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The appraisal of water rights: their nature and transferability.

ABSTRACT

This article is part one of a two-part article on the appraisal of water rights. This article identifies various aspects of the water fights that may be the subject of an appraisal: part two, which will appear in the Spring 2008 issue of the The Appraisal Journal, will discuss the actual appraisal process. The rules and regulations that exist in California provide the background for the presentation, and many of the principles presented have general applicability. However, there is variability among states, and appraisers with assignments involving water rights should be knowledgeable about the rules of the state in which the water rights exist.

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This article is the first in a two-part series addressing the appraisal of water rights. It focuses on understanding the subject of the appraisal, and provides an introduction to basic concepts including the types of water rights, the transfer of water rights, and the terminology related to water rights. The water rights rules and regulations in California provide the background for the presentation. Although there is variability in water rights among states, many of the principles presented here have general applicability. Part two of this article will build upon the concepts discussed and present the actual appraisal process and methodology for valuing water rights.

Introduction

Life cannot exist without water, and neither can economic prosperity. Nothing is more fundamental to our existence and to our wealth than water. Yet there is no question that the earth's population is increasing while the supply of pure fresh water is decreasing. Toxic contamination from many sources has dramatically reduced the amount of fresh water available for human and agricultural use. It is inevitable that there will be disputes.

Legal battles over water have taken place for hundreds of years in the United States, with no end in sight. Appraisers enter the fray when money and conflicting interests are involved. An appraisal may be required in a litigation situation where the Endangered Species Act requires additional stream flows for specific species, like salmon, and the irrigators are demanding compensation. Or, an appraisal may be required when an irrigated ownership is in an area where urban demand for water is such that the highest and best use of the property may involve sale of the water rights and conversion of the property to an alternate, nonirrigated use.

A clear understanding of the property interest being appraised is foundational to the appraisal of water rights. Water rights are only one interest in the bundle of rights of real property ownership. Since a water right is generally a real property right, it is a partial interest being valued.

The water rights regulations are legion and vary from state to state. In order to competently perform assignments involving water rights, the appraiser may need to become intimately familiar with the regulations of the state in which the water rights exist. Usually the primary question to be answered is whether the water rights may be transferred, and, if so, under what conditions.

Water issues may have a very wide geographic scope. For example, the Metropolitan Water District of Southern California (which includes the greater Los Angeles area) is restricted in the amount of water it can extract from the Colorado River at the state's eastern border. In addition, this water district depends on extractions from the Sacramento-San Joaquin Delta to the north, near San Francisco, so the impact of any restrictions there extends throughout the state--as happened recently when a court significantly restricted extractions from the Delta to protect a tiny fish, the Delta Smelt. Similarly, in Nevada, the Southern Nevada Water Authority (Las Vegas) has proposed building a pipeline hundreds of miles long to capture unappropriated groundwater to the north, potentially changing the water market dynamics in the entire state. As these examples show, an understanding of the broader water rights situation may be needed before the significance and value of one element can be appreciated.

Types of Water Rights and Interests

There are different types of water rights and interests. Key areas of distinction include the source of the water, the entity holding the water rights, and how the rights were acquired. For example, the different types of water rights in California include prescriptive, pueblo, groundwater, riparian, and appropriarive water rights. In addition, an entity may hold a contractual entitlement to water. These rights are defined as follows.

* Prescriptive water rights are water use rights gained by trespass or unauthorized taking that ripen into a title on a par with rights to land gained through adverse possession. (1)

* Pueblo water rights are water rights possessed by a municipality, which as a successor of a Spanish-law pueblo is entitled to the beneficial use of all needed, naturally occurring surface and subsurface water of the entire watershed of the municipality. Water use under a pueblo right must be within the modern city limits and excess water may not be sold outside the city. (2)

* Groundwater rights are water rights held by owners of interests in land overlying the groundwater basin. Groundwater should be thought of as the water that occupies the space between soil particles beneath the surface of the land. Groundwater is not water flowing in an underground channel, i.e., a stream that is underground. Groundwater is extracted exclusively by means of wells.

The Dictionary of Real Estate Appraisal defines groundwater as "all water that has seeped down beneath the surface of the ground or into the subsoil; water from springs or wells." (3) This is an adequate working definition if the phrase "springs or" is eliminated, because whenever groundwater reaches the surface in a natural manner, whether through springs or seepage into a surface water stream, channel, or lake, it ceases to be groundwater and becomes surface water.

* Riparian water rights are defined in The Dictionary of Real Estate Appraisal as
 The incidental right of the owners of land bordering
 a lake or stream to the use and enjoyment
 of the water that flows across their land or is
 contiguous to it; entitles the user to reasonable use
 that does not materially diminish the quality or
 quantity of the water for other owners. The owners'
 rights are equal, regardless of their location
 along the stream or the time when each property
 was purchased. (4)


* Appropriative water rights exist in situations where surface water is transported away from its naturally occurring location and used on lands that are not adjoining the source water body. In California, appropriative water rights generally fall into two categories: pre-1914 appropriative rights, which predate the existence of California's State Water Resources Control Board (SWRCB) and its regulation of the state's water supply; and license rights, which are post-1914 rights provided through an official document that grants permission to engage in a specified activity, such as an appropriation of water. (5)

* Contractual entitlements are interests in water but are not water rights. A water right is held by the entity that takes water directly from a body of water. A contractual entitlement is created by means of a contract between the appropriative water right holder and another entity that will take delivery of water diverted by means of the water right. For example, the California State Water Project (SWP) and the Central Valley Project (CVP) districts have contracts with the Department of Water Resources and the Reclamation Board, respectively, that specify the amount of water each district is entitled to if full allocations are available. If less than the full amounts specified in the contracts are available, then each district receives a reduced amount as determined by the terms of the contract. The districts generally have contracts with landowners for distribution of water the districts receive. Therefore, there is a second tier of contractual entitlements. When there are subdistricts, there could be yet another tier of contractual entitlements that come into play before the landowner or the actual user of the water is involved.

Concepts of Ownership Interests

Water Ownership Interests

Water can have different ownership interests. Water Rights Laws in the Nineteen Western States, (6) published by the U.S. Department of Agriculture, summarizes these interests as follows:

* Water flowing in a natural stream is owned by the public. Private rights to the water in a stream are usufructuary for the purpose of putting it to beneficial use.

* Water in a stream, lake, or in the ground is real property, i.e., part of the land.

* The legal diverter of the water from its natural location becomes the owner of the water.

* Water used for irrigation is not personal property but real property, even after delivery is complete.

* Water in canals and other artificial conduits or reservoirs does not become personal property as soon as it is diverted from its natural location, but usually retains its character as real property until delivery to the municipal or industrial consumer, at which time it does become personal property.

Water Rights Ownership Interests

The previous list refers to the classification of the water itself. The following classifies the ownership interests of the water rights involved. (7) Note that water rights traditionally have been considered as rights in real property. The points presented for groundwater, riparian, and appropriative rights in the following discussion are representative of how these rights are characterized. (8) Contractual entitlements and the concept of dedicated instream water interests are also explained.

Groundwater Rights. Groundwater rights have the following characteristics.

* Groundwater rights are appurtenant to the land overlying the groundwater basin or aquifer.

* Groundwater rights are correlative with similar rights of all other overlying owners.

* An insufficient supply of groundwater may be apportioned among overlying owners by a court, This process is called adjudication.

* Surplus groundwater may be appropriated for nonoverlying uses. Surplus groundwater exists when the overlying landowners, on average, use less than what is recharged into the aquifer.

* Groundwater rights are not forfeited through non-use.

* In California, no state-issued license for groundwater rights is required from the SWRCB.

Riparian Water Rights. Riparian water rights have the following characteristics.

* Riparian rights are considered to be part of the riparian land.

* A riparian right is part and parcel of riparian land, and the right to the flow is real property. Real property remedies are therefore available for riparian rights.

* Riparian rights cannot be severed from the riparian land and transferred elsewhere.

* Riparian rights are generally correlative with other riparian rights and are not junior to appropriative rights regardless of date of first use.

* The assemblage of riparian land with nonriparian land does not make the assembled ownership all riparian. Only the original riparian parcel is considered riparian.

Subdividing riparian land in such a manner that makes one or more of the newly created parcels nonriparian will cause those parcels to lose their riparian water rights unless those rights are retained in the title.

* Riparian rights apply only to the natural flow of a stream. If water is stored upstream and released later in the year, the riparian right holder does not have a right to any portion of the stream flow consisting of released stored water.

* Riparian rights cannot be used to move water into storage.

* Riparian rights are not forfeited through nonuse.

* In California, no state-issued license for riparian water rights is required from the SWRCB.

Appropriative Water Rights. Appropriative water rights have the following characteristics.

* Private ownership of water in a natural stream does not exist; however, private rights to extract the water do exist, and they are real property rights.

* An appropriative right is also an interest in real property. Thus, appropriative rights may be, but are not necessarily, appurtenant to the land. If they are appurtenant, the right is incidental to the land.

* The appropriative right is generally appurtenant to the land receiving the water diverted under the right.

* Appropriative rights can be severed from one parcel of land and become simultaneously appurtenant to another parcel of land.

* Seniority of appropriative water rights is established by the date of first use. More senior water rights must have their needs fulfilled before more junior ones receive water.

* Appropriative rights can be forfeited through a period of non-use.

* In California, all post-1914 appropriative rights must have been issued a license from the SWRCB to divert water. The SWRCB has no jurisdiction over pre-1914 water rights.

Contractual Entitlements. Although contractual entitlements are not water rights they are linked to water rights. The entity that has an appropriative water right has entered into a contractual agreement with a second entity to deliver up to a certain amount of water, if it is available. The second entity (contractor) then is said to have a contractual entitlement for the specified amount of water. There is usually a point of delivery specified where the water will be delivered. Fixed costs (infrastructure related) and variable costs (operations and energy for pumping related) are associated with the entitlement. Contractual entitlements may cascade to other contractors further down the delivery system by means of additional contracts.

It is common for a contractual entitlement to be associated with a parcel of land and to transfer with the land. However, it is not part of the real estate and therefore is not a real property interest in the real estate. By definition, a contractual entitlement is intangible property.

Dedicated Instream Water Interests. Another type of interest is a use protection through designation of a dedicated instream water interest. In California, this right is provided in Section 1707(a)(1) of the California Water Code, which states,
 Any person entitled to the use of water, whether based upon an
 appropriative, riparian, or other right, may petition the board....
 For a change for purposes of preserving or enhancing wetlands
 habitat, fish and wildlife resources, or recreation in, or on, the
 water.


Similar statutes on dedicated instream water rights can be found in other states.

Essentially, under this type of arrangement the purpose of a water right being utilized on a parcel of land can be changed to benefit wildlife. Usually this is done by foregoing the right to divert the water from a stream. This is considered a reasonable and beneficial use and the ownership of the water right is not lost through disuse.

Though extremely unlikely, the potential exists for an instream dedication to be reversed. Any valuation of a dedicated instream water right would have to examine all of the economic uses to which it could be put--including reversing the dedication--and consider the costs and risks of reversing the dedication.

Because of the expense and risks associated with attempting to reverse an instream dedication, a seller of a water right would not be prudent to initiate the dedication process even if the buyer is a public agency acquiring the right for exactly that purpose. The acquiring agency should be the one that applies for change of purpose after close of escrow in the transaction.

Any private party looking to acquire a water right for economic purposes could be expected to be reluctant to acquire a dedicated instream water right because of the difficulty of gaining the right to use the water for other purposes. At a minimum, the price would be discounted to consider risk and cost of reversing the dedication process.

Transfers of Water Rights

Water rights may be transferred. A transfer of water rights occurs when water allocations among users are changed. The nature of a water right and the ownership interests will affect the transfer of the rights. Generally, "you can transfer water if it is your water and not somebody else's water, provided the transfer does not injure another water right holder or unreasonably affect instream beneficial uses." (9)

The appraiser must understand the hurdles, risks, and costs associated with a proposed transfer of the water right being appraised, and also those of any comparable sales utilized. These items should be kept in mind in adjusting comparable sales to the subject.

Several terms must be introduced that are relevant to any discussion about transfers of water rights. These terms are related to the use and availability of the water at issue.

* Applied water (AW) is water that is applied to land by the various irrigation techniques.

* Evapotranspiration (ET) is the amount of water that either evaporates from a parcel of land or is transpired by the crops growing there.

* Evapotranspiration of applied water (ETAW) is that portion of the evaporated or transpired water (ET) that was water applied to the land by irrigation (AW). This excludes rainfall.

* Consumptive use includes ETAW plus additional water that has been removed from the system. This could include applied water that percolated underground depending upon the connectivity between the surface water system and the groundwater basin. One of the fundamental principles involved in determining the amount of water available for transfer is the amount that has been consumptively used in the past.

As previously described, water rights and interests can be classified as prescriptive rights, pueblo rights, groundwater rights, appropriative rights, and contractual entitlements. Special considerations in the transfer of these rights will be discussed next. Since prescriptive water rights that have ripened are simply treated as appropriative rights, they will not be addressed separately. Also, since it is highly unlikely that pueblo rights will ever be available for sale or lease, they will not be discussed further.

Transfer of Groundwater Rights

In California, several groundwater basins have been adjudicated where groundwater rights have been bought and sold apart from the land. (10) In adjudicated basins, the total extractions allowed are generally equal to the total average annual yield of the basin. There is frequently a well-defined market for these rights, especially if a growing urban entity has been acquiring them. Transfers can be affected by reducing pumping at one location in the basin and increasing pumping by a like amount at another point.

Transfer of nonadjudicated, percolated groundwater is possible under certain conditions. Also, a landowner who has access to both surface water and groundwater can transfer the surface water and replace it with groundwater, again under certain conditions.

The SWRCB report "Water Transfer Issues in California" (11) addresses transfers of percolated groundwater. The issues and complexities of groundwater transfers presented in that report are summarized as follows:

* The portion of underground percolation that makes its way back to useable water supplies downstream does not qualify as consumptive use.

* Applied water that percolates into a salt sink is consumptively used.

* Site-specific analyses are frequently required that examine the distance to waterways, seasonal hydrologic continuity, other groundwater pumping, and geologic conditions.

* Water transfers must not cause injury to other legal users of water.

The topic of groundwater transfers is also addressed in the report "A Guide to Water Transfers" (12) The guide indicates that although some areas have access to both surface water and usable groundwater, the surface water is often the preferred water source. The use of surface water is often cheaper because it does not require pumping. Also, the quality of the surface water may be better.

At times, both water sources are used together because it expands the overall water supply of the system. If the groundwater is pumped and used in lieu of the surface water, then the surface water can be used by others. This allows the surface water to be transferred to another user downstream, and the transferor can be compensated for the extra costs of pumping the groundwater. The guide notes that this practice and transfer can impact other groundwater users. It goes on to emphasize that local groundwater management plans must be considered and that the no-harm principle must apply as well. (13)

Transfers of Riparian Rights

As previous indicated, riparian rights are associated with land adjacent to a water source. It should be noted, however, that the water for riparian lands may be extracted on another ownership, generally upstream, and delivered to the uphill portion of the property by means of canals or pipelines from which gravity irrigation could take place. Therefore, a riparian right may have the appearance of an appropriative right because the water is extracted offsite. If the land being irrigated has frontage on the stream from which the water comes, it is probable that a riparian right is being exercised. Once again, the exact nature of the water right being valued must be understood. The appraiser should never assume anything about the water right unless directed to do so by the client. Such assumptions must always be presented prominently in the report as extraordinary assumptions or hypothetical conditions, with care being exercised to avoid creating a misleading report, as is addressed in the Uniform Standards of Professional Appraisal Practice (USPAP). (14)

Another situation could arise whereby water is extracted from a tributary stream and used to irrigate land that fronts on the main stream. Even though functionally it is a matter of indifference whether the irrigation water was withdrawn from the tributary or the main stem, it is probable that the right is appropriative. If that is the case, then an interesting situation exists, whereby the holder of the appropriative water right may want to sell it and irrigate directly from the main stem by means of a riparian right. In that case, downstream water right holders could very well be harmed. Because of the no-harm rule, it is unlikely that the transfer would be allowed.

There appear to be only two ways that riparian water rights can be transferred to the benefit of instream use. The first, and most obvious, is to purchase the land outright. It would then belong to the agency to manage as it wishes. Any water not used on the property would remain in the stream. This would benefit in-stream needs. However, it would also be available for any downstream appropriator or riparian user, since the conserved water would be part of the natural flow of the stream. Therefore, the in-stream benefit may be short-lived.

The transfer of the riparian water right could also be by means of a conservation easement. The easement could specify certain hydrologic conditions under which the landowner would need to leave the land fallow. The same drawback exists for this approach as for the previous one regarding the inability to keep the water in the stream in the face of downstream water right holders' capacity to extract it. In essence, the economic use of the water would be simply shifted to one or more downstream locations. Again, the cost-benefit ratio would have to be considered.

Transfers of Appropriative Water Rights

In California, all appropriative water rights have a priority associated with them. The manner in which this priority is established has changed over time.

Before 1872, appropriative water rights could be acquired simply by taking and beneficially using the water: "The priority of the right was the first substantial act leading toward putting the water to beneficial use provided the appropriation was completed with reasonable diligence; otherwise, priority did not attach until beneficial use of the water commenced." (15) Beginning in 1872, under the California Civil Code a priority of right also could be established by posting a notice of appropriation at the proposed point of diversion and recording a copy of the notice with the local county recorder.

Since 1914, the SWRCB must issue a permit, or license to divert, before a legal appropriation of water may take place. The priority date associated with the water right is the date of the permit. The license to divert specifies the point of diversion; the period when diversion can take place; the quantity of water that can be diverted, usually in cubic feet per second; the intended place of use; and the intended purpose of use.

The licensee is to report to the SWRCB every year how much water has been diverted and when the diversion took place. Riparian and pre-1914 water right holders are also supposed to report, but there is no penalty for nonreporting in their cases.

If a water source has greater flows or yields than the amount that has been legally appropriated, then new appropriations may be granted to applicants. When the natural flows are insufficient to fulfill all of the existing appropriations in a particular year, then the most junior (recent) water right holders must refrain from diversion until the rights of the senior holders are fulfilled. Consequently, the more senior the right, the more reliable it is considered. Pre- 1914 water rights are not under the jurisdiction of the SWRCB and, therefore, do not need the board's approval for transfer. However, the no-harm rule to other water rightholders still applies. An injured party would have to seek a remedy in the courts, not before the SWRCB.

Short-term transfers (one year or less) are relatively straightforward and gain rapid approval while long-term or permanent transfers are much more complicated and are subject to greater scrutiny.

Long-term transfers are subject to the requirements of the California Environmental Quality Act, which means there may be times when a full environmental impact report is needed. The SWRCB must give public notice of the proposed transfer and a public hearing also may be required. The services of attorneys and engineers are frequently required in these situations.

Transfers of Contractual Entitlements

Contractual entitlements are tied by contract to an appropriative water right. Consequently, all of the seniority associated with the water right is passed to the contractor. The specific contractual entitlement being considered for transfer must be analyzed as to what opportunities and obstacles exist for the transfer.

In California, for example, the SWP and CVP water districts hold rights to divert water out of the Sacramento-San Joaquin Delta and pass it, through entitlements, to contractors to the south. Because of recent developments of a political and legal nature, the SWP and CVP are generally not able to deliver full entitlement amounts to their contractors. (16) Also, the transfers involving SWP entitlements have had the buyer assuming all of the ongoing financial responsibilities to the SWP that the seller had. Further, the CVP charges a higher rate for municipal and industrial use compared to agricultural use.

Whether or not the entitlements are transferable to noncontractors also should be investigated on a case-by-case basis. Frequently, entitlements either are not transferrable or other peer contractors must be given a right of first refusal. If a transfer to a noncontractor is allowed, the contractors not involved in the transfer will pay great attention to ensure their financial position is not being impacted negatively by the transfer.

Conclusion

Understanding what you are appraising is absolutely critical when dealing with water rights. The appraiser should fully understand, not only the complete legal and financial environment for the subject, but also for any sales utilized as comparables. Time invested in thorough research will serve the appraiser well in avoiding the numerous and serious pitfalls that await the unwary in water right valuations.

The rules and regulations associated with water rights vary from state to state so geographical competency comes into play when accepting an assignment in a new state. Every water right appraisal assignment tends to be a learning experience with its own set of challenges. Though not for the faint of heart, these appraisal assignments can be intellectually stimulating and rewarding. A subsequent article, in the Spring 2008 issue of The Appraisal Journal, will address the appropriate appraisal methodology to employ when appraising water rights.

(1.) State Water Resources Control Board, California Environmental Protection Agency, "Water Words," at http://www.swrcb.ca.gov/waterwords.html (accessed March 2007).

(2.) Ibid.

(3.) Appraisal Institute, The Dictionary of Real Estate Appraisal, 4th ed. (Chicago: Appraisal Institute, 2002), 133.

(4.) Ibid., 250.

(5.) State Water Resources Control Board.

(6.) Hutchins et al., Water Rights Laws in the Nineteen Western States (Washington DC: U.S. Department of Agriculture, 1971).

(7.) The source of this information is court cases cited in Arthur L. Littleworth and Eric L. Garner, California Water (Point Arena, California: Solano Press, 1995), 27; see also the discussion in Hutchins et al.

(8.) See especially Littleworth and Garner, and Hutchins et al.

(9.) "A Guide to Water Transfers," Division of Water Rights, State Water Resources Control Board, Draft July 1999, 1-1, available at http://www.watertranfers.water.ca.gov/geninfo/geninfo_index.cfm.

(10.) The State of California is not authorized by its water code to manage groundwater. Landowners and other parties overlying some groundwater basins have used the courts to settle disputes over the amount of groundwater that can be extracted by each landowner. To identify the adjudicated ground water basins see the California Division of Water Rights' Web site at http://www.dpla2.water.ca.gov/publications/waterfacts/water_facts_3.pdf.

(11.) "Water Transfer Issues in California, Final Report to the California State Water Resources Control Board by the Water Transfer Workgroup," June 2002, available at http://www.calwater.ca.gov/content/Documents/library/ WaterTransfers/Final_Report%20_water_Transfer_Group.pdf.

(12.) "A Guide to Water Transfers," 1-1.

(13.) "A Guide to Water Transfers" also discusses transfers of "banked" groundwater and direct transfers of groundwater, including the many obstacles to out-of-basin transfers of such water.

(14.) See Standard 1 in Appraisal Standards Board, Uniform Standards of Professional Appraisal Practice, 2008-2009 ed. (Washington, DC: The Appraisal Foundation, 2008).

(15.) State Water Resources Control Board, "Information Pertaining to Water Rights in California, 1990," available at http://www.waterrights.ca.gov/application/forms/infobook.htm.

(16.) Both of these projects also have contractors north of the Delta; those deliveries tend to be closer to full entitlement amounts.

Steven J. Herzog, MAI, has been actively involved with appraising water rights in California for many years, and has previously published in The Appraisal Journal on this topic. He recently wrote "Guidelines for the Appraisal of Water Rights in California," which federal agencies use when valuing water rights. He has been an instructor on water rights and timberland valuation techniques at federal agency workshops. Herzog currently is a review appraiser for the Appraisal Services Directorate of the U.S. Department of the Interior in Portland, Oregon. Contact: Steven_Herzog@blm.gov
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Author:Herzog, Steven J.
Publication:Appraisal Journal
Geographic Code:1USA
Date:Jan 1, 2008
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