestead of long duration)
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37 Legislation proposed in Connecticut would increase the level of compensation for property acquired through eminent domain by a development agency to 125 percent of its average appraised value.429 In Indiana when property is condemned that is a person's primary residence, state law requires the payment of compensation at a rate equal to 150 percent of the fair market value of the property.430 One commentator notes that Kansas law authorizes the use of eminent domain for private economic development purposes but states that "the legislature shall consider requiring compensation of at least 200% of fair market value [for] property owners…."431 In Kansas, when taking property for an "auto race track facility" a city must pay an additional amount equal to 25 percent of the compensation or damage "finally awarded…with respect to any property" taken.432 London, 64 WASH & LEE L
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38 more years."438 The Supreme Court of Missouri recently held that adding heritage value to the fair market value of a condemned property does not violate the Missouri Constitution.439 As for the legislature's intent in enacting provisions to increase just compensation in certain circumstances, the process of revising Missouri's eminent domain laws began in 2002 when some groups complained that the government unfairly took private land for a trail project.440 The legislature was unsuccessful in making any changes to the state's eminent domain laws until after the United States Supreme Court's decision in Kelo in 2005. The heritage value and homestead taking provisions were added to protect property owners by increasing the compensation that must be paid when property is taken in certain situations.
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39 are being so taken, located upon adjoining lands owned or held by such party, the probable damages to such business which the denial of the use of the property so taken may reasonably cause….446 In Idaho, an unsuccessful bill that was offered in the Senate would have added Section 7-727 to the state's Eminent Domain Code to require that "[a] ny displaced person who moves or discontinues a business…shall receive a fixed location payment…not less than [$2,500]
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40 loss. They should not be left bankrupt and unable to purchase a comparable home.
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41 under the URA is to assist homeowner-occupants bridge the "gap between the just compensation they are constitutionally entitled to receive for the acquisition of their property and the additional costs they may incur to obtain a comparable replacement property."473 The amount of the payment may not exceed $22,500 and is calculated as provided in Sections 24.401(b)
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42 Right-of-Way Manual, will apply to the use of the waiver;" and "[e] nsure that a homeowneroccupant with negative equity has not received and has not applied to receive mortgage debt relief or mortgage reduction to ensure that a windfall is not realized as a result of a negative equity waiver negotiated settlement."483 The waiver has positive and negative aspects.
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43 C The Use of Eminent Domain to Take Underwater Mortgages 1.
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44 irreparably harmed financially; thus, they sought declaratory and injunctive relief. The plaintiffs' complaint alleges that the Richmond Plan violates the United States and California Constitutions because the takings would not be for a public use, would violate the prohibition against extraterritorial seizures, and would not provide the plaintiffs with just compensation.506 It is alleged that the Richmond Plan has no public purpose, because it would seize property from private entities, the plaintiffs, and transfer it to MRP and its private investors, thereby conferring "private benefits on a select set of individuals."507 The plaintiffs claim that the seizures of the mortgages would be extra- territorial, because the mortgages and the underlying notes are held in trusts outside the city of Richmond and because "the situs of a debt for eminent domain is deemed to be the location of the creditor."508 The plaintiffs argue that the Richmond Plan would violate the Commerce Clause of the United States Constitution, because the plan would have the effect of regulating the national residential mortgage-backed securities market and cause substantial losses to trusts holding the loans around the nation.509 The plaintiffs contend that the city's plan violates the Contracts Clause of the federal Constitution, because the program would nullify the trusts' rights to obtain the payments they bargained for and the trusts would have to accept significantly lower payments instead.
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45 where an eminent domain program was used within the past 10 years; the Federal Housing Administration from guaranteeing mortgages within counties where an eminent domain program has been used in the past 10 years; and the United States Department of Agriculture "from making, insuring, or guaranteeing mortgage loans."520 FHFA suggests that the use of eminent domain to seize underwater mortgages could lead to redlining and violations of fair housing laws if only certain areas of a community are targeted.521 However, supporters of the eminent domain program suggest that it is FHFA that would be redlining. That is, FHFA would prohibit Fannie Mae and Freddie Mac from lending in communities that use eminent domain to acquire mortgages, communities that tend to have large numbers of underwater mortgages and large lowincome and minority populations.522 XI.
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46 to the maximum extent possible.529 The statute provides that relocation benefits are to be paid by an acquiring authority according to 49 C.F.R., Part 24 "with respect to reimbursement of reestablishment expenses for nonresidential moves…, except that the acquiring authority shall reimburse the displaced business for eligible expenses up to a maximum of $50,000."530 Kansas, Iowa, and Oregon also have provisions requiring the payment of relocation expenses.531 XII. FEDERAL REIMBURSEMENT OF PAYMENTS IN EXCESS OF FAIR MARKET VALUE Assuming that supercompensation is permitted by a state statute or by judicial decision for one of the reasons discussed in the digest, transportation departments will be interested in whether there would be federal reimbursement.
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47 and that valuation should be based on what constitutes a normal market. However, the cases did not specify any methodology for proving what a normal market is or would be under the circumstances.
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A-1 APPENDIX A SURVEY QUESTIONS NCHRP 20-6, STUDY TOPIC 19-01 EMINENT DOMAIN AND FAIR MARKET VALUE IN A DEPRESSED REAL ESTATE MARKET Agency Name: ________________________________________________________________________ Name of Employee: ________________________________________________________________________ Job Title: ________________________________________________________________________ Contact telephone/cell phone number: ___________________/ _____________________ Email address: _________________________________ How many years have you been with the agency? _____ NOTE: The following questions relate primarily to the nationwide financial and real estate crisis, hereinafter referred to as the "financial crisis" or the "real estate crisis," that began approximately in 2006 or 2007 when property values began a significant decline.
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A-2 If your answer is "Yes," please provide a copy of any policies with your response.
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A-3 9. During the real estate crisis has your agency or the courts in your jurisdiction permitted the use of distributive justice535 principles when determining just compensation such as by allowing compensation for an owner's subjective or sentimental loss (e.g., the taking of an owner's home or of a family homestead of long duration)
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B-1 APPENDIX B -- SUMMARY OF TRANSPORTATION DEPARTMENTS' RESPONSES TO THE SURVEY 1. Of 23 state transportation departments responding to the survey, 10 departments stated that during the real estate crisis that they had had eminent domain cases in which property owners argued that the valuation of their property for a transportation project should take into consideration the effect of depressed property values because of the financial or real estate crisis.536 2.
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B-2 Four transportation departments stated that they were unaware of any opinions accepting that the effect of the real estate crisis and depressed property values should be considered.538 3. As for whether any transportation departments had developed or revised any eminent domain policies regarding the valuation of property because of the effect of depressed property values, three departments stated that they had done so, California Department of Transportation (Caltrans)
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B-3 5. Transportation departments were asked whether during the real estate crisis the ability to value real property in their jurisdiction had been affected by government intervention (e.g., efforts to reduce foreclosures)
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B-4 6. In connection with the preceding question, four transportation departments stated property owners in their jurisdictions had argued that sales are not comparable sales because they were not sales conducted voluntarily or at arm's length.
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B-5 The Idaho Transportation Department stated in regard to the replacement cost method that it "was used rarely, (1-2 cases) over the last few years;" that "no procedure or criteria were established; and that the method was used on a "case-by-case basis." Other departments responding to the question had not encountered situations in which property owners had resorted to the replacement cost method of valuation.541 Caltrans advised that "[t]
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B-6 Seven departments responding to the question stated that the courts in their jurisdiction had not admitted evidence of the price paid by an owner for the property.
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C-1 APPENDIX C -- TRANSPORTATION DEPARTMENTS RESPONDING TO THE SURVEY Arizona Department of Transportation Arkansas State Highway and Transportation Department California Department of Transportation Colorado Department of Transportation Connecticut Department of Transportation Delaware Department of Transportation Florida Department of Transportation Kansas Department of Transportation Idaho Transportation Department Indiana Department of Transportation Iowa Department of Transportation Maine Department of Transportation Massachusetts Department of Transportation Michigan Department of Transportation Missouri Department of Transportation Nebraska Department of Roads Ohio Department of Transportation Pennsylvania Department of Transportation Tennessee Department of Transportation Texas Department of Transportation. Utah Department of Transportation Wisconsin Department of Transportation Wyoming Department of Transportation
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ACKNOWLEDGMENTS This study was performed under the overall guidance of the NCHRP Project Committee SP 20-6. The Committee is chaired by MICHAEL E
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These digests are issued in order to increase awareness of research results emanating from projects in the Cooperative Research Programs (CRP)
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