Trends in appraising conservation easements.
Most easement acquisitions must be justified, at least in part, by market value appraisals. Real estate appraisers are at a watershed in determining the method for appraising conservation easements.
There are two basic methods for appraising a conservation easement. Each is outlined and briefly discussed below.
Before and after method
Before value (unencumbered by the easement)
-- After value (encumbered by the easement)/Value of easement interests
where the after value reflects offsetting benefits and severance damages
Here, the before and after values each equal the value to a typical purchaser who is considering the highest and best use of the property. In the case of one particular easement now being negotiated in which development rights would be purchased, the highest and best use before is subdivision/recreation, while the highest and best use after is commercial timber production.
The after value may be estimated in one of two ways--either by considering sales that are encumbered by similar easements, or by considering sales that are constrained in the same way, but by different forces (e.g., zoning, access).
Offsetting benefits, which reduce the value of an easement, may result not only from benefits to the property burdened by the easement, but also from benefits to adjacent lands under the same ownership that are not burdened by the easement.(1) A common example of such a benefit is the enhancement of lot values caused by their proximity to the protected area.
Severance damages, which increase the value of an easement (by lessening the after value), are not cited in the literature, but they are real and should be considered. A good example is an easement "shadow."(2) Here, the conservation easement confers an additional burden on the property not specifically prescribed in the easement instrument. This reduces the value of the encumbered property and, in some cases, the unencumbered portion of the larger parcel as well. For example, in the after situation the easement may cast a shadow of implicit land use regulation on the remainder property by applying pressure on the landowner to forgo clear-cutting, intensive mining, or some other legally available use that is socially unacceptable because of the easement. Another example is when commercial timberland is encumbered by a conservation easement, and the most competitive purchaser in the before situation is the "jobber" type of buyer.(3) In the after situation, this class of buyer is much less likely to be interested in sensitive property, which limits the market to a much narrower range of purchasers. This not only reduces competition for property but also results in longer marketing periods.
The before and after method, for lack of any other reasonable procedure, has long been the accepted approach to easement valuation. With the advent of direct sales of easements, however, a new method is available for certain types of easement appraisals.
Direct comparison method
In the direct comparison method, actual sales of easements are compared directly to the easement being appraised. This requires careful consideration of the following points:
* Interests transferred in the easement sales
* Motivating forces behind the easement sales (e.g., were abnormal political forces influential in the sale? Was money dedicated that had to be either spent or lost?)
* Physical comparability of the real estate
* Market opportunities for realizing economic potential
* Availability of capital for easement purchases
* Public attitude toward the resource being protected
* Offsetting benefits and severance damages unique to the sales
One obvious disadvantage of this approach that is not encountered when using the before and after method is the difficulty of accounting for offsetting benefits and severance damages. This may be overcome if 1) neither benefits nor damages are significant factors in sale and subject properties; or 2) both sale and subject properties are affected in the same way by benefits or damages.
The difficulty with this approach is in finding comparable real estate with comparable easements. It is difficult to find comparable real estate and is even more difficult if comparable easements and sale conditions are required. In certain instances, however, it is definitely possible to make good use of easement sales.
The United States Treasury Department has never insisted on the use of the before and after rule. Stephen Small, noted expert on conservation easements and author of federal regulations governing their treatment for tax purposes, commented in The Federal Tax Law of Conservation Easements on the evolution of the Treasury's current position:
The Proposed Regulation did indeed qualify the use of the |before and after~ rule: 1) if no substantial record of marketplace sales is available, then 2) as a general rule, 3) but not necessarily in all cases, we will use the before and after rule. What other methods might be appropriate? The only other possibility suggested by the Proposed Regulation was comparison with other |easement~ sales in the marketplace.
The Final Regulation has now elevated comparable sales in the marketplace to the rule in the first instance. Only if no such record of sales exists, according to the Regulation, should the before and after test be used.(4) (Emphasis added.)
When appropriate market data exist, the Treasury appears to prefer the more direct evidence afforded by actual easement sales to the less direct before and after analysis.
When sufficiently comparable easement sales exist, an appraiser must seriously consider giving greater weight to the direct comparison method than to the before and after method. There are two fundamental reasons for this: 1) easement sales can be the most objective evidence of market value; and 2) an easement is a unique bundle of rights for which there is a unique market. Points one and two are closely related to one another.
Concerning point one, if sufficiently comparable easements are available and comparison is not unduly clouded by offsetting benefits and severance damages, then the best indication of what the market will pay for an easement is past evidence of similar sales. Even if some fairly significant differences exist between the sale and the subject properties, easement sales may establish a lower or upper limit of value that staves off incorrect conclusions which otherwise might be reached through the before and after method.
For example, two well-known New York State (NYS) easements sold for $175 and $180 per acre, respectively, over large ownerships. Rights transferred included limited hunting rights, recreation access, and the restriction of development rights. If these sales are inferior to the subject property, then the subject easement is worth over $180 per acre. With use of the before and after approach, however, the intrinsic value of development rights (which takes the perspective of the subdivider) is likely to be significantly lower, especially in a faltering economy. The reason for this becomes clear as we consider point two.
An easement is a unique bundle of rights. An appraiser's job is to estimate what that precisely defined bundle of rights would sell for on the open market. Subdividers do not buy easements or development rights--government agencies and preservationists are the only ones who do. They are the market for this unique bundle of rights.
There are those who object to this line of reasoning, with the argument that this approach leaves open too many opportunities for comparing sales that were influenced by abnormal sale conditions, some involving duress that is difficult to account for.(5) This argument, however, fails to consider the paramount question that an appraiser must answer. If this particular bundle of rights were offered for sale, what price would it fetch? The answer lies in the identity of a typical buyer as well as in the historical evidence for such transactions.
Consider the evidence
There is unanimous consent among those involved in the first NYS easement sale ($175 or more per acre for 40,000 acres) that abnormal political pressure pushed up the price of the sale.(6) I have had extended discussions with the key negotiators in that transaction, and am aware of the basic sale conditions. The public, however, has given the state virtually no grief about the sale price paid.(7) The seller needed NYS and the deal nearly was derailed several times, but The Nature Conservancy brought the parties back together. It was negotiated after days of hard work, and the Comptroller of the State of New York had to be convinced by the Department of Environmental Conservation (DEC, the acquiring agency) that it was in the state's best interest to pay 10% to 15% over appraised value. The DEC justified this by documenting savings in unit land management costs (e.g., reduced costs for maintaining access to state land).
Perhaps even more important is the fact that this inaugural sale was used by a subsequent landowner as a basis for negotiating the sale of easements on about 19,000 acres for $180 per acre (the additional $5 per acre accrued to mineral rights that were included).(8) Precedent has been established, and it has become clear that government agencies and preservationists will pay a lot for easements that protect property into perpetuity.
Small notes that because conservation easements have only recently arrived on the scene, few areas of the country will have a significant enough number of sales of encumbered property to enable valid comparisons. He goes on to state, however, that "It is understood that it is not uncommon for the National Park Service to pay 60% to 80% of the fair market value of a property for an easement on that property. It remains to be seen how widespread the applicability of these numbers will become.(9)
It should be noted that while the before and after method takes the perspective of a developer, the direct comparison method takes the perspective of a preservationist. The highest and best use of the unique bundle of rights contained in the easement is for protection, as is evidenced by the types of buyers and their motivations. This point helps explain why value conclusions derived through these two basic appraisal methods can differ widely.
The social discount rate
When development rights are appraised by the before and after method, it is not uncommon to consider the present value of future cash flows available from development or subdivision. If timber rights are included, the same discounted cash flow (DCF) approach to valuation may be appropriate. In these cases, the buyer discounts future net cash flows into an indication of present value, using a discount rate that reflects risks of price, liquidity, and future regulation, and that is competitive with alternative investments having similar composite risk. At discount rates typically ranging from 12% to 20%, the present value of opportunities relatively far into the future is small; that is, a premium is placed on short-term opportunities, and a great discount is placed on longer term benefits.(10)
This economic reality is especially significant with larger properties. Profit-oriented investors, especially subdividers and developers, generally pay much less per acre for large properties than for small ones. Hence, recreation and development rights on large forest properties may pose modest values to an investor. This is particularly true in the currently depressed market in which subdivision opportunities are limited and land use regulations are restrictive.
In stark contrast to profit-oriented investors, preservationists have both different motives and different priorities regarding the price of time. Economists will say that they are driven by implicit social discount rates approaching zero percent. That is, they place much more priority on benefits to be received far into the future than does a profit-oriented investor. In fact, to fulfill their social and ethical responsibilities they must consider the well-being of future generations to be just as important as the well-being of today's society.(11) Thus, while current subdivision opportunities appear weak, we expect strong market conditions to return, and therefore the property should be protected from all future threats. Further, because the present value of future subdivision is discounted at low or negligible rates, high prices are paid by preservationists.
Numerous sales of large packages of properties have occurred in recent years when government agencies paid retail prices for wholesale quantifies of property. It was common for a buyer to simply add the individual market values of separate property components (either a collection of parcels or a collection of resources within a parcel) and pay the sum total of all the values with no discounts for size or liquidity.
This philosophy of acquisition pervades government spending. Some private preservation organizations are more prudent with their money, and many state agencies are compelled to relate prices to market value. Considerable latitude nevertheless exists for these buyers to pay premium prices well above what the general marketplace would support.
Uninformed buyers or prudent sellers?
One may argue that these buyers are uninformed, that they are abandoning the sacred principle of substitution, which holds that a buyer will pay no more for a property than the cost to obtain an equivalent substitute property having the same utility. The argument continues that a property is threatened only if its sale to a developer is reasonably probable, and that the preservationist need only offer a slightly higher price than the developer would to protect the property. There are several flaws in this reasoning, however, as it bears on the market for easements.
First, if a parcel has modest development values, the threat of development is not imminent. If an owner can realize only a few dollars per acre for development rights, based on their current market value, he or she will not be likely to sell them at all. It is not worth the nuisance or the risk of shadow conversion to share property rights with the public.(12) Further, a prudent owner will prefer to speculate on development values by holding them until such opportunities are ripe. Therefore, there is a threshold of value below which the sale of development rights is simply not likely to occur. Below this threshold, willing sellers do not exist.
The second flaw relates again to the principle of substitution, but this time the sacred principle supports our conclusions. Easement sales in NYS provide a good example.
When NYS purchased easements on 40,000 acres, it set a precedent. This precedent has already been used as a comparable sale for at least two subsequent easement sales in NYS, and more easements are being negotiated at this writing. Similar easements currently being negotiated in northern New England are of regional significance, and the sellers are carefully scrutinizing the NYS deals.
It is time to rethink the valuation process in conservation easement appraisal. Tangible market evidence compels appraisers to consider direct sales of easements as evidence of true market value. An appraiser's duty to simulate the marketplace requires it.
This is a significant watershed for the easement appraisal process, which disturbs agencies and organizations acquiring easements, but which offers significant opportunities to those who currently hold these precious property rights.
The market for conservation easements is broadening. As easement transactions increase in number, many challenges lie ahead for the appraisal profession. But an appraiser's job has not and will not change. As one veteran stated, "Our job is to report the facts and let the truth be known."
1. As in eminent domain valuation, such adjacent property is included in the appraisal if it meets the "larger parcel" tests of unity of highest and best use and unity of title (National Trust for Historic Preservation and the Land Trust Alliance, Appraising Easements |Washington, D.C.: National Trust for Historic Preservation and the Land Trust Alliance, 1990~, 22).
2. Land economists refer to "shadow conversion," where changing land use, such as urban sprawl, affects the utility or value of adjacent rural property.
3. This term refers to one who typically purchases property in anticipation of liquidating as much merchantable timber as possible and then selling the cutover property in parts or as a whole.
4. Stephen J. Small, The Federal Tax Law of Conservation Easements (Washington, D.C.: Land Trust Alliance, 1990), 17-6.
5. One land trust has argued that the traditional buyers of conservation easements are not competing with each other for development rights, but rather are competing with developers. The before and after approach thus makes more sense than the direct comparison approach. This fails to explain, however, why easement values remain a high percentage of before values in depressed development markets.
6. The parent parcel of nearly 96,000 acres was purchased in December 1988 for $178 per acre. The easement sale, which closed shortly after, included selected parcels with relatively high development and recreation values, which explains why the per-acre price of the easement is nearly the same as the fee simple acquisition price of the parent parcel. A fee simple interest in an additional 15,000 acres from the parent parcel was sold to The Nature Conservancy for substantially more than $200 per acre.
7. However, the state was sharply criticized for missing the opportunity to purchase the lands in fee.
8. This transaction closed in September 1989. The appraised fee simple (before) value of this property was well over $200 per acre.
9. Small, 17-6.
10. For example, the present value of $100,000 to be received 50 years into the future, discounted at 20%, is only $10.99.
11. Realistically, we recognize that politicians are concerned about their present constituency, and preservation organizations are concerned with the wishes of their members, so it is probably not correct to conclude that their social discount rates are zero. Their motives, however, include protection into perpetuity, so implicit discount rates may well come close to zero percent.
12. This is particularly true with commercial timberland owners, who value highly their dominion over land management practices, and whose land commonly has modest intrinsic short-term development or subdivision potential.
Bret P. Vicary, PhD, is an appraiser/forest analyst with the James W. Sewall Company, a natural resources consulting, engineering, and surveying firm in Old Town, Maine, and is also a faculty associate at the College of Forest Resources, University of Maine, in Orono, Maine. Mr. Vicary received an MBA and a PhD from the University of Maine, and specializes in natural resources appraisal as well as economic and investment analysis for the forestry industry.
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|Author:||Vicary, Bret P.|
|Date:||Jan 1, 1994|
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