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Valuation of Contaminated Property Acquired by Eminent Domain
Real Estate Newsletter
A property owner has a constitutional right to receive "just compensation" for property taken by eminent domain. (Cal. Const., Art. I, § 19; San Diego Gas & Electric Co. v. Daley, 205 Cal.App.3d 1334, 1344 (1988) ("The Constitution demands the condemnee receive just compensation for the taking of his property.")) "Just compensation" means the fair market value of the property taken plus damages to compensate for any injury to the remainder of the owner's property, if less than the whole property is taken. (Daley, supra, at 1344; Code of Civil Procedure §§ 263.010, 1263.410, 263.420(a).) "Fair market value" is the highest price that would be agreed to by a willing seller and a willing buyer, neither of whom is under any particular necessity or obligation to make the deal, and each having full knowledge of all the purposes for which the property can reasonably be used. (California Code of Civil Procedure § 1263.320(a).)
In most eminent domain cases, the primary dispute is over the property's fair market value and the principal evidence on that issue will be the parties' competing appraisals. Those appraisals typically state that the appraiser has assumed the property is free from contamination. But that assumption is often false. Many types of public projects -- including high-voltage electrical transmission lines, long-distance freight and passenger rail lines and high-volume water treatment and distribution systems -- tend to be located, at least in part, in areas where a history of industrial use has left a legacy of soil or groundwater contamination.
The presence of such contamination can have a significant impact on the value of a property and, therefore, on the amount of just compensation to which the owner is entitled. But how is that impact to be measured? The answer in many cases requires supporting evidence of nonappraisal experts to determine what weight that hypothetical "willing buyer" of the property would give to the contamination when deciding on the price he or she would be willing to pay for the property.
Identifying and Analyzing Valuation Issues Relating to Contamination
The essential first step to analyzing the potential effect of environmental contamination on property value is, of course, to develop an understanding of the nature and extent of the contamination. Environmental studies conducted in connection with the public project are valuable sources of information but may not reveal all relevant contamination issues. A thorough title search may reveal restrictive covenants or consent decrees limiting a property to certain uses because of contamination, and a review of the local planning department files may identify generalized areas (e.g., large-scale landfill areas, or former industrial sites) where toxic substances are prevalent. Such generalized information, however, may not be sufficient to identify what specific impact such contamination may have on the value of a particular property.
The sufficiency of available information and the need for additional testing or analysis depend upon the specific circumstances of each case. Ultimately, if an eminent domain case goes to trial, a jury will decide what value a willing buyer and a willing seller would agree upon. To be able to present a persuasive answer to that question, the parties must first determine what information the buyer and seller would reasonably require in order to make an informed decision about the property's value. If more information would reasonably be sought in the market, then the parties should acquire that information as early in the condemnation process as possible.
Each party should also consider early what expertise can assist them (and, perhaps, the jury) on the question of valuation. In virtually every case, the opinion of a qualified appraiser will be necessary. Where the available market information allows the appraiser to reach a valuation opinion that incorporates the effects of contamination, other experts may not be needed. (For example, in an area of localized contamination there might be sufficient property sales data to allow the appraiser to compare matched sales of properties with and without contamination. The appraiser might be able to render an opinion that does not assume the property is free from contamination but, rather, takes the contamination into account in reaching the valuation.) In other cases, the opinions of other experts such as environmental remediation experts, development consultants, construction cost estimators and real estate economists may be helpful in quantifying the effect of contamination on the property's value. Identifying and involving such experts early in the condemnation process can save the parties time and mitigate litigation expense by giving them a more reliable basis for their valuation conclusions.
The Effect of Contamination on the Property's Highest and Best Use
In some cases, the presence of contamination directly affects the fair market value of property because it affects the use to which the property can be put.
Fair market value must be determined based on the "highest and best use" of the property, which is defined as "the reasonably probable and legal use of vacant land or an improved property, which is physically possible, appropriately supported, financially feasible, and that results in the highest value." The highest and best use of a property may change over time, as economic or physical conditions of the area around the property change. Moreover, what is legally permissible or economically feasible may be affected by either the nature and extent of the contamination, or the costs of remediating it.
Take, for example, a property that legally may be used for multifamily residential or light industrial purposes. Assume further that the property's value is appraised at $100 per square foot as a residential site and at $90 per square foot as an industrial site. The highest and best use of the property would appear to be as a residential site. But if the presence of contamination on the property increases the costs of developing the property for residential use by more than $10 per square foot, then industrial use may be the more economically feasible use and, therefore, the highest and best use of the property. In fact, the environmental remediation costs could be de minimis for a slab-on-grade industrial building, since the building itself could essentially cap the contamination and keep it in place, which may be all the remediation that would be required for such a use.
The ABC Manufacturing Plant Site: A Case Study
In a recent case, a public agency sought to condemn a substantial part of a two-acre parcel of raw land for a roadway. The land was the former site of the ABC Manufacturing plant. Although the plant had been torn down decades earlier, the owner left behind an array of heavy metals and petroleum products at depths of two to 20 feet below the surface.
The neighborhood was going through an economic and cultural renaissance and had seen a dramatic increase in high-density housing and retail uses in what had historically been an industrial area. The appraisers hired by the property owner and the public agency agreed that the property's highest and best use was as a multiunit residential complex with a maximum allowable height of four stories covering the entire lot, as permitted under the local zoning regulations. The property could not, however, be used for residential purposes so long as the contamination remained.
The parties' appraisers agreed that the value of the ABC property as a residential complex site would be $10 million if it were free of contamination. An environmental remediation expert concluded it would cost between $3 million and $4 million to remove the contaminated soil from the property, transport and dispose of the soil in an appropriate hazardous waste landfill, replace it with clean soil, and compact and re-grade the lot -- i.e., to bring the property to an uncontaminated condition on which a residential development could be built.
So, What Is the Fair Market Value of the ABC Property and How Do We Find It?
It is tempting to just do the math and conclude the value of the ABC Property is $6 million-$7 million -- in other words, to take the $10 million appraised value that assumed the property was uncontaminated and subtract from it the $3 million-$4 million cost of rehabilitating the site to satisfy that assumption. But that simple arithmetic does not lead to a true fair market value because it fails to recognize what the "willing buyer" would consider in deciding how much he or she would be willing to pay for the property.
Would the willing buyer of the ABC property expect to spend $3-$4 million to excavate and replace thousands of cubic feet of soil to transform the property into an uncontaminated empty lot? Could a jury be convinced that a reasonable buyer would do so? The answer to both questions is "Probably not."
Instead, the question a jury would ultimately decide is what remedial measures would be reasonably necessary to make the property suited to its highest and best use and what a reasonable buyer would expect those measures to cost over and above the ordinary costs of developing the property. (Coachella Valley Water Dist. v. Western Allied Properties, Inc., 190 Cal.App.3d 969, 976-977 (1987) (in determining just compensation, the jury was entitled to determine what flood control measures would have been reasonably necessary to make property suitable for its highest and best use); Emeryville Redevelopment Agency v. Harcros Pigments, Inc., 101 Cal.App.4th 1083, 1122 (2002) (question is "how much the hypothetical buyer and seller would have deducted from the price" as a result of the need to mitigate damage to archeological resources on the property).)
A willing buyer of the ABC Property would likely intend to develop it to its most productive use, thereby maximizing the return on his or her investment. That would mean building a multiunit residential complex of the maximum four-story height. The complex would need parking for residents and visitors (in fact, the city would require a minimum number of spaces per unit), but the buyer would not want to sacrifice profitable living area within its four stories for parking. So the buyer could be expected to do what many other developers in the area had done -- build underground parking. The two floors of underground parking that would be needed for a four-story complex would require excavation to a depth of approximately 20-25 feet. In the course of that excavation -- which would occur during construction of such a complex regardless of whether the property was contaminated -- the contaminated soil would be removed from the property.
To be sure, the presence of the contaminants on the ABC Property would affect the cost of developing the lot to its highest and best use, and would therefore affect the price a willing buyer would be inclined to pay for the property. For example, special precautions and monitoring of the site would probably be required during excavation and the contaminated soil would be more expensive to dispose of than clean soil, since it would have to be transported a greater distance to a more costly hazardous waste site. A buyer might also factor in a cost for increased risks or potential delays because of the contamination. The buyer could then be expected to deduct from the appraised value the amount of the costs expected to be incurred to develop the subject property over and above the costs of developing a clean property. With input from their environmental remediation experts and an experienced development consultant, the public agency and the property owner were able to reach an agreement that those additional costs would be approximately $1 million and, therefore, that the fair market value of the property in its contaminated condition was $9 million.
By engaging in an early analysis of the environmental issues and their likely impact on the development of the property, the parties were able to negotiate a settlement and avoid protracted and expensive litigation. The public agency also avoided the penalties that can be assessed against a condemnor -- including the property owners' attorneys' fees and litigation expenses -- where the condemnor fails to make a reasonable and informed offer of probable compensation. In that process, the parties were aided by the appraisers and environmental remediation experts, as well as by a development consultant with expertise in the areas of design and construction cost estimating.
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