VAPS: The Basics
Many types of facilities have been identified as a cause of alleged or actual diminution in the value of nearby properties. These include industrial sites, municipal landfills, hazardous waste–disposal sites, wind farms, prisons, state mental institutions, and mines, to name a few.
Whether through a structured program or simply as motivated buyers in the market, responsible parties and government agencies have long responded to fears of off-site price impacts by purchasing surrounding properties. An early and well-known example of this was Love Canal, a neighborhood in Niagara Falls, New York, in which state and federal agencies bought hundreds of homes and relocated residents.
Our understanding of real estate markets has grown since Love Canal, and VAPs have likewise become more sophisticated. Of particular importance in designing a VAP is the demarcation of an appropriate geographical area. VAPs offer qualifying property owners within this geographical area the difference between the actual selling price of their property and a hypothetical market value based on some control area that is comparable to the qualifying area but not affected by the externality—in particular, contamination. In addition to this difference, compensation may also include closing costs and relocation expenses.
Recent Example: Dartmouth College VAP
A recent and particularly grim example of a VAP implemented by Dartmouth College in New Hampshire serves to illustrate the motivations for these programs, as well as their design.
Dartmouth College’s medical school legally disposed of thousands of pounds of lab-research animal carcasses from 1965 to 1978 at a site known as the Rennie Farm. Constituents associated with the disposal (1,4-dioxane) seeped into the groundwater and migrated downgradient under neighboring properties. The solvent 1,4-dioxane is classified by the Environmental Protection Agency as “reasonably anticipated to be a human carcinogen.”
Dartmouth College voluntarily implemented the Rennie Farm VAP in February 2017 due to real estate market fears associated with the off-site contamination. To remain eligible, property owners (48 total) are required to sell their properties between February 2017 and February 2022 through approved agents. One of three chosen appraisers must complete the unimpaired appraisals. Comparable sales must be outside the containment area to establish the hypothetical market value. The program is not transferable to a new buyer but does apply if a property is inherited.
In September 2017 and after meeting the qualifications of the VAP, five properties were purchased at market value by the college, prompting other property owners to request that the VAP geographic constraints be expanded and include more favorable terms because of perceived market resistance.
Advantages and Disadvantages of VAPs
VAPs offer the advantage of unimpaired market value in property sales. From an appraisal point of view, a VAP offers several advantages to the guarantor.
Rather than relying on an impaired appraisal, which can be a time-consuming process often complicated by a lack of comparable data, a VAP replaces the impaired appraisal with an actual transaction. The unimpaired appraisal, often more straightforward, is then based on a chosen unimpaired control area. At a minimum, property owners are then compensated for any difference between these two values. In theory, property owners covered by a VAP should receive nothing less than unimpaired market value for the sale of their property.
The usefulness of the transaction price used in a VAP relies on its indication of market value in an arm’s-length transaction. To ensure consistency and legitimacy of prices, a VAP will typically include provisions outlining the qualifying process for property owners before or after the consummation of a sale or refinancing. The property owner may also have a responsibility during the marketing period to maintain the physical condition of the property, make the property available for showings, and negotiate in good faith.
VAPS offer the disadvantage of potential below-market sales. The existence of a VAP, however, may create an incentive for owners of covered properties to transact at prices below market value even in the absence of any property value diminution effects due to an externality. This is similar to the potential moral hazard inherent in any insurance mechanism. Although VAPs generally include guidelines for actions taken by the seller, there does exist an economic incentive for sellers to accept lower offers than they might have in the absence of the program. Sellers are compensated for the difference between the sale price and market value, and, in some cases, transactions and relocation costs are covered by the guarantor. This could result in sellers saving thousands of dollars. In addition, reduced time on the market—as well as reduced hassle and the elimination of other transaction costs—provides an incentive for sellers to accept offers less than they might have in the absence of the VAP.
From an appraisal perspective, the problem here is that sales subject to a VAP may fail to satisfy the definition of market value if the sellers are not typically motivated. That is, the incentives offered by the program could push prices lower than their market value, leading to an interesting empirical question. Are the incentives created by a VAP enough to affect market prices? From a real estate economics perspective, the difficulty here is separating any impacts from the externality from any impacts of the VAP itself. Louis Wilde, Jack Williamson & Carl Dietz, A Hedonic Analysis of a Value Assurance Program (VAP) (2015) (unpublished paper) (available from the authors upon request).
The Neodesha VAP
In 1897, Standard Oil Company of Kansas constructed an oil refinery on what was then the outskirts of Neodesha in Wilson County, Kansas. In 1970, the refinery was closed, and most of the property was deeded to the City of Neodesha for industrial development.
Community-wide notification of off-site groundwater contamination emanating from the former refinery appears to have begun in the spring of 2000. In May 2000, a map of on-site and off-site contamination surrounding the former refinery was published in the local newspaper.
Following that article, the prior owner of the former refinery sent letters to residents within the Neodesha area notifying them of their eligibility to participate in a VAP. As described above, like most VAPs, the Neodesha VAP set out a guarantee that if an owner of a property within a defined geographical area made a reasonable effort to sell his property and the sale price turned out to be less than fair market value, the guarantor would pay the owner the difference.
The determination of fair market value in this case depended on when the property was purchased. For properties purchased before April 2000, fair market value was based on one or more appraisals using sales comparisons largely drawn from the nearby town of Fredonia. For properties purchased after April 2000, fair market value was based on the original purchase price plus 2 percent per year from the purchase date to the sale date. If the sale price was less than fair market value, the owner would also be compensated for closing costs, including broker’s commissions.
Using sales data from the Kansas Department of Revenue, a hedonic regression analysis was conducted of the overall effects of the off-site contamination on residential property values in all of Neodesha; an analysis of the Neodesha VAP was conducted as well. See Jack Williamson, Orell C. Anderson & Alexander R. Wohl, Hedonics, Litigation, and Property Value Diminution (ABA Envtl. & Energy Litig. Aug. 28, 2017). The findings showed a temporary decline in the value of residential property in the program area. The root cause for this decline cannot be known definitively, only inferred based on statistical results. As discussed below, this decline was likely due to the incentives created by the Neodesha VAP rather than by the off-site contamination.
The timing of the decline indicates VAP responsibility. Though there was widespread awareness of the off-site groundwater beginning in the mid-2000s, there was no significant difference for the following three years between property values inside and outside the VAP area. In addition, property values outside the VAP area in Neodesha outperformed those in Fredonia over the same period and were thereafter essentially identical. When residential property values within the VAP area began to drop in 2002, they were still essentially the same as in Fredonia. These results indicate that if the off-site groundwater contamination were the cause of the price decline in years 2002 and 2003, there would have been a three- to four-year lag between the time the local real estate market became informed of it and the time that it influenced property values. There is no evidence of such delayed price effects in the appraisal or real estate economics literature.
An increased participation rate indicates VAP responsibility. Another indication that the decline was due to the economic incentives created by the VAP is that the decline coincided with increased participation in the VAP. The hedonic regression model includes 18 transactions in the VAP area in years 2000 and 2001, only six of which were part of the Neodesha VAP. But in years 2002 and 2003, there were 12 transactions in the VAP area, nine of which were part of the Neodesha VAP. In years 2004 and 2005, there were 17 transactions in the program area, only seven of which were part of the Neodesha VAP. In other words, the decline in property values occurred precisely when the percentage of participation in the Neodesha VAP was highest.
Conclusion
The use of VAPs as a case-specific risk-management strategy has been—and likely will continue to be—a useful tool for parties held responsible for alleged decreases in residential property values due to environmental contamination. As with any risk-management strategy, however, there are potential consequences. As the Neodesha VAP illustrates, the program may create incentives that depress prices. Resulting temporary price declines may then be misinterpreted as latent effects of the contamination event itself. Nevertheless, compared to costly, drawn-out litigation, VAPs may, in certain cases, remain the most efficient option.
Orell Anderson, MAI, is the president of and Alexander Wohl is a research associate with Strategic Property Analytics, Inc., in Orange County, California. Louis Wilde has a PhD in economics and is a former professor at Caltech.