“What’s It Worth—Who Wants to Know?”: The Valuation of Real Property in Litigation
By Michael Rikon
P R O B A T E   &   P R O P E R T Y
January/February 2002
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O ften the value of real property is not simple to fix. We all recall the study of the legal dilemmas that faced Blackacre in law school, but the focus on the value of Blackacre is far more illusive. If beauty is in the eye of the beholder, then the value of real property often lies in the one who has title.

Real property rarely presents itself for valuation in perfect, model circumstances, but one occasionally does get lucky. There can be a very recent sale of a condominium unit in the same building, in the same line, and only one floor away. This rarity aside, real property is usually unique in a number of factors, including its location. It generally lasts forever and is of limited supply. Its value may be very dependent on its use, which could be unique to its present owner. Accordingly, the value of real property may not be equated to what it cost; nor does fair market value necessarily mean assessed value. Real property value will often vary depending on subjective factors, legal issues, and the very nature of the inquiry. Thus real property value is dependent on the factual circumstances presented. It is also dependent on the reason for the need to value the property. This article addresses the valuation of real property as it may appear in the context of litigation.

Eminent Domain

In no other field of litigation is value so keenly put in issue as in a condemnation case. Condemnation—forced sale of property—is a harsh remedy. In many cases, the owner would not part with title no matter the price. Yet the power of eminent domain is inherent in the sovereign. Nothing in our constitutions creates the power to condemn; this power existed long before our constitutions came into existence. What does exist is a limitation on that power. The Fifth Amendment provides that in the event property is taken for a public use, the owner must receive “just compensation.” Accord, e.g., N.Y. Const. art. 1, § 7(a). The search for what exactly constitutes “just compensation” is the paramount issue in any condemnation case.

The constitutional provision of just compensation requires that the property owner be indemnified so as to be put in the same relative position, insofar as possible, as if the taking had not occurred. See Olson v. United States, 292 U.S. 246, 255 (1934). As a general rule, just compensation is to be determined by reference to the fair market value of the property at the date of the taking. Ketchikan Cold Storage Co. v. State, 491 P.2d 143 (Alaska 1971). Fair market value is the price for which the property would sell if there were a willing buyer under no compulsion to buy and a willing seller under no compulsion to sell. Keator v. State, 244 N.E.2d 248, 249 (N.Y. 1968). The fundamental question then to be answered in valuing damages is “[w]hat has the owner lost, not what has the taker gained.” Boston Chamber of Commerce v. City of Boston, 217 U.S. 189, 195 (1910). This is so because the owner is to be put in as good a position pecuniarily as it would have occupied if the property had not been taken. United States v. Miller, 317 U.S. 369, 373 (1943).

In a condemnation case, a former owner (at this stage, a claimant) is not limited to a study based on the property’s actual use. The property must be valued on its highest and best use regardless of the actual use. United States v. 320.0 Acres of Land, 605 F.2d 762, 781 (5th Cir. 1979). As will be discussed below, this standard differs significantly from tax reduction cases. Not only is an owner allowed to pro-ject a value of the property on a different highest and best use, but that owner may also have the trial court consider the reasonable probability of re-zoning the property. Morton Grove Park Dist. v. American Nat’l Bank & Trust Co., 350 N.E.2d 149, 154 (Ill. App. Ct. 1976).

How Real Property Is Valued

Appraisers estimate property value by using three approaches to analyze real estate data: the market data or comparable sales approach, the income capitalization approach, and the cost approach.

The cost approach is rarely used in real estate condemnation cases. Real property must constitute a “specialty” for the cost approach to be employed. A “specialty” has been defined as a building designed for a unique purpose. In re County of Nassau, 349 N.Y.S.2d 422, 427 (N.Y. App. Div. 1973). For a building to be a “specialty,” it must be truly unique so that only the owner would have use for it and the sole way to replace it would be by its reproduction. Commonwealth v. Massachusetts Turnpike Auth., 224 N.E.2d 186, 189 (Mass. 1967). The cost approach requires the appraiser to determine a value of the land and then add the estimated value of the improvements. The value of the improvements is the current cost of constructing a reproduction of the subject property, less depreciation. All incremental costs are also considered and added to value. In re City of New York (Harlem-East Neighborhood Development Area), 373 N.E.2d 984, 985 (N.Y. 1978). Although the cost approach is rarely used in a real property condemnation case, it is always used in a trade fixture case. See In re Phase II of Stage III of Fulton Park Urban Renewal Project, 395 N.Y.S.2d 99 (N.Y. App. Div. 1977), aff’d , 380 N.E.2d 327 (N.Y. 1978); see also In re Redevelopment Auth., 331 N.W.2d 840, 843 (Wis. Ct. App. 1983), rev’d on other grounds, 355 N.W.2d 240 (Wis. 1984).

The market data, or comparable sale, approach is used when the subject property is similar to other properties that have been sold (or perhaps are currently for sale) in the subject property neighborhood. This method works well for residential properties and is always used for vacant land. The appraiser will analyze the sales by making a grid to show the expert’s adjustments for location, size, time, zoning, marketing factors, view, and other factors that a buyer would consider, all with the idea that the comparable sales, as adjusted, will indicate a value of the subject.

In reviewing an appraiser’s adjustment factors, be alert for any large adjustment: the greater the adjustment, the less reliable the sale. Sometimes a condemned parcel, often denominated a “damage parcel” (an archaic description that survives), may have been recently purchased. The New York Court of Appeals has held that a recent sale, if not explained away as abnormal in any fashion, is evidence of the “highest rank” to determine the true value of the property at that time. Plaza Hotel Assocs. v. Wellington Assocs., 333 N.E.2d 346, 349 (N.Y. 1975). But a recent sale of such property is not relevant to the question of value if such a sale was “abnormal” and, therefore, not reflective of market value. See Dennis v. County of Santa Clara, 263 Cal. Rptr. 887, 892 (Cal. Ct. App. 1989).

If the property was purchased for development, the owner is entitled to a far greater return than mere acquisition costs. Because an owner is entitled to be fully indemnified, that owner should be entitled to recover not only the fair market value of the land but all costs expended and an entrepreneurial return on the investment. If the use is specific, such as the construction and operation of a new funeral parlor or self-storage facility that was well advanced when condemned, that claimant is entitled to receive exactly what the owner would have received in a fair market sale. In other words, the property increased in value substantially because of the owner’s money, knowledge, and hard work. Every step that was taken to advance the project would provide an incremental and, perhaps, geometrical increase in value. This is because “[a] sagacious and experienced prospective purchaser on the day of the taking would undoubtedly have taken into consideration the net rental income which might have been derived from [the] property if the taking had not intervened.” Levin v. State, 192 N.E.2d 155, 156 (N.Y. 1963); see also United States. v. 25.406 Acres of Land, 172 F.2d 990, 993 (4th Cir. 1949).

If the subject property is income producing, it should be valued by the income capitalization approach. Simply put, this approach finds the present value of real property based on its future income. In condemnation, the property is valued as if it were free and clear of all liens, encumbrances, and leases. United States v. 25.936 Acres of Land, 153 F.2d 277, 279 (3d Cir. 1946).

The appraiser makes an extensive market study and estimates the economic rent of the property. Actual rents must be considered. In re Lincoln Square Slum Clearance Project, 222 N.Y.S.2d 786, 794 (N.Y. App. Div. 1961), aff’d , 190 N.E.2d 423 (N.Y. 1963). Actual rents provide the best indicator of fair market rental, especially if there is no indication that the actual rental is too high or too low. In re City of Albany, 523 N.Y.S.2d 652, 654 (N.Y. App. Div. 1988).

The appraiser then estimates the expenses of the property. The net income is then applied to a capitalization rate, which is determined by a study of various economic factors, including the returns on other investments, taking into account mortgage, equity components, and risk. The rate of capitalization should be a reflection of the market, or, in other words, what an investor would require from an investment in a property of similar age, kind, and condition. The resulting “cap” rate is then divided into the net income to indicate a value for the property. Care must be taken not to capitalize a speculative or hypothetical income stream from a non-existent structure. See Winooski Hydroelectric Co. v. Five Acres of Land, 769 F.2d 79, 82 (2d Cir. 1985). A property with an existing lease and in development may certainly be valued on a capitalization approach, however, for that is exactly what a buyer would do when purchasing the property. City of Chicago v. Lord, 115 N.E. 8, 11 (Ill. 1916).

Partial Takings

Sometimes a condemnor does not take all of the property. A partial taking is a frequent occurrence in a street widening. As a general rule, the measure of damages for a partial taking is the difference between the fair market value of the whole before the taking and the fair market of the remainder after the taking. Acme Theatres, Inc. v. State, 258 N.E.2d 912, 913 (N.Y. 1970).

The damages from a partial taking are broken into direct and consequential. Direct damages represent the value for the property (whether real or trade fixtures) that are within the area condemned or appropriated. Con-sequential damages are those that result to the portion of the property remaining (the remainder), not only by reason of the direct taking, but also by virtue of the use to which the appropriated parcel is put by the condemnor. United States v. 33.5 Acres of Land, 789 F.2d 1396, 1398–99 (9th Cir. 1986) (road construction caused invasion of knapweed to remainder); Raleigh C. & S. Railroad Co. v. Mecklenburg Mfg. Co., 85 S.E. 390, 392–93 (N.C. 1915) (railroad use); Dennison v. State, 281 N.Y.S.2d 257, 258 (N.Y. App. Div. 1967), aff’d, 239 N.E.2d 708 (N.Y. 1968) (damages to remainder caused by loss of view and noise); Criscuola v. Power Authority, 621 N.E.2d 1195 (N.Y. 1993) (loss of value to remainder caused by high voltage power line).

One of the surest guides in measuring damages occasioned by a partial taking is the diminution in rental value resulting therefrom. Humble Oil & Refining Co. v. State, 187 N.E.2d 791, 791 (N.Y. 1962). Further, a deterioration of the quality of the income stream merits the award of substantial consequential damages. See Star Plaza, Inc. v. State, 434 N.Y.S.2d 804, 806 (N.Y. App. Div. 1980) (change in traffic flow, loss of parking spaces).

A partial taking may be small in area, yet it may cause substantial damage to the remainder if it leaves the remainder with unsuitable access for its highest and best use. Judge Burke of the New York Court of Appeals defined “suitable” as meaning

that which is adequate to the requirements of or answers the needs of a particular object. The concepts are not mutually exclusive and, therefore, a finding that a means of access is indeed circuitous does not eliminate the possibility that the same means of access might also be unsuitable in that it is inadequate to the access needs inherent in the highest and best use of the property involved.

Priestly v. State , 242 N.E.2d 827, 830 (N.Y. 1968).

Tax Certiorari

The ability of government to tax, similar to its power of eminent domain, is an inherent power of a sovereign. Real property tax laws are complex. Generally the same basic valuation theories will apply because “[t]he ultimate purpose of valuation, whether in eminent domain or tax certiorari proceedings, is to arrive at a fair and realistic value of the property involved.” Allied Corp. v. Town of Camillus, 604 N.E.2d 1348, 1350 (N.Y. 1992). The big difference between condemnation and tax certiorari cases, however, is that the law requires the maximum award based on a parcel’s highest and best use in a just compensation claim, but a tax certiorari inquiry will require an inquiry as to the property’s condition and ownership on the applicable valuation date. See N.Y. Real Prop. Tax Law § 302(1) (2000).

Judge Frank Rossetti compared the two types of cases in In re Club of Garden City, Index 12696/88 (N.Y. Sup. Ct. Nassau Co.), reprinted in N.Y. L.J., June 17, 1991, at 33:

The general standard of value in assessments is market value, although other tests can be used if market value is not determinable. . . . This is analogous to appropriation, although there an overriding constitutional standard prevails, to wit, just compensation. . . . no such more embracive constitutional standard exists in assessment law, but there are the underlying purposes and goals of assessment to equitably and fairly distribute the tax burden in a nondiscriminatory manner in light of the existing “varied and multifaceted patterns of land use.”. . . in pursuit of its constitutional mandate of just compensation, appropriation law has applied and evolved the concept of highest and best use, whereby a condemnee’s taken property is valued according to its most valuable probable use, whether actually so used or not. . . . Thus, where appropriated property has a more valuable use to which it is reasonably probable it could or would be put in the reasonably near future, that is the use under which the property’s value is determined. . . . This accords with the basic condemnation principle that a condemnee should be compensated on the basis of what he has lost. . . . . in assessment, however, the statutory prescription of valuation according to extant conditions . . . has been interpreted to require valuation of improved property according to its existing use, not a potential one contemplated in the future.

Id. (citations omitted).

Judge Rossetti noted that different forces are at work in the two types of cases. An appropriation value seeks “to arrive at a single one time amount that ‘justly compensates’ a condemnee for the loss of his property,” but an assessment valuation seeks “to arrive at a value each year that equitably and fairly apportions the tax burden among all taxpayers’ property each year.” Id . Another distinction is the recurring nature of assessment, as compared with the one-shot nature of appropriation. “In the latter, where just compensation is the controlling standard, it is entirely proper to consider future potentialities which are sufficiently certain. . . . In assessment cases, however, the property is evaluated every year and thus there is no comparable need to insure that future potentialities be precisely accounted for.” Id . (citation omitted).

Valuation of Real Property in Other Contexts

Judges or arbitrators are often shocked at the wide disparity in values found by appraisers for the same property in the same case. In judicial proceedings, the judges who must often hear real estate valuation cases do so without a jury. These jurists have the ability to move a case forward quickly. Arbitrations dealing with the valuation of a leasehold for a lease renewal may go on for years.

Appraisals are often so subjective that they are not reliable. Appraisals for estate tax may bear no resemblance to appraisals prepared for the same property in a condemnation. A husband’s expert’s opinion of value of the marital home is often widely different from that of the wife’s appraiser’s opinion.

Case law has held that appraisers have broad discretion as to their methods and sources of information and may determine “’which of the myriad factors are relevant to a particular valuation and how such factors impact the valuation of the parcel of land . . . without interference or direction’ absent an agreement expressly identifying such factors.” Vitale v. Friedman, 666 N.Y.S.2d (N.Y. App. Div. 1997).

Qualification of Appraiser

The qualification of a witness as an expert rests in the discretion of the trial judge, subject to review only if the judge has made a serious mistake, committed an error of law, or abused discretion. Werner v. Sun Oil Co., 482 N.E.2d 921, 922 (N.Y. 1985). Put another way, the determination of a witness’s qualification to testify as an expert in a specific field rests in the broad discretion of the trial court, and such a determination will not be lightly disturbed. Union Trust Co. v. Woodrow Mfg. Co., 63 F.2d 602, 607 (8th Cir. 1933). Because a condemnation or tax certiorari claim is tried without a jury, the court, as the trier of fact, solely determines the weight of the expert testimony. Baker Properties v. Town of Hamden, 1994  WL 271322 (Conn. Super).

Requirement of the Judicial Decision

A trial court is obligated to make its factual findings and underlying mathematical calculations as explicit as possible. Lord v. State, 397 N.E.2d 1173, 1174 (N.Y. 1979). “In determining an award to an owner of condemned property, the findings must either be within the range of the expert testimony or be supported by other evidence and adequately explained by the court. . . . “ In re City of New York (College Point Industrial Park), 433 N.E.2d 1266 (N.Y. 1982). Conversely, if the court’s total award, as well as its various components, is within the range of the expert testimony, it should be upset only if the trial court committed legal error. Alexander’s Department Store v. Board of Assessors, 642 N.Y.S.2d 940, 942 (N.Y. App. Div. 1996).

Conclusion

The approach to resolving the issue of the value of Blackacre depends upon the context in which the issue arises. Appraisers use three basic valuation approaches: market data or comparable sales, income capitalization, and cost. The value for “just compensation” in a condemnation case, however, will require inquiries and the application of legal standards different from those used to determine value in taxation and other situations. Real property appraisers, lawyers, and judges should be aware of these distinctions in eminent domain cases.

Michael Rikon is a partner in Goldstein, Goldstein, Rikon & Gottlieb, P.C., in New York City.

 

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