How Australian Appraisers Assess Contaminated Land.

abstract

The availability of more information about land contamination, the short supply of development worthy land in urban areas, and the relatively low value of contaminated land have created a niche market in recent years for redeveloping contaminated land in Australia. Appraisers are frequently required to assess the value of such contaminated land. This article analyzes how Australian appraisers value contaminated land and analyzes the results of a survey of Australian appraisers conducted in 1998. This article also compares the Australian methods with methods

In recent years, the availability of information on land contamination, the short supply of development-worthy land in urban areas, and the relatively low value of contaminated land have created a niche market for redeveloping contaminated land in Australia. Appraisers are frequently required to assess the value of such contaminated land.

It has been generally accepted that valuation of contaminated property involves more than simply deducting routine cleanup costs from the uncontaminated value. Marketability, [1] stigma, [2] and possible change of highest and best use3 (the likely changes in land zoning) must also be considered. If the land is cleaned up to an approved standard, more sensitive and lucrative enterprise such as residential and commercial use may be allowed on a former contaminated site.

At present, Australian appraisers mainly use two basic approaches to value contaminated land. The first is the unimpaired valuation approach, or unaffected valuation approach; this requires the appraiser to assess the property as if it were clean. The appraiser emphasizes that this assumption has been made in the valuation report and warns the client about the possible impacts of the site's contamination. This type of evaluation is not particularly helpful to the client since the valuation does not reflect the real condition of the site.

The other approach is known as the impaired valuation approach, or affected valuation approach. It requires the appraiser to take into consideration the contaminated state of the property. The appraiser first evaluates the property as if it were clean; and then makes deductions for any future production (income) loss due to contamination and losses due to investigation and remediation costs and possible stigma. This approach can be represented by the following expression (Equation 1):

[V.sub.c] = [V.sub.u] - L - [C.sub.r] - S (1)

where:

[V.sub.c] = contaminated value,

[V.sub.u] = uncontaminated value,

L = loss due to reduced income/productivity and/or legal liabilities,

[C.sub.r] = investigation, remediation, and monitoring costs,

S = stigma impacts.

The above expression may be presented in different ways: some researchers prefer to refine and expand the values for [L.sup.u] and [C.sub.r] into a detailed list of various income losses or cost deductions due to contamination. (Generally, other formulas used are similar to the one presented here; however, it should be noted that the loss of income/productivity and legal liabilities may not necessarily be calculated for every case. In certain cases, they may be a zero.)

Regarding remediation costs, Kinnard [4] points out that it should not be the cost to cure (a complete cleanup) because an absolute cure simply may not exist. Instead, it should be the cost to correct, i.e., the cost to clean up the site to meet the current standards of intended use. This idea matches with that proposed in the 1999 National Environment Protection (Assessment of Site Contamination) Measure [5] in Australia. This document suggests adopting a site-specific assessment to determine if unacceptable health risks exist and to ascertain the nature and magnitude of environmental risks, rather than assessment based on de facto cleanup or response levels.

The Australian Valuation Approaches

Australia is generally regarded as a clean country but unfortunately, it does contain some contaminated land. To help appraisers assess contaminated land, the Australian Institute of Valuers and Land Economists (now the Australian Property Institute [API]) published a Contaminated Land Practice Standard in 1994. [6] The document was subsequently incorporated into Guidance Note 15 "Reporting on Contaminated Land" of the API Professional Practice 2000. [7] Besides providing members with background information about contaminated land issues, the document also introduces four bases (unaffected valuation basis, affected valuation basis, environmental balance sheet basis, and comparative basis) for the evaluating contaminated land.

To find out how Australian appraisers assess contaminated properties in practice, a mail survey of appraisers in New South Wales, Victoria, and Queensland was mailed out in April, 1998. These three States were selected as study areas because they are more populated and are home to more commercial and industrial enterprises than other States and territories; it is therefore logical to assume that they contain more contaminated land. It also follows that appraisers in these three States have more contact with contaminated properties and therefore more experience in carrying out relevant valuations.

Questionnaires were sent to appraisers in the three States using a mailing list provided by the divisional office of the Australian Property Institute in New South Wales (NSW), Victoria, and Queensland. (At present, the Institute does not keep a register of appraisers who specialize in contaminated land valuation.) The Institute supplied 1,368 addresses in NSW, but only 19 in Victoria and 28 in Queensland. The divisional offices in Victoria and Queensland reported that the appraisers they recommended were believed to have experience in contaminated land valuation but similar preselection had not been made by the divisional office in NSW. To keep the survey to a manageable size, questionnaires were sent to 500 appraisers in these three States. Since the number of addresses in Victoria and Queensland was substantially smaller, all were used. For NSW, 453 addresses were selected randomly. A follow-up interview of 40 participating appraisers (22 in NSW, 7 in Victoria, and 11 in Queensland) was subsequently conduc ted. The survey results are summarized in Tables 1-5.

Similar surveys have also been administered recently in the United Kingdom, New Zealand, and the United States. In 1997, Kennedy [8] surveyed 100 preselected appraisers (from a variety of recommendations and sources) in the United Kingdom and garnered a response rate of 54%. In 1998, Bond [9] surveyed 15 preselected appraisers (those who replied to a call to participate) in New Zealand and achieved a response rate of 47%. Kinnard and Worzala [10] (also in 1998) surveyed 208 preselected appraisers in the United States and Canada (192 in the United States and 16 in Canada) and received a response rate of 46%. These surveys found that appraisers in these countries mainly use sales comparison (direct comparison) and income capitalization methods (including discounted cash flow [DCF] method) techniques to value contaminated property. The overseas survey findings are contrasted with the Australian survey findings as outlined in Table 1.

Table 1 shows that the response rate to this survey in Australia was lower than that in the UK (54%), New Zealand (47%), and the United States (46%). The higher overseas response rate may be due to the fact that the surveyed appraisers were all preselected and some of them had replied to a call for participation. The small number of appraisers recommended in Victoria and Queensland and the low response rate in NSW suggest that the majority of appraisers in Australia do not have experience in contaminated property valuation. Nevertheless, the survey results reveal that some of the respondents have valued up to 100 contaminated properties. This shows that experienced contaminated property appraisers do exist in Australia, despite the fact that land contamination is not considered a common problem there.

Given the small sample size in Victoria and Queensland and the overall small number of returns, it is inappropriate to carry out a comparison between these results and those from the United States. I prepared a distribution graph based on the responses of appraisers who have experience in contaminated land valuation (Figure 1). This figure shows that the respondents fall into two distinct groups: an experienced group (those who have valued six or more contaminated properties) and a less experienced group (those who have valued less than six contaminated properties); there were 31 less experienced respondents and 32 experienced respondents, sample sizes large enough for meaningful analysis. It should be noted that the less experienced group refers to appraisers who have less experience in the valuation of contaminated properties only. It does not mean that they are less experienced overall.

As mentioned above, the Australian Institute of Valuers and Land Economists published a Contaminated Land Practice Standard in 1994 (now the API Professional Practice Guidance Note 15) to give members the necessary guidance in relation to contaminated land issues. [11] Table 2 shows the Australian appraisers response to this document.

Table 2 shows that about 90% of those surveyed in both groups are aware of the document; the Institute has done a good job introducing it. However, the number of respondents who use the document or follows its guidelines in practice is not as high. This directly correlates with the fact that, as reflected in Table 2, a substantial number of respondents do not find that the suggested valuation approaches reflect real-life practice. The follow-up interview revealed that respondents like that the document provides more information on valuation and the dangers involved in each of the problematic land uses and industries mentioned in the document. The overseas surveys in the United States, New Zealand, and Canada did not include this item, so there is no comparison between surveys on this point.

The application of valuation basis suggested in the document, as evaluated by the Australian respondents, is summarized in Table 3.

The Table shows that in both groups there is a preference for using the unaffected valuation basis over the affected valuation basis. More respondents in the experienced group use the affected and unaffected valuation basis overall. In the United States, 54% of respondents claimed they use the unaffected (unimpaired) approach to valuation; this is approximately the same percentage who claim they use it in the less-experienced group in Australia. This question was not included in the United Kingdom and New Zealand surveys; no comparison can be made.

Of the four suggested valuation approaches, the environmental balance sheet approach is the least popular. One reason for this may be that the respondents are not familiar with the balance sheet format used in this method and therefore are not comfortable using it. The overseas surveys did not include this subject so there is no basis for comparison.

Table 4 shows the valuation methods used by the Australian respondents in practice. About 80% of both groups use the comparison method in their valuation. It is interesting to note that this result contrasts sharply with the results in Table 3 that shows less than 40% of respondents use this method. This may be because some respondents were not familiar with the content of the Practice Standard and gave an uninformed answer to this question. In contrast, 80% of respondents in the United States, 0% in the United Kingdom, and 29% in New Zealand reported using this method.

The survey results show that over 50% of the respondents in both groups use the capitalization method. In comparison, 80% of respondents in the United States, 100% in the United Kingdom, and 100% in New Zealand reported using this method. Regarding the cost method, 71% in the Less-experienced group and 59% in the experienced group claim to have used this method. A similar query was not made in the overseas surveys, so there is no comparison possible.

The Table shows that 40% to 50% of respondents in both groups have used the hypothetical development method. Since the hypothetical development method is generally used to assess the development potential of land, it indicates that the highest and best use of the relevant contaminated land is not the current use. This supports the fact that there is a niche market to acquire contaminated land for redevelopment. Again, this method is not reported in the overseas surveys.

Regarding the discounted cash flow method, 32% of the less-experienced group and 16% of the experienced group use this method. In comparison, 64% of respondents in the United States, 7% in the United Kingdom, and 29% in New Zealand use this method, showing that the Australian respondents are more open to using this method than their counterparts in the United Kingdom.

According to responses to the Australian survey, the accounts method is used relatively infrequently. The use of this method is not reported in the overseas surveys, so there is no basis for comparison. The subject survey shows that the only methods used to value contaminated land are the methods listed in Table 4. In fact, these are the same methods used to value clean properties; the only difference is that the respondents need to adjust for the impact of stigma at the end as outlined in Table 5.

Over 70% of respondents reported that the existing methods for valuing contaminated land are suitable for the purpose. Less than 50% of the respondents reported that methods can/shall be improved, showing that respondents are content with the current methods used. This item was not covered in the overseas surveys, so there is no basis for comparison.

Table 5 below shows the valuers' point of view about stigma: 48% of the less-experienced respondents state that their clients have concern for this value impact, and 56% of the experienced respondents share the same view. It appears that the stigma issue has already caused significant concern, if not alarm, among clients in the three Australian States. A significant number of respondents (58% of less-experienced and 72% of experienced) have allowed for the stigma factor in their valuations. This implies that the majority of contaminated properties valued have stigma impact. Appraisers realize the seriousness of this issue and have taken appropriate action when completing valuations. The overseas surveys did not cover this area so there is no basis for comparison.

For those respondents who claim to have made allowance for stigma impacts, various approaches have been applied (Table 6). A number of respondents have chosen not to respond to the questions in Table 6. The figures obtained show that the majority of respondents use the arbitrary discount rate and percentage adjustment methods to allow for stigma impacts. The lump sum adjustment method has the least support. In comparison, 66% of respondents in the United States, 80% in the United Kingdom, and 83% in New Zealand use the increased discount rate for adjustment.

Regarding other methods of valuation, respondents claim to have used zero adjustment, arbitrary adjustment, higher profit and risk factor, using comparable evidence, and lower loan-to-value ratio methods. In comparison, respondents in the United States use reduced rental income, increased vacancy rate, increased capitalization rate, increased debt interest rate, reduced loan-to-value ration, reduced amortization period, increase equity yield rate, and increased equity dividend rate for adjustment. The United Kingdom and New Zealand respondents only use reduced rental income an as alternative method for adjustment. In a separate survey in 1997, Richards [14] found that appraisers in the United Kingdom mainly use upward adjustment for all-risk-yields, or overall capitalization rate, to account for stigma.

It is interesting to note that despite the lack of a uniform method of allowing for stigma, few Australian respondents responded that there is a need for a specific valuation method. The experienced group is more open: about 70% reported a willingness to try a new method.

Analysis of the Australian Valuation Approaches

At present, Australian appraisers are mainly using conventional valuation methods to value contaminated land. The use of conventional methods is not a bad idea: a number of property researchers (Patchin, [15] Mundy, [16] Wilson, [17] Simm, [18] Fisher, Lentz, and Tse, [19] and others) have used them in their research. Apart from conventional valuation techniques such as the comparison method and capitalization method, Australian appraisers also use the cost method, hypothetical development method, and accounts method to value contaminated property. Of all the valuation methods, the accounts method and discounted cash flow method are not used frequently; this may be due to the fact that the accounts method is normally used to value specialized properties such as hotels, nursing homes, and pubs. Contamination of these properties is generally uncommon; accordingly, this method is rarely used. The discounted cash flow method is generally used to meet institutional clients' requirements. If given a choice, apprais ers would rather use more familiar traditional valuation methods such as the comparison method and direct capitalization method for the job.

Since conventional valuation methods rely heavily on market evidence, the use of familiar traditional methods is not without problems. First, there is a lack of transaction data on contaminated properties; it is therefore difficult to rely on market evidence to estimate prices, rents, and yields of contaminated properties. [20] Second, as Wilson [21] states, "each environmental problem is as unique as a fingerprint"--it is difficult to get true comparables to apply in the direct comparison method. Accordingly, alternative valuation methods such as the environmental balance sheet (EBS) method, [22] survey method, [23] multiple regression analysis, [24] option pricing approach, [25] mortgage-equity analysis approach, [26] Monte Carlo simulation method, [27] and expected utility model, [28] and others, are introduced by property researchers. However, apart from the EBS method, the respondents do not use these methods. Some Australian appraisers may use the EBS method because the Australian Property Institute ha s incorporated this method into Guidance Notes 15 of its Professional Practice (formerly the Contaminated Land Practice Standard).

Australian appraisers have a greater preference for using the unaffected valuation basis for valuing contaminated land. The reason for this may be that clients have given instructions to do so or that the clients do not insist the valuation be done on an affected basis. Clients may ask for an unaffected basis valuation for specific purposes such as accounting or share floating. When there is no clear instruction from the clients, appraisers tend to perform an unaffected basis valuation for expedience.

Apart from the above reasons, another possible reason for the reluctance to use the affected basis for valuation may be the following: the assessment of various income and financial losses due to contamination and cleanup costs is fairly straightforward. The income and financial losses are calculated from facts provided by the client, and clean up costs are provided by environmental consultants. It is assessing value loss due to stigma impacts that creates problems. Spencer [29] points out that the major problem is a comparative lack of satisfactory evidence related to stigma-affected properties in Australia."

On the other hand, methods used by the respondents to assess stigma impact are not satisfactory. In the United States, Patchin [30] suggests using the direct comparison method to assess the unimpaired and impaired values of the property. The indicated stigma is estimated by subtracting the impaired value from the unimpaired value. In the United Kingdom, a similar yet more elaborate approach (the improved stigma assessment approach) based on Patchin's work is also suggested by Syms. [31] Apart from including the nature and extent of contamination of comparable properties, it also takes into consideration the present value of remediation costs. In addition, Syms [32] also suggests a risk assessment model to estimate stigma impact based on 26 industrial activities and a stigma value reduction range of 21%-69% borrowed from Patchin's work in 1994. The model creates a "value adjuster" that is used as a stigma adjustment factor. However, respondents report that they do not use these methods, possibly because they do not know they exist. Nevertheless, Syms's improved stigma assessment approach has been borrowed and included in the Professional Practice 2000 by the Australian Property Institute. It is likely that some appraisers will begin using this method in the near future.

Conclusion

A niche market for contaminated land has emerged in Australia and other countries in recent years. Appraisers are receiving more requests to value contaminated properties. This study finds that appraisers in Australia are mainly using conventional valuation methods to value contaminated land. These valuation methods are fine for valuing the unimpaired value of contaminated properties, but because of the lack of transaction data and the uniqueness of individual property are not suitable to value the impaired value of the properties. Property researchers have introduced a number of alternative methods. The Australian Property Institute is aware of the progress overseas and is willing to bring practical ideas to its members; and to this end, it has incorporated the EBS approach and Syms's improved stigma assessment approach in the Professional Practice 2000.

The survey shows that there are more Australian appraisers using the unaffected approach than the affected approach for valuation. While there are many reasons that Australian appraisers tend to use the unaffected approach, the difficulty in assessing stigma impacts is likely to be an essential one. The lack of transaction evidence is beyond the control of an appraiser; however, the deficiency maybe compensated for by a reliable method of assessing stigma impacts.

At present, the stigma assessment methods used by Australian appraisers are unsatisfactory and indefensible. The methods suggested by property researchers are also far from satisfactory. Patchin's method suffers from oversimplification. Equation 1 shows that the difference between the unimpaired and impaired values is more than just the value loss due to stigma. Syms's improved approach is better. However, even if the present value of the expected repair cost (remediation cost) is added to the sale price (the impaired value) as he suggests, it will not necessarily "give a good read on residual stigma." [33] Syms's other approach, the risk assessment model, is an improvement, but it is not easy to use. A better method to assess value loss due to stigma impacts needs to be researched.

This article provides an insight into how Australian appraisers value contaminated properties. However, the findings are not conclusive since the survey results are from small and unstructured sample sizes. Studies of larger random samples will likely support these findings; nevertheless, further research in this area is needed.

Nelson Chan is a valuation lecturer of the University of Western Sydney, Hawkesbury. He has published/presented several research papers about contaminated land issues. In 1999 he became a committee member for the Australian Property Institute to help revise the contaminated land valuation practice standard.

(1.) See, for example, Mundy, B., "The Impact of Hazardous Materials on Property Value," The Appraisal Journal (April 1992): 155-162 and Wilson, A.R., "The Environmental Opinion: Basis for an Impaired Value Opinion," The Appraisal Journal (July 1994): 410-423.

(2.) See, for example, Patchin, P.J., "Contaminated Properties-Stigma Revisited," The Appraisal Journal (April 1991): 167-172, Mundy, B., "The Impact of Hazardous Materials on Property Value," The Appraisal Journal (April 1992): 155-162, Roddewig, R., "Stigma, Environmental Risk and Property Value: 10 Critical Inquiries," The Appraisal Journal (October 1996): 375-387, and Neustein, R.A. & Bell, R., "Diminishing Diminution: A Trend in Environmental Stigma," Environmental Claims Journal (Autumn 1998): 47-59.

(3.) Wilson, D.C., "Highest and Best Use: Preservation Use of Environmentally Significant Real Estate," The Appraisal Journal (January 1996): 76-86.

(4.) Kinnard, W.N., "Measuring The Effect Of Contamination On Property Values: The Focus Of The Symposium In The Context Of Current Knowledge," Technical Report: Measuring the Effects of Hazardous Materials Contamination on Real Estate Values: Techniques and Applications, (Chicago: Appraisal Institute, 1992): 1-22.

(5.) National Environment Protection Council Committee 1999, National Environment Protection (Assessment of Site Contamination) Measure.

(6.) Australian Institute of Valuers and Land Economists (AIVLE), Contaminated Land Practice Standard (1994).

(7.) Australian Property Institute (API), Professional Practice 2000, Guide Note 15, (1999): 183-205.

(8.) Cited in Kinnard, W.N.; Worzala, E.M.; Bond, S.; & Kennedy, P., "Comparative Studies of United States, United Kingdom and New Zealand Appraisal Practice: Valuing Contaminated Property," paper presented at the 15th American Real Estate Society Annual Meeting in Tampa, Florida, April 7-10, 1999.

(9.) Bond, S.G., " The Appraisal of Contaminated Land in New Zealand," paper presented at the 14th American Real Estate Society Conference in conjunction with the International Real Estate Society Meeting, Monterey, California, April 15-18, 1998.

(10.) Kinnard, W.N.; Worzala, E.M.; Bond, S.; & Kennedy, P., "Comparative Studies of United States, United Kingdom and New Zealand Appraisal Practice: Valuing Contaminated Property," paper presented at the 15th American Real Estate Society Annual Meeting in Tampa, Florida, April 7-10, 1999.

(11.) Australian Institute of Valuers and Land Economists (AIVLE). Contaminated Land Practice Standards, (1994).

(12.) The hypothetical development method, also known as residual method in the UK, is a variation of the cost method and is used to assess development land value. It is based on the assumption that land value equates to difference of completion value and total development cost.

(13.) The accounts method, also known as profits method in the UK, is used to assess the market value of special premises that have some degree of monopoly. It is based on the assumption that value of the particular property is related to the profits of the business conducted on the premises,

(14.) Richards, T., "Beware the Contamination Factor in Valuation," Chartered Surveyor Monthly, (May 1997): 28-29.

(15.) Patchin, P.J., "Contaminated Properties and the Sales Comparison Approach," The Appraisal Journal, (July 1994): 402-409.

(16.) Mundy, B., "The Impact of Hazardous Materials on Property Value," The Appraisal Journal, (April 1992):155-162

(17.) Wilson, A.R., "The Environmental Opinion: Basis for an Impaired Value Opinion," The Appraisal Journal, (July 1994): 410-423.

(18.) Simm, G., "Problems for the valuation surveyor," Paper presented at Seminar on 'Environmental Assessment,' Sheffield City Polytechnic, 5 March 1992 cited in Syms, P.M., Contaminated Land, (London: Blackwell Science, 1997).

(19.) Fisher, J.D., Lentz, G.H. & Tse, K.S.M., "Valuation of Commercial Properties Contaminated With Asbestos," journal of Real Estate Research, (7: 1992):331-350.

(20.) See, for example, Kinnard, W.N., "Measuring The Effect Of Contamination On Property Values: The Focus Of The Symposium In The Context Of Current Knowledge," Technical Report: Measuring the Effects of Hazardous Materials Contamination on Real Estate Values: Techniques and Applications, (Chicago: Appraisal Institute, 1992), 1-22 and Syms, P.M., Cantaminated Land, (London: Blackwell Science, 1997), 197-203.

(21.) Wilson, A.R., "Environmentally Impaired Valuation: A Team Approach To a Balance Sheet Presentation," Technical Report: Measuring the Effects of Hazardous Materials Contamination on Real Estate Values: Techniques and Applications, (Chicago: Appraisal Institute, 1992): 23-42.

(22.) Wilson, A.R., "Environmentally Impaired Valuation: A Team Approach To a Balance Sheet Presentation," Technical Report: Measuring the Effects of Hazardous Materials Contamination on Real Estate Values: Techniques and Applications (Chicago: Appraisal Institute, 1992): 23-42.

(23.) See, for example, Greenberg, M. & Huges, J., "Impact of Hazardous Wastes Sites on Property Value and Land Use: Tax Assessors' Appraisal," The Appraisal Journal, (January 1993): 42-51, and McLean, D.C. & Mundy, B., "The Addition of Contingent Valuation and Conjoint Analysis to The Required Body of Knowledge for the Estimation of Environmental Damages," Journal of Real Estate Practice and Education, (1: 1, 1998): 1-19.

(24.) See, for example, Dotzour, M., "Groundwater Contamination and Residential Property Values," The Appraisal Journal, (July 1997): 279-285 and Reichert, A.K., "Impact of a Toxic Waste Superfund Site on Property Values," The Appraisal Journal, (October 1997): 381-392.

(25.) Lentz, G.H. & Tse, K.S.M., "An Option Pricing Approach to the Valuation of Real Estate Contaminated with Hazardous Materials," Journal of Real Estate Finance and Economics, (10: 2, 1995): 121-144.

(26.) Chalmers, J.A. & Jackson, T.O. "Risk Factors in the Appraisal of Contaminated Property," The Appraisal journal, (January 1996): 44-58.

(27.) See, for example, Gain, K.J., "Appraising by Probability Analysis," The Appraisal Journal, (January 1990): 119-126 and Byrne, P., Risk, Uncertainty and Decision-making in Property Development, 2nd edition, (London: E & FN Spon, 1996) and Weber, B.R. "The Valuation of Contaminated Land," Journal of Real Estate Research, (14: 3, 1997): 379-398.

(28.) Wiltshaw, D.G., "An economic analysis of contaminated land, remediation and liability," Journal of Property Research, (13, 1996): 131-141.

(29.) Spencer, J.A., "Standard for Valuation of Contaminated Land In Australia," The Valuer and Land Economist (November 1993): 585-587.

(30.) Patchin, P.J., "Contaminated Properties and the Sales Comparison Approach," The Appraisal Journal (July 1994): 402-409.

(31.) Syms, P.M., "Dealing with Contaminated Assets," Estates Gazette (Issue 9612 1996): 124-12S.

(32.) Syms, P.M., Contaminated Land (London: Blackwell Science, 1997): 197-203.

(33.) Sanders, M.V., "Post-Repair Diminution in Value from Geothechnical Problems," The Appraisol Journal (January 1996): 59-66.

References

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