The Appraisal

SPRING 2021 Journal Volume LXXXIX, Number 2

F  Valuation of Private Golf and Country Clubs for Ad Valorem Taxation by Laurence A. Hirsh, MAI PAGE 85

Land Values and External Obsolescence by Stanley D. Longhofer, PhD PAGE 95

Environmental Dead Zones: The Evaluation of Contaminated by Michael Tachovsky PAGE 104

Contents The Appraisal Journal | Spring 2021 | Volume LXXXIX, Number 2

ii Mission Statement iv A Message from the Editor-in-Chief v Appraisal Journal Awards xii Annual Conference Announcement

COLUMNS & DEPARTMENTS

71 Cases in Brief Recent Court Decisions on and Valuation by Benjamin A. Blair, JD

118 Resource Center Inflation Outlook and Statistical Analysis Software Resources by Dan L. Swango, PhD, MAI, SRA

129 Letters to the Editor

PEER-REVIEWED ARTICLES

85 Valuation of Private Golf and Country Clubs for Ad Valorem Taxation by Laurence A. Hirsh, MAI

95 Land Values and External Obsolescence by Stanley D. Longhofer, PhD

104 Environmental Dead Zones: The Evaluation of Contaminated Properties by Michael Tachovsky

ANNOUNCEMENTS

131 New Publications 132 Article Topics in Need of Authors 133 Manuscript Guide 134 Appraisal Journal Order Form

COVER PHOTO: Congressional Country Club in Bethesda, Maryland, by Badz/PGA Tour via Getty Images

www.appraisalinstitute.org Spring 2021 • The Appraisal Journal i

The Appraisal Journal Published by the Appraisal Institute

Rodman Schley, MAI, SRA, President Pledger M. “Jody” Bishop III, MAI, SRA, AI-GRS, President-Elect Craig Steinley, MAI, SRA, AI-GRS, AI-RRS, Vice President Jefferson L. Sherman, MAI, AI-GRS, Immediate Past President Jim Amorin, CAE, MAI, SRA, AI-GRS, Chief Executive Officer

Stephen T. Crosson, MAI, SRA, Editor-in-Chief Nancy K. Bannon, Managing Editor Justin Richards, Senior Communications Coordinator

The Appraisal Journal (ISSN 0003-7087) is published quarterly (Winter, Spring, Summer, and Fall). © 2021 by the Appraisal Institute, an Illinois Not-for-Profit Corporation at 200 W. Madison, Suite 1500, Chicago, Illinois 60606. www.appraisalinstitute.org. All rights reserved. No part of this publication may be reproduced, modified, rewritten, or distributed, electronically or by any other means, without the expressed written permission of the Appraisal Institute.

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Mission Statement: The Appraisal Journal is published to provide a peer-reviewed forum for information and ideas on the practice and theory of valuation and analyses of real estate and related interests. The Appraisal Journal presents ideas, concepts, and possible appraisal and analytical techniques to be considered; some articles are for the development and expansion of appraisal theory while others are useful in the evolution of practice.

Disclaimer: The materials presented in this publication represent the opinions and views of the authors. Although these materials may have been reviewed by members of the Appraisal Institute, the views and opinions expressed herein are not endorsed or approved by the Appraisal Institute as policy unless adopted by the Board of Directors pursuant to the Bylaws of the Appraisal Institute. While substantial care has been taken to provide accurate and current data and information, the Appraisal Institute does not warrant the accuracy or timeliness of the data and information contained herein. Further, any principles and conclusions presented in this publication are subject to court decisions and to local, state, and federal laws and regulations and any revisions of such laws and regulations.

This publication is for educational and informational purposes only with the understanding that the Appraisal Institute is not engaged in rendering legal, accounting, or other professional advice or services. Nothing in these materials is to be construed as the offering of such advice or services. If expert advice or services are required, readers are responsible for obtaining such advice or services from appropriate professionals.

Nondiscrimination Policy: Organized in 1932, the Appraisal Institute advocates equal opportunity and nondiscrimination in the appraisal profession and conducts its activities in accordance with applicable federal, state, and local laws.

The Appraisal Institute advances professionalism and ethics, global standards, methodologies, and practices through the professional development of economics worldwide.

ii The Appraisal Journal • Spring 2021 www.appraisalinstitute.org

The Appraisal Journal Editorial Board Stephen T. Crosson, MAI, SRA,* Chair, Dallas, Texas Larry T. Wright, MAI, SRA, AI-GRS, Vice Chair, Houston, Texas Julie Friess, SRA, AI-RRS, Sedona, Arizona Walter E. Gardiner, SRA, AI-RRS, Hammond, Louisiana Kerry M. Jorgensen, MAI, Sandy, Utah David C. Lennhoff, MAI, SRA, AI-GRS, Gaithersburg, Maryland Mark . Linné, MAI, SRA, AI-GRS, Lakewood, Colorado James H. Martin, MAI, Mt. Pleasant, South Carolina Stephen D. Roach, MAI, SRA, AI-GRS, San Diego, California

The Appraisal Journal Review Panel The Appraisal Journal Academic Review Panel Gregory J. Accetta, MAI, AI-GRS, Providence, Rhode Island Tim Allen, PhD, Florida Gulf Coast University Anthony C. Barna, MAI, SRA, Pittsburgh, Pennsylvania Anjelita Cadena, PhD, University of North Texas C. Kevin Bokoske, MAI, AI-GRS, AI-RRS, Ft. Lauderdale, Florida Peter F. Colwell, PhD, University of Illinois Norman Chung, MAI, AI-GRS, Los Angeles, California François Des Rosiers, PhD, Laval University George Dell, MAI, SRA,* San Diego, California Barry A. Diskin, PhD, MAI, AI-GRS, Florida State University John G. Ellis, MAI, Encino, California Donald R. Epley, PhD, MAI, SRA, University of South Alabama Stephen F. Fanning, MAI, AI-GRS,* Denton, Texas Jeffrey D. Fisher, PhD, Indiana University Kenneth G. Foltz, MAI, SRA, Wesley Chapel, Florida Terry V. Grissom, PhD,* University of Missouri–Kansas City Jack P. Friedman, PhD, MAI, SRA, Chicago, Illinois Thomas W. Hamilton, PhD, MAI,* Roosevelt University Brian L. Goodheim, MAI, SRA, Boulder, Colorado William G. Hardin III, PhD, Florida International University Robert M. Greene, PhD, MAI, SRA, AI-GRS, Olympia, Washington Lonnie W. Hendry Jr., Texas Tech University John A. Kilpatrick, PhD, MAI, Seattle, Washington Mark Lee Levine, PhD, JD, MAI, University of Denver S. Warren Klutz III, MAI, SRA, AI-GRS, Bristol, Tennessee Kenneth M. Lusht, PhD, MAI, SRA,* Florida Gulf Coast University, Douglas M. Laney, MAI, Tucson, Arizona Penn State University Michael A. McElveen, MAI, Tampa, Florida Mark E. Moore, PhD, Texas Tech University Mark E. Mitchell, MAI, AI-GRS, Louisville, Kentucky Barrett A. Slade, PhD, MAI, Brigham Young University Dan P. Mueller, MAI, St. Paul, Minnesota Brent C Smith, PhD, Virginia Commonwealth University Nathan Pomerantz, MAI, Rehovot, Israel Mark A. Sunderman, PhD, University of Memphis Rudy R. Robinson III, MAI, Austin, Texas Grant I. Thrall, PhD, University of Florida David J. Sangree, MAI, Cleveland, Ohio Alan Tidwell, PhD, University of Alabama Eric C. Schneider, MAI, SRA, AI-GRS, San Diego, California H. Shelton Weeks, PhD, Florida Gulf Coast University John A. Schwartz, MAI, Denver, Colorado John E. Williams, PhD, Morehouse College Melanie Sieger, MAI, AI-GRS, Chevy Chase, Maryland Elaine M. Worzala, PhD, George Washington University Dan L. Swango, PhD, MAI, SRA, Tucson, Arizona James D. Vernor, PhD, MAI, Atlanta, Georgia

*Statistics Work Group member

www.appraisalinstitute.org Spring 2021 • The Appraisal Journal iii From the Editor-in-Chief Stephen T. Crosson, MAI, SRA

Thought Leadership

Dear Readers:

Each year, the Spring issue of The Appraisal Jour- as to when such value loss is attributable to the nal recognizes exceptional work within this forum land and when it is attributable to the structure. for ideas on real estate valuation, and on the fol- The discussion demonstrates that external factors lowing pages you will see the announcement of that affect the property’s value are attributable to our 2020 article awards. It is important that we the land if the current use is the property’s highest pause and acknowledge these excellent articles and best use and are attributable to external obso- and their authors. In addition, we recognize the lescence of the building otherwise. outstanding service of Larry T. Wright, MAI, SRA, AI-GRS, who during the past year has con- The third feature, “Environmental Dead Zones: tributed valuable volunteer hours to the Journal. The Evaluation of Contaminated Properties,” proposes categories and classifications of contam- We also have three peer-reviewed feature articles inated properties based on the environmental aimed at helping professional appraisers with land use restrictions. The article suggests that by their value analyses of certain properties with categorizing environmental land use restrictions, special circumstances. comparisons of market data can be made and the condition of a subject property can be described, The cover article, “Valuation of Private Golf and assisting in assignments involving environmen- Country Clubs for Ad Valorem Taxation,” exam- tally contaminated properties. ines relevant issues in the valuation of private golf and country clubs, including business intangible Also, in this issue you will find the latest edition property, golf club intangible personal property, of Resource Center, with helpful links to materials and the issue of isolating value from and analyses on the inflation outlook. Here, read- the going concern. This article summarizes the ers will find a plethora of relevant government, widely known methods of estimating the value academic, and private-sector data on this topic. of intangible personal property. The discussion In addition, the column presents descriptions of highlights the differences between the facilities’ useful, popular statistical software to enhance val- real property components and business operations uation analyses—especially free online tools. models of daily-fee, semi-private, private, and resort golf facilities. We appreciate the dedication of all who have contributed to The Appraisal Journal’s peer review The second feature, “Land Values and External process as well as the authors who have shared Obsolescence,” looks at the challenge of address- their knowledge with our readers. As always, we ing external obsolescence in a cost approach welcome your comments regarding any aspect of analysis. Loss due to external obsolescence is The Appraisal Journal. driven by factors outside the property, and it can be difficult to distinguish between external obso- Stephen T. Crosson, MAI, SRA lescence of the improvements and a reduction in Editorial Board Chair and Editor-in-Chief value of the land. This article provides guidance The Appraisal Journal

iv The Appraisal Journal • Spring 2021 www.appraisalinstitute.org Appraisal Journal Outstanding Service Award For Exceptional Commitment in 2020

Larry T. Wright, MAI, SRA, AI-GRS

Larry T. Wright, MAI, SRA, AI-GRS, is the winner of The Appraisal Journal’s 2020 Outstanding Service Award. This award recognizes the member of the Journal’s Editorial Board, Review Panel, or Academic Review Panel who during the previous year showed exceptional commitment to The Appraisal Journal through out- standing service. Wright has been a real estate appraiser since 1973. He gradu- ated from the University of Oklahoma with a bachelor of science degree in mathematics. During his career as an appraiser, he has been involved in appraising for various individuals, corporations, and government entities such as the federal government, the State of Texas, Harris County, and the City of Houston. The primary focus of his practice has been litigation related to , , estate tax, , divorce, and bankruptcy; errors and omissions cases involving appraisers, real estate agents, and brokers; ; and cases involving builder and developer defects. Since 1997, he has been an approved instructor for the Appraisal Institute. He currently serves as vice chair of The Appraisal Journal Editorial Board and serves on the Appraisal Insti- tute Education Committee. He previously served as chair of the Education Committee of the Houston Chapter of the Appraisal Institute. While still consulting, his current endeavors have con- centrated on teaching, writing seminars, and aiding in the writing or reviewing of Appraisal Institute courses and seminars. He also holds a teaching position with the C. T. Bauer College of Business Real Estate Program at the University of Houston, lecturing about market analysis and valuation.

www.appraisalinstitute.org Spring 2021 • The Appraisal Journal v Armstrong/Kahn Award Most Outstanding Article of 2020 • Sponsored by the Appraisal Institute Education and Relief Foundation

Winning Article: “Golf Course Communities as Multisided Markets: Ownership Implications”

Bruce K. Cole, PhD, and David B. Hueber, PhD, are the winners of the 2020 Armstrong/Kahn Award for their article, “Golf Course Communities as Multisided Markets: Ownership Implications,” published in the Spring 2020 issue of The Appraisal Journal. The Armstrong/Kahn Award is presented by The Appraisal Jour- nal’s Editorial Board for the most outstanding original article published in The Appraisal Journal during the previous year. Arti- cles are judged on the basis of pertinence to appraisal practice; contribution to the valuation literature; provocative thought; thought-provoking presentation of concepts and practical prob- lems; and logical analysis, perceptive reasoning, and clarity of presentation. In “Golf Course Communities as Multisided Markets: Owner- ship Implications,” Cole and Hueber explain the connection of golf courses to land value in golf course communities, and the Bruce K. Cole, PhD unique challenges that homeowners associations (HOAs) face as they try to reconfigure golf course operations and preserve property values within their communities. The authors’ study suggests that HOA ownership of a course may have a negative impact on sale prices in a golf community; therefore, HOAs should consider alter- natives to course ownership for ensuring the financial security of golf course communities. Bruce K. Cole, PhD, is president of the Richard T. Greener Institute for Social Policy Research, and he currently serves as chair of the State Executive Committee of the Sierra Club of South Carolina. Through his real estate advisory firm, Palmetto Realty Advisors, Cole provides guidance to business leaders in the areas of commercial and residential real estate investment management and development. Cole previously served as an assis- tant professor of finance at the University of South Carolina and as the chief financial officer of the Boston Public Library. He holds a doctorate in planning, design, and the built environ- David B. Hueber, PhD ment from Clemson University; a master’s degree in business administration from the Stanford Graduate School of Business; a master’s degree in accounting from Northeastern University; and

vi The Appraisal Journal • Spring 2021 www.appraisalinstitute.org Armstrong/Kahn Award

a bachelor’s degree in economics from Harvard University. He is a certified public accountant and a licensed real estate broker. Cole has published numerous case studies, newspaper articles, and trade journal analyses. David B. Hueber, PhD, is a former senior executive at the PGA Tour and past president and chief executive officer of the National Golf Foundation, the Ben Hogan Company, and Cosmo World Group—a privately held Japanese conglomerate of golf companies and facilities including Angeles National in Los Angeles, Pebble Beach in California, the Four Seasons Hualalai in Hawaii, and golf course properties in Western Europe and Australia. He holds a doctorate in design and the built environment from Clemson University, a master’s degree in business administration from the University of Memphis, and a bachelor’s degree in business administration from Florida State University. His published works include the text In the Rough: The Business Game of Golf.

To read the award-winning article, go to http://bit.ly/Appraisal_Journal.

www.appraisalinstitute.org Spring 2021 • The Appraisal Journal vii Swango Award Best Article by a Practicing Appraiser in 2020 • Sponsored by the Appraisal Institute Education and Relief Foundation

Winning Article: “Timing Is Everything: The Role of Interim Use in the Conclusion”

David C. Lennhoff, MAI, SRA, AI-GRS, and Richard L. Parli, MAI, are the winners of the 2020 Swango Award for their article, “Timing Is Everything: The Role of Interim Use in the Highest and Best Use Conclusion,” published in the Summer 2020 issue of The Appraisal Journal. The Appraisal Journal’s Editorial Board presents the Swango Award to the best article published during the previous year on residential, general, or technology-related topics, or for original research of benefit to real estate analysts and valuers. The article must be written by an appraisal practitioner. Articles are judged based on practicality and usefulness in addressing issues faced by appraisers in their day-to-day practice; logical analysis, perceptive reasoning, and clarity of presentation; and soundness of methodol- ogy used, especially in an area of original research. “Timing Is Everything: The Role of Interim Use in the Highest David C. Lennhoff, MAI, and Best Use Conclusion” proposes the formal incorporation of SRA, AI-GRS the concept of interim use into the definition of highest and best use to help improve understanding of the relationship of the two con- cepts. The article suggests new definitions of interim use and mixed- use development to improve clarity. David C. Lennhoff, MAI, SRA, AI-GRS, is a principal with Lennhoff Real Estate Consulting LLC, which is officed in Gaithersburg, Maryland. His practice centers on litigation valua- tion and expert testimony relating to appraisal methodology, the Uniform Standards of Professional Appraisal Practice, and allocating assets of a going concern. He has taught nationally and internationally for the Appraisal Institute. International presentations have been in Tokyo, Japan; Beijing and Shanghai, China; Berlin, Germany; Seoul, South Korea; and Mexico City, Mexico. He has been a development team member for numerous Appraisal Institute courses and seminars and was editor of its Capitalization Theory and Techniques Study Guide, third edition. He was the lead developer for the Institute’s asset allocation Richard L. Parli, MAI course, Fundamentals of Separating Real Property, Personal Property, and Intangible Business Assets, and edited the two accompanying business enterprise value anthologies. He also authored the

viii The Appraisal Journal • Spring 2021 www.appraisalinstitute.org Swango Award

Small Hotel/Motel Valuation seminar. Lennhoff also is a principal member of the Real Estate Counseling Group of America, a national organization of analysts and academicians founded by the late William N. Kinnard Jr., PhD. He is a past editor-in- chief of and frequent contributor to The Appraisal Journal, and a previous recipient of the Journal’s Armstrong/Kahn Award and Swango Award. Richard L. Parli, MAI, is president of Parli Appraisal Inc., a full-service appraisal firm located in Fairfax, Virginia. He has been involved in the development of numerous Appraisal Institute courses and seminars, is a coauthor of the Appraisal Institute text The Valuation of Properties, and is a professional faculty member of the Johns Hopkins Carey Graduate School of Business. He has an MBA in finance from the Pennsylvania State Univer- sity and is a principal member of the Real Estate Counseling Group of America. He is a three-time recipient of The Appraisal Journal’s Armstrong/Kahn Award.

To read the award-winning article, go to http://bit.ly/Appraisal_Journal.

www.appraisalinstitute.org Spring 2021 • The Appraisal Journal ix Richard U. Ratcliff Award Best Article by an Academic in 2020 • Sponsored by the Appraisal Institute Education and Relief Foundation

Winning Article: “Perspectives on the Assembled Workforce in Real Property Valuation”

Kimberly K. Merriman, PhD, and Leonard J. Patcella, MAI, are the winners of the 2020 Richard U. Ratcliff Award for their article, “Perspectives on the Assembled Workforce in Real Property Valua­ tion,” published in the Summer 2020 issue of The Appraisal Journal. The Richard U. Ratcliff Award is presented annually for the best original article published in The Appraisal Journal written by an academic author. Articles are judged on the basis of pertinent appraisal interest, provocative thought, logical analysis, perceptive reasoning, clarity of presentation, and overall contribution to the literature of valuation. To be eligible for this award, an article must have been peer reviewed by members of The Appraisal Journal’s Academic Review Panel and an author must be primarily engaged in teaching at a college or university. In “Perspectives on the Assembled Workforce in Real Property Valuation,” Merriman and Patcella discuss appraisals for ad valorem Kimberly K. Merriman, PhD tax purposes, which may require appraisers to remove the value of non–real property elements from the real property value. The article examines theory and practice surrounding a recognized yet debated non–real property element: the trained and assembled workforce. It describes the theoretical footings of this intangible asset and presents a step-by-step conceptual treatment of the assembled work- force in real property valuation with a case study demonstration. Kimberly K. Merriman, PhD, is an independent Pennsylvania general certified appraiser and Candidate for Designation of the Appraisal Institute, specializing in the valuation of real prop- erty going concerns. She is owner of the realty firm FineHill LLC and a professor with the Manning School of Business at the University of Massachusetts Lowell. Her research related to the assembled workforce is widely cited and has received national attention. She is the author of Valuation of Human Capital: Quanti- fying the Importance of an Assembled Workforce, which is used exten- sively in university classrooms. Merriman holds a PhD in business Leonard J. Patcella, MAI administration and a BBA in accounting from Temple University. Leonard J. Patcella, MAI, is a principal in the firm Equity Appraisal Co. Inc., which he founded in 1987. He has performed

x The Appraisal Journal • Spring 2021 www.appraisalinstitute.org Richard U. Ratcliff Award

valuation studies involving a wide range of property types and appraisal problems. He served as the Appraisal Institute Philadel- phia Chapter president in 1997 and serves as a member of its national faculty. Patcella is a CMI-designated member of the Institute for Professionals in Taxation and also serves as a member of its national faculty. Patcella has been qualified as a real estate valuation expert in numerous state tax courts, courts of common pleas, and federal bankruptcy courts, and he has presented testi- mony before more than seventy city and county boards of assess- ment. He holds a bachelor of science degree in real estate from Pennsylvania State University.

To read the award-winning article, go to http://bit.ly/Appraisal_Journal.

www.appraisalinstitute.org Spring 2021 • The Appraisal Journal xi

Cases in Brief by Benjamin A. Blair, JD

Recent Court Decisions on Real Estate and Valuation Market rent paid to shareholders expenses it pays in carrying on business, includ- in a rural town not excessive ing the rent paid by the business. But for an expense to be ordinary and necessary, it must also Plentywood is a town of about 1,700 people in be reasonable in amount. The Commissioner northeast Montana. Plentywood Drug, Inc. (PDI) does not often question the reasonableness of is a Montana corporation that operates the only rent agreed to by parties at arm’s length, but pharmacy in Plentywood. Founded in 1910, PDI when there is a close relationship between the is now owned by Robert and Marilyn Mann and and lessee, an inquiry into what constitutes Kathryn and Marvin Eberling. The pharmacy reasonable rent is necessary to determine whether rents space in a building on Plentywood’s Main the sum paid is in excess of what would have Street, owned in equal shares by the Manns and been required in a with a stranger. Eberlings. The building contains 8,125 square The parties “quickly realized that finding com- feet of retail space and 5,250 square feet of base- parable properties in a town of 1,700 people in ment support area. frontier Montana” would be difficult. Montana is PDI pays rent to the four owners of the build- a nondisclosure state, so real estate data such as ing. The rent is set by oral agreement at the sale price is legally confidential and unavailable. beginning of each year and is not reduced to a And the issue is magnified in a town the size of formal written lease. PDI paid rent of $83,584 in Plentywood, which has a limited number of 2011 and $192,000 in 2012 and 2013. Because potentially comparable buildings. the couples each owned half the building, they The Taxpayers produced a rent-survey report each reported half the rent on their income tax from an appraiser based in Williston, North returns; PDI deducted the rent from its corporate Dakota, a larger town an hour away from Plenty- income each year. wood. He surveyed rent comparables in Plenty- The Commissioner of the Internal Revenue wood and in Williston. He first considered a lease Service (Commissioner) audited PDI for tax for the US Post Office in Plentywood, which years 2011–2013, then expanded the audit to the signed a ten-year lease for $18 per square foot Manns and Eberlings, issuing notices of defi- that was renewed in 2008 for $15.90. He also ciency to them and to PDI. All proposed adjust- found in Williston for office buildings and ments were resolved except those related to the a pharmacy, but he noted that rents were increas- rent paid to the couples as lessors and deduced by ing in Williston during the years at issue because PDI as lessee. On that issue, the Commissioner of its location in the middle of the North Dakota contended that PDI had paid its shareholders too oil boom. He concluded to rent for PDI of $25 high a rent, which would in effect make some of per square foot of the main floor, plus $8 per that rent a nondeductible dividend. PDI and the square foot for the basement, based on finished couples (collectively, Taxpayers) timely appealed basement rents in Williston. He described this to the US Tax Court to decide what fair market conclusion as a rent survey, not an appraisal. rent for the building would be. The Commissioner offered the testimony of an The Internal Revenue Code (Code) allows IRS staff appraiser. He used data from only prop- a taxpayer to deduct ordinary and necessary erties located in Plentywood but found only four

www.appraisalinstitute.org Spring 2021 • The Appraisal Journal 71 Cases in Brief

comparables: two government-subsidized apart- post office rent could be applied. The tax court ment buildings, the post office, and a 625-square- also rejected the Commissioner’s appraiser’s con- foot donut shop. He adjusted the rents for clusion that the basement had no value; it various factors, including for the different types adopted the Taxpayers’ appraiser’s conclusion for of construction; he observed that retail proper- the basement space, even though it was based on ties generally have lower construction costs than rents in Williston. . He developed rent only for PDI’s Accordingly, the tax court concluded to fair main level; he concluded that the basement market rent for PDI of $171,187.50 per year. space had no value in itself, but rather contrib- Although PDI paid slightly higher rent in 2012 uted to the value of the main floor space. His and 2013, the court noted “just how difficult it market rent conclusions were below $60,000 was for the parties’ professional appraisers to cal- each year. culate a fair rent themselves.” Accordingly, the The tax court began by addressing the Com- tax court concluded that there was no underpay- missioner’s argument that the Taxpayers’ ment of tax, and thus no penalties were applied. appraiser should have, but failed to, comply with USPAP because his assignment was an appraisal. Plentywood Drug, Inc. v. Commissioner The tax court agreed that under Uniform Stan- US Tax Court dards of Professional Appraisal Practice (USPAP) April 26, 2021 a market rent opinion is an appraisal assignment, T.C. Memo. 2021-045 but the tax court’s rules allow it to consider expert valuation opinions that do not comport with USPAP, though the weight assigned to that Build-to-suit leases do not reflect evidence may be diminished. market rent and are not definitionally The tax court then considered each party’s part of real property comparables. The court found that the differ- ences between Plentywood and Williston were In 2005, Bass Pro Shops (Bass Pro) negotiated a too substantial to rely on Williston leases. Willis- twenty-year, build-to-suit lease agreement with ton’s population was eight times that of Plenty- the owners of a property in Johnson County, wood, and it had a much stronger economy, Kansas (County). Under the lease, the generating higher rents. But the Commissioner’s was responsible for various expenses, including comparables were just as problematic: “when a property taxes. The lease required Bass Pro to pay town is so small that an appraiser looking for annual rent of $600,000, but it gave Bass Pro the comparables for retail space ends up looking at option of buying the property for $10 at the end apartment buildings, perhaps it might be wiser to of the lease term. Bass Pro ultimately built a go to the next town over.” 130,998-square-foot building on the property The parties’ appraisers did share one compara- and has occupied it since construction. ble, the post office building. The tax court found In 2008, Arciterra BP Olathe KS LLC (Arci­ many of the Commissioner’s adjustments to that terra) purchased the property for $1.9 million, lease to be excessive, but the court observed one subject to the 2005 lease. The lease produced a factor he did not consider: the creditworthiness positive cash flow until 2016, when the County of the government and the long-term nature of doubled the property’s tax assessment. Arciterra the lease. That factor offset the downward adjust- appealed to the Board of Tax Appeals (Board), ments, so the court concluded that the $15.90 which conducted an evidentiary hearing.

72 The Appraisal Journal • Spring 2021 www.appraisalinstitute.org Cases in Brief

Both parties’ appraisers agreed that the income arguments on appeal is its unwillingness to follow approach was the most relevant indicator of the Prieb.” First, the County argued that Prieb’s defi- property’s value. The County’s appraiser consid- nition of fee simple interest should be rejected in ered a mix of lease types, including build-to-suit favor of the definition from Black’s Law Dictio- leases. He explained that it was acceptable to nary. But the court of appeals found it “unneces- consider build-to-suit leases to determine market sary to parse any linguistic differences between rent if the necessary adjustments were made, the two” because the County never explained though he did not say what adjustments he made why the original definition was wrong or how use to account for that factor. He ultimately con- of Black’s definition would make a difference. cluded to rent of $10 per square foot and arrived The court also reiterated that, while Kansas tax at a value of $14.4 million, which he said was for statutes do not use the term “fee simple,” it is the fee simple estate as required by Kansas law, clear that the legislative intent underlying the though he denied that such a standard required statutory scheme of property taxation has always the property to be valued as though it was vacant been to appraise the property as if in fee simple. on the date of value. The County also disagreed with Prieb’s finding Arciterra’s appraiser prepared two valuations: that build-to-suit leases are essentially financing one of the fee simple interest and one of the agreements, instead asserting that such leases are “hypothetical leased fee” estate, in which he nothing more than operating leases to occupy assumed that the property would be encumbered real property. The court likewise rejected this by a short-term lease to a moderate-credit tenant. argument, finding that second-generation as-is He explained that he performed this second leases are most indicative of market rent, as the analysis because he was unsure what Kansas law cost of owner-occupied renovations are amor- required in valuing a fee simple interest when a tized over the term of the lease. Market rent is property is occupied. He excluded first-genera- not necessarily accurately reflected in a particu- tion build-to-suit leases, observing that such lar lease that encumbered a property, particularly rents were not representative of market because when the lease is a build-to-suit lease or is other- they were typically negotiated before improve- wise unique. Here, not only was the lease build- ments were made to the property. He concluded to-suit, but it also included the unusual provision to rent of $7 per square foot, arriving at a fee sim- giving the tenant the option of buying the prop- ple value of $7.5 million and a “hypothetical erty for $10 at the end of the 20-year lease term. leased fee” value of $9 million. Finally, the County argued that the statutory The Board concluded that build-to-suit leases definition of real property for tax purposes sup- do not reflect market rent and should not be used ported the conclusion that the value of the lease- to determine market rent unless an appraiser hold must be included in the valuation. That makes the necessary adjustments. Accordingly, definition states that real property includes “not the Board rejected the County’s appraisal. only the land itself, but all buildings, fixtures, Instead, the Board adopted Arciterra’s hypothet- improvements, [and] rights and privileges apper- ical leased fee valuation. The County appealed. taining thereto.” The court found no authority, In an earlier Kansas case, In re Prieb, the court though, that a lease is a “right relating to real concluded that Kansas law required that property property” such that the lease is definitionally part tax valuations be based on the fee simple inter- of the real property. “This argument is merely est, not the leased fee estate. The court here another way of asserting that fee simple is not observed that “underlying most of the County’s required,” and the court rejected it.

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Ultimately, the Board heard two days of testi- Mohit continued to pursue his legal claims, mony, and while “there may be legitimate ques- however. He amended his complaint to allege tions about some of the assumptions that that the regulation and the permit requirement underlie” the hypothetical leased fee value pre- were contrary to state law, violated the Due Pro- pared by Arciterra’s expert and concluded to by cess Clause of the US Constitution, and effected the Board, those questions were not appealed. a regulatory taking without just compensation. The County failed to show that the Board erred Haines City was granted summary judgment on in rejecting its appraisal, and the court affirmed most issues, but the federal claims were dismissed the Board’s determination. without prejudice, so Mohit filed in federal court, alleging violations of the Takings Clause, among In re Arciterra BP Olathe KS, LLC others. The federal district court denied all of Kansas Court of Appeals Mohit’s claims, and he appealed. April 2, 2021 The Fifth Amendment to the US Constitu- 484 P.3d 261 tion provides that private property shall not be taken for public use without just compensation. The US Supreme Court has noted two scenarios Inconvenience from city’s development where a government regulation is so onerous regulation does not constitute a taking that it constitutes a taking. The first is when, with certain qualifications, a regulation denies In May 2012, Benedict Mohit purchased a all economically beneficial or productive use of twenty-acre property located in Haines City, land. The second is when the regulation is found Florida, and “immediately began growing a com- to be a taking based on a complex of factors mercial hay crop.” His intent was to farm and including the economic impact of the regulation use the profits to build and maintain a family on the claimant and the extent to which the reg- home on the property. Two months after he ulation has interfered with distinct investment- bought the property, Haines City adopted a land backed expectations. development regulation that prohibited using On the first scenario—the only avenue his land for keeping farm animals or for other expressly mentioned by Mohit in his claims— agricultural purposes absent a permit. After the court of appeals observed that Mohit cannot being told by city officials that he needed a per- plausibly argue that he was deprived of all eco- mit to carry out his farming plans, Mohit filed nomically beneficial or productive use of the suit in state court, alleging that Haines City was property. After all, he was permitted to engage unlawfully prohibiting his proposed livestock in some agricultural activities, even if those grazing on his farm. activities were less extensive than he would The state trial court concluded that Mohit have liked. That is not a denial of “all” produc- should submit a new application for a conditional tive uses of the property. use permit to pursue livestock farming. Mohit did On the second scenario, involving the com- so, though he wrote on the top of his application plex of factors, Mohit limited his briefing to argu- that he viewed the permit requirement as unlaw- ments about state law instead of engaging in the ful. Three months later, Haines City granted him analysis of the various factors. The court con- the permit, allowing him to have up to twenty cluded that Mohit did not adequately connect goats, twenty cattle, and five horses—exactly his argument to the only inquiry that matters: what Mohit asked for in his application. whether the regulation constituted a taking. The

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court concluded that “it may well be that the transaction, with Randall and Kathleen Erick- land development regulation and the permit son as the current heirs. caused deep inconvenience and frustration for Between 1926 and 2017, the surface rights to Mohit.” But because inconvenience is not suffi- the land transferred several times through cient to show a compensable taking, and because recorded instruments, with each instrument Mohit failed to substantiate his arguments, the reciting the same “excepting and reserving” lan- court affirmed the decision of the district court. guage from the 1926 . By 2017, the owner- ship of the land had transferred to the trusts of Mohit v. City of Haines City Paul and Vesta Morrison. US Court of Appeals, Eleventh Circuit In August 2017, the Ericksons filed an action January 26, 2021 to quiet title and for declaratory judgment that 2021 WL 244583 they own the mineral rights to the land by virtue of the reservation. The Morrisons counter- claimed for a declaration that the reservation of Recitation of a preexisting interest the mineral rights had been extinguished under in a recorded title transaction preserves the Act. The trial court ruled in favor of the the interest Ericksons, and the Morrisons appealed. They argued that the trial court erred by holding that Ohio’s Marketable Title Act (Act) provides that the severed mineral interest at issue was pre- an unbroken to land for a period of served from extinguishment. The court of forty years establishes a marketable record title to appeals agreed, explaining that the reservation the land, which generally extinguishes property does not state by whom the interest was origi- interests that predate the landowner’s root of nally reserved, nor to whom the interest was title. However, the Act provides that marketable granted. Thus, the reservation was general, not record title is subject to “all interests and defects” specific. The Ericksons appealed to the state inherent in the chain of title with a key excep- supreme court. tion: a “general reference” to easements, restric- On appeal, the Ericksons maintained that the tions, or other interests created prior to the root Act does not require a reservation to include the of title is not sufficient to preserve that interest name of the owner of a mineral interest in order unless the general reference also includes “spe- for it to be preserved, and that even in the cific identification” of the recorded title transac- absence of a specific name in the reservation, a tion that created the interest. title search would reveal the owner of the reser- In February 1926, James and Rose Logan con- vation by a review of the chain of title, reading veyed the surface rights to 139 acres of land in the 1926 deed and searching forward in time. Guernsey County, Ohio, to Edward Riggs, but Because the owner of the reservation can be the Logans retained the mineral rights by adding determined through the chain of title, the Erick- the following language to the deed: “excepting sons contended that it is a specific reference, not and reserving therefrom all coal, gas, and oil a general reference. The Morrisons argued that with the right of said first parties, their heirs and under the Act, a title examiner should need to assigns, at any time to drill and operate for oil review only the language in the root of title and and gas and to mine all coal.” The Logans ulti- the instruments recorded during the 40 years mately sold their mineral rights through execu- prior in order to locate any specific references to tion of a deed specifically referring to the 1926 an interest predating the root of title. Here,

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because the prior interest cannot be located sets forth no such rule. Likewise, there is no rule without a more extensive search and none of the that requires the reference to identify the type of recorded title transactions within the prior forty interest or its owner. A recitation of a preexisting years mentioned the Ericksons, they contended interest is not a general reference simply because the reservation is not a specific reference. it does not name the owner. The state supreme court reframed the question Here, the transfer of the surface rights does as whether a reference to a reservation of mineral not contain vague, boilerplate language except- rights in a surface landowner’s root of title is a ing any reservations that may or may not exist. general reference that is insufficient to preserve Rather, the root of title was made subject to a the reservation if it does not name the owner of specific, identifiable reservation of mineral the reserved rights. rights recited though the chain of title using The Act was created in 1961 to extinguish the same language as the recorded title trans­ stale interests and claims in land that existed action that recorded it. Accordingly, that prior to the root of title, with the goal of sim­ reference is sufficient to preserve the reserved plifying and facilitating land title transactions rights from being extinguished under the Act. by allowing persons to rely on a record chain The trial court’s judgment for the Ericksons of title. The court quoted a commentator was reinstated. who observed that the specific identification provision in the Act was directed at the com- Erickson v. Morrison mon practice of including in the Supreme Court of Ohio deed description language like “subject to ease- March 16, 2021 ments and use restrictions of record.” This type 2021 WL 966949 of general provision is probably adequate to protect the grantor from liability on covenants for title in a warranty deed, but such a general Adjusting sale for conversion costs makes reference leaves it unclear whether a prior inter- sale less comparable to subject facility est in fact exists. The Act creates a three-step inquiry: (1) Is Detroit Diesel Corporation (Diesel) owns a there an interest described within the chain of single-user manufacturing facility located pri- title? (2) If so, is the reference to that interest a marily in Redford Township, Michigan (the general reference? (3) If so, does the general ref- Township). As of December 31, 2016, Diesel erence contain a specific identification of a used the property to manufacture powertrains, recorded title transaction? Here, the answer to diesel engines, and axles for heavy and medium the first question is yes, because the documents trucks. The facility spanned three million square in the chain of title state that surface rights in feet; the first million was constructed before the land are subject to a reservation of mineral World War II, with the remainder expanded rights. At issue is whether that reference to the piecemeal over time. Despite the facility’s age, reservation was a general reference. Diesel was using it to conduct modern manufac- In an earlier case, the Ohio court declined to turing activities, having made improvements to establish a bright-line rule that an interest is pre- the real estate. Nevertheless, large portions of served only if the reference to it includes either the facility were not up to modern standards. the volume and page where the interest was cre- For the 2017 tax year, the Township deter- ated or the date it was recorded, because the Act mined the true cash value of the property to be

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$41 million. Diesel challenged that value as sales for single-user manufacturing. The Town- excessive, filing an appeal with the Michigan ship argued that Diesel’s appraiser’s conclusion Tax Tribunal. was generic industrial use, rather than specific. At trial, Diesel offered the testimony of an The Tribunal noted that it was generally unsat- appraiser who explained that very few users were isfied and unpersuaded by the appraisers’ sale in the market for a three-million-square-foot comparables. But taking a global view of the complex. Many automakers had shut down their testimony, the Tribunal found that multitenant plants in Michigan, and while there was demand use is the most frequent use for large manufactur- for this type of building from warehouse and ing facilities, given that nine of eleven of Diesel’s distribution companies, a plant like the subject comparable sales were converted to multitenant property would most likely be purchased for use after sale and that five of eight of the Town- industrial redevelopment or conversion to a ship’s sales were already multitenant at the time multi­tenant space. Accordingly, Diesel’s appraiser of sale. But because the cost of converting a concluded that the highest and best use of the three-million-square-foot, single-user building property was for “industrial development.” would be substantial, the Tribunal found that Based on that determination, the appraiser the highest and best use of the property was identified and adjusted four sales of manufactur- “industrial use,” not solely single-use manufac- ing plants with over one million square feet and turing as the Township had advocated. located in the Midwest. All four sales were of for- For various reasons, the Tribunal rejected most mer automotive plants, and the appraiser adjusted of the parties’ comparable sales, but concluded for differences in market conditions, size, loca- that Diesel’s first sale comparable was a good tion, ceiling height, and age, among other fac- indicator of the subject’s value. After adjusting tors. He also considered seven supplemental that sale, the Tribunal concluded that Diesel’s sales. He concluded to a value of $9.41 million property had a total value of $18 million. The for the subject property. Township appealed. The Township’s appraiser argued that high On appeal, the Township argued that the Tri- demand existed for industrial space, driven by bunal erred in finding that industrial use— the auto industry as well as ecommerce and tech encompassing both single-use and multi-use—was companies. He concluded that the property’s the highest and best use of the property. Accord- highest and best use was a continuation of single- ing to the Township, that conclusion was legally user manufacturing, opining that conversion of erroneous and not supported by substantial evi- the property was not feasible. He identified four dence. The court of appeals was not persuaded. sales, only one of which was over one million The Township first argued that it was inconsis- square feet. Further, three of the properties were tent for the Tribunal to adopt industrial use as multitenant properties, two of the sales were the highest and best use because the Tribunal leased fee transfers, and another was purchased rejected single-user manufacturing—a subcate- by a long-term tenant. He also considered four gory of industrial use—as the highest and best supplemental sales, but he arrived at an opinion use. The court found this argument misplaced, as of value of $50 million. it was clear the Tribunal was rejecting single-user At the close of evidence, Diesel argued that manufacturing as the one and only highest and the Township’s highest and best use conclusion best use, but not rejecting a highest and best use was not supported by its own appraiser’s compa- conclusion that encompassed single-user manu- rables, because the majority of them were not facturing. Moreover, the focus of the highest and

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best use analysis is the identification of the most Equitable partition of co-owned land profitable use of the property going forward so can be divided collectively among groups long as there is market demand for that use. This of owners does not necessarily mean, however, that the identified use will always produce the same sale Leonard and Linda Smith (the Smiths) and their price in every circumstance. four children—Lynden, Jaclyn, Sarah, and The Township also argued that no evidence Lucas—are co-owners of 4,972 acres of land in supported the conclusion that multitenant use Sheridan County, Nebraska, which they inher- was financially feasible. Diesel’s appraiser did not ited from Linda’s parents. The shared land is account for those costs in his appraisal, and, made up of three noncontiguous parcels. Two according to the Township, without discussion parcels are 46% owned by Linda, with each child of specific conversion costs for the infinite com- owning 13.5%. The third parcel, consisting binations of potential conversions, there is no largely of pastureland, is 32.5% owned by the substantial evidence to support a conclusion that Smiths in common, with the remainder divided conversion is financially feasible. equally among Linda and the four children. The court rejected this argument, noting that In 2017, three of the Smiths’ children, Appel- the Township “wrongly assumes” that a robust lants Lynden, Jaclyn, and Sarah, filed a shared discussion of conversion costs was necessary. complaint for partition of the co-owned land, Diesel showed that conversion was financially seeking that the property be partitioned and feasible through its comparable sales analysis, divided among its owners in kind and if it which specifically identified multiple older, large cannot be partitioned in kind, then that it be single-user manufacturing facilities sold for con- sold, with the net proceeds divided accordingly. version to multitenant industrial use. Further- The Smiths and son Lucas (Appellees) filed a more, conversion costs would not be a relevant shared answer, conceding that partition of the adjustment to calculating the property’s value, co-owned land was necessary and appropriate since the comparable relied on by the Tribunal and requesting that a referee be appointed. The was a price before conversion to multitenant use. trial court appointed a referee to recommend The subject has not been converted to multi­ whether the property could be partitioned in tenant use. Adjusting that sale for conversion kind without great prejudice to the owners or costs would make it less comparable, not more whether the property should be sold and the pro- comparable, to the subject. ceeds divided. In sum, the court found that material and The referee inspected the property and opined substantial evidence supported the Tribunal’s that partition in kind could not be made without findings and conclusions. Therefore, its decision great prejudice to the owners. Appellees filed an was affirmed. objection to the referee’s report, alleging that the sale of the property would work a serious and Detroit Diesel Corp. v. Redford Township unique hardship on the Appellees given their Michigan Court of Appeals investment in the property and its location adja- January 21, 2021 cent to other property owned by the Smiths. 2021 WL 218311 The purpose of partition is to provide owners with separate and exclusive possession of their portion of co-owned land. Partition in kind phys- ically divides the property, whereas partition by

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sale involves the division of sale proceeds. There The court of appeals agreed that such a remedy is a strong presumption in favor of partition in should be rarely used and only when it is equita- kind if feasible and equitable. bly necessary, but that under a court’s equitable During trial, most of the family testified. powers, a court can divide property between two Appellants and Appellees both called an expert groups of owners. It said that this case was “one witness to testify regarding the feasibility of par- of the rare situations which warrants a partition titioning the co-owned land in kind. Leonard in kind” collectively between the Appellants proposed a division that would give Appellants and Appellees. 1,880 acres of the total acreage; while that was First, the Appellants clearly aligned their not equal to the Appellants’ collective 40.5% interests, acting as a unit through the proceed- interest by acreage, it would provide them with ings and, at least implicitly, indicating a collec- their collective share of the value of the co-owned tive desire to partition by sale. Additionally, land. The Appellees also called an appraiser who partition by sale would create a significant hard- calculated the value of each of the three parcels ship for Appellees, especially because Leonard and opined that the land could be fairly parti- and Linda own land which borders the co-owned tioned between Appellees collectively and property and because their ranching and farming Appellants collectively. operations have been in place on the property for For the Appellants, Jaclyn testified that she did decades. By dividing the land in kind collectively not want a collective share of the land, because between the two groups, the trial court awarded then another partition action would have to be Appellees sufficient land to keep their operation initiated, and she did not want to be legally running, while giving Appellants more than bound to the other family members. The Appel- their fair share of the value of the land to sell. lants also called their own appraiser who valued The appraisers concluded the land was very mar- each parcel, but applying the Appellees’ division ketable, and the Appellants could sell the land using his values would yield only 35.75% of the awarded them and obtain more than their 13.5% total value, versus their 40.5% interest in the individual share of the total value of the land. land. That would be an inequitable result. This was precisely what they sought in their par- The court entered an order sustaining the tition action and at trial. Appellees’ objection to the referee’s report and Because collective division between groups of ordering an in-kind division of the property such co-owners is within the powers of the trial court, that Appellants collectively received 41.17% of and here such an approach resulted in an equita- the total value of the property. While partition ble outcome, the court of appeals affirmed the in kind may be difficult in this case, the court trial court’s decision to partition the land in kind concluded that an equitable division was not rather than to order the sale of all of the land. impossible, and a forced sale would not advance the interests of most of the family. The Appel- Smith v. Smith lants appealed. Nebraska Court of Appeals The Appellants challenged the trial court’s March 16, 2021 authority to order partition in kind such that 957 N.W.2d 511 co-owned land is divided collectively between two groups of owners. They argued that partition in kind can only be achieved by awarding each owner his or her individual share of the land.

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Foreclosure sale is not an The County Assessor took the position that a open market transaction for sale is not an open market transac- establishing full cash value tion. For support, the Assessor pointed to the State Board of Equalization’s annotation to the In May 2000, an individual (Previous Owner) property tax law stating that the presumptions of purchased real property in Humboldt County, full cash value under the tax code do not apply to California, for $125,000. The property consisted execution or foreclosure sales, since those are of two wooded 80-acre parcels. The Previous forced sales and thus considered non-market Owner added a 1,500-square-foot manufactured transactions. Moreover, the trustee’s sale here home on a permanent foundation at a cost of was limited by the requirements that a deposit of $85,000. The Previous Owner then tried to sell $2,500 be submitted before the auction and a the property various times without success. Even- winning bid must be paid within three days, mak- tually, in 2012, the mortgage holder foreclosed; ing traditional financing unavailable. the unpaid debt was $245,179. In June 2013, Tim The county Assessment Appeals Board rejected Phillis purchased the property at a public trustee Phillis’s argument that the sale price should be the sale for $153,806. At the time of the trustee sale, assessed value. It concluded that foreclosure sales the manufactured home was in poor condition are not fair market sales, but also rejected compo- and lacked a functional water or electrical source. nents of the Assessor’s valuation. The Board also Under California’s Proposition 13, property is found that even if foreclosure sales could be con- to be assessed at its full cash value, which is sidered in some circumstances, this sale did not defined as the appraised value of the property at meet the parameters of an open market sale the time of purchase. Where full cash value is because of the inability of a buyer to obtain tradi- established upon purchase and sale of the prop- tional financing, the seller was forced to sell, and erty, the term full cash value means fair market the buyer was in “at least the potential position” of value. The California tax code further provides being able to take advantage of the owner’s neces- that for purposes of determining full cash value sity to sell. The superior court agreed. of real property being appraised upon purchase, On appeal, Phillis made the same argument: full cash value is the purchase price paid in the that the Assessor had the burden of proving that transaction unless it is established that the prop- the foreclosure sale in which he purchased the erty would not have transferred for that price in property was not an open market transaction, an open market transaction. The tax code fur- and that the Assessor had failed to meet the bur- ther provides a rebuttable presumption that the den. According to the court, Phillis’s position purchase price is the full cash value if the terms assumed that the rebuttal purchase price pre- of the transaction were negotiated at arm’s length sumption applies in every case and controls and neither party could take advantage of the absent evidence the particular purchase was not exigencies of the other. an arm’s-length, open-market transaction. But In November 2013, the property was assessed the court disagreed with that assumption. for tax purposes at a value of $469,976. Phillis The court noted that “it is common knowledge submitted an application for a changed assess- that at forced sales such as a trustee’s sale, the full ment for 2013 and 2014. In his application, potential value of the property being sold is rarely Phillis argued that his property should be assessed realized.” Property that must be sold within the at the price he paid for the property in the trust- strictures of the time and manner of a state- ee’s sale. prescribed foreclosure “is simply worth less.”

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Here, Phillis argued that the sale was not that all taxes, penalties, and fees be disallowed “forced” because the trustee was a willing party and refunded to IAEF. DCAD appealed. and the auction was noticed for seven months. The Texas tax code provides that property But these arguments were not persuasive because owned by the state or a political subdivision of all foreclosure sales must be conducted in accor- the state is exempt from taxation if the property dance with statutory requirements regarding is used for public purposes. Thus, in order to qual- notice, timing, and bids. Moreover, the trustee is ify for this exemption, IAEF was required to not attempting to maximize gain, as would be establish that the property is both owned by the expected of a seller in an open market transac- state and used for a public purpose. tion. Rather, the trustee is attempting to recoup Prior case law had determined that open the amount of the defaulted loan, regardless of enrollment charter schools are part of the public the actual value of the security property. In school system in Texas, and thus are deemed short, a foreclosure sale is by nature not an open agencies of government, at least for purposes of market transaction supporting application of the the Texas Tort Claims Act. Accordingly, DCAD purchase price presumption. The Board’s judg- did not dispute that IAEF’s property was used for ment was affirmed. the public purpose of operating schools. Instead, the parties dispute whether the property is owned Phillis v. County of Humboldt by the state or a political subdivision thereof. California Court of Appeal, First District Texas courts generally have defined “owner- December 31, 2020 ship” for taxation purposes in terms of the per- 59 Cal.App.5th 432 son or entity holding legal or equitable title. Equitable title for these purposes includes the “present right to compel legal title.” For exam- Charter school had equitable title ple, in an earlier case, the state possessed prop- entitling it to tax exemption erty and would acquire full legal title upon payment of all lease payments; the earlier court The International American Education Federa- concluded that the property was owned by the tion, Inc. (IAEF) operates charter schools in state “no differently from that of any private Dallas County, Texas. In 2016, IAEF leased real owner who holds property against which there is property from a private landowner to operate an outstanding lien.” IAEF’s schools. The following year, IAEF Here, IAEF argued that it has equitable title requested that the Dallas Central Appraisal Dis- to the property because a purchase option within trict (DCAD) designate the property as exempt the lease agreement gave it the unqualified, uni- from ad valorem taxes. DCAD denied IAEF’s lateral right to assume fee title to the property, exemption request, as did the reviewing admin- at least if the option was exercised within the istrative agencies. first five years of the lease term. Notwithstand- IAEF filed its petition for review in the Dallas ing the limited time in which IAEF could exer- County District Court, arguing that it was enti- cise its option, the court of appeals agreed that tled to a property tax exemption on the properties the lease provision provided IAEF with the it leased for educational purposes. The trial court power to compel transfer of legal title. Indeed, in agreed, ordering DCAD to take all steps neces- 2018, IAEF took full legal title through a special sary to notify the county Tax Assessor-Collector warranty deed, which DCAD conceded during that the property “was and is exempt” and ensure the oral argument.

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Under the facts of this case, the court held, parking. After unsuccessfully requesting that the “there was no room for reasonable disagreement City compensate it for these harms, RDB sued about whether IAEF could have compelled issu- the City under the Fifth Amendment for taking ance of the title.” By granting IAEF the immedi- its property without just compensation. ate right to compel the transfer of fee title by RDB claimed that the City facilitated Turano’s unilateral exercise of its own will, the lease was actions by granting a variance to the com- sufficient to grant IAEF equitable title to the pany, by transferring public land to the company, property, entitling it to an exemption from prop- and by approving the cul-de-sac construction. erty taxation under the Texas tax code. Nevertheless, none of RDB’s allegations was severe enough for a constitutional taking, and Dallas Central Appraisal District v. International RDB failed to allege its injuries denied it all or an American Education Federation, Inc. essential use of its property. Texas Court of Appeals The City moved to dismiss the complaint, December 29, 2020 arguing it had no role in the alleged taking 618 S.W.3d 375 because the actions at issue were those of Turano, a private entity. The district court granted the City’s motion to dismiss, though on different Loss of business’s on-street parking grounds. RDB appealed. is not a compensable taking A wide range of government actions may require just compensation under the Fifth Amendment, Turano Baking Company (Turano) owned a long, including permanent physical invasions, depri- narrow facility in Berwyn, Illinois (City). vation of a property’s entire value, exactions, and Although its property was geographically con- regulations that unduly interfere with property strained, an alley ran behind the length of the rights. Compensable takings generally fall into facility, with single-family homes on the opposite one of two categories: per se takings, which occur side. Two north-south streets ran perpendicular when the government physically seizes private to the alley, and thus Turano’s facility. property, and regulatory takings, which occur Desiring to expand its premises to allow for when government regulation of private property more in-site parking, Turano acquired several becomes sufficiently onerous. residential lots just south of the alley. It planned RDB contended that it suffered a per se, physi- to create one row of perpendicular parking spots cal taking, characterizing the City’s cul-de-sac on the former residential lots, reconfiguring the allowance as a physical encroachment on its alley into a driveway. In 2014, the City granted a nearby street parking. But the court of appeals zoning variance to Turano allowing Turano to found that RDB’s argument missed one crucial cut off access to the parking lot from the perpen- point: RDB does not, and never has, owned any dicular streets by ending them in cul-de-sacs. street parking places. It is impossible to suffer a This plan had the effect of depriving RDB taking of property that one does not have. By Properties LLC (RDB), whose property lay near neglecting to identify any physical intrusion on the end of one of the newly blocked roads, of its own property, RDB failed to allege any kind of parking spaces on the city streets. The loss of direct physical seizure. street parking, according to RDB, diminished the Alternatively, RDB maintained that it ade- value of its property, and without street parking, quately alleged a regulatory taking in the form of RDB had lost spots suitable for handicapped a decline in property value due to the loss of

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street parking. But the court opined that even if land lying between a body of fresh- or salt water it took RDB’s statements as true, the complaint and the base of a bluff or dune” or all land lying still failed to allege a regulatory taking. First, not between the body of water and the naturally every regulation that decreases property value occurring beach grass or upland vegetation. This qualifies for compensation. And the fact that definition of beach includes both the upland title street parking might be desirable or valuable does claimed by the Associations, which extends to not show that the City’s decision to eliminate a the mean high-water mark, as well as the under- few parking spaces amounts to a taking, either water land between the high and low water marks. from the standpoint of economic impact or inter- The Associations filed suit to quiet title to the ference with investment-backed expectations. beachfront portions of their respective properties Nor did RDB plausibly allege a deprivation of and a judgment declaring that they owned title property rights, as opposed to an incidental to the disputed area in fee simple. They likewise decrease in property value. sought a judgment declaring that a reservation in In total, then, the court concluded that noth- their , dated to March 1882, had been ter- ing in RDB’s fact pattern “even remotely approx- minated or could not be construed as authorizing imates the type of government action” considered the Town to issue permits to operate and park a taking. The City’s decision about how to use vehicles on the Associations’ properties. the public roads did not deprive RDB of any stick At trial, the Associations produced a land title in the bundle of property rights. Accordingly, the expert who testified to each respective property’s district court properly dismissed RDB’s case. chain of title. The expert testified, based on doc- umentary evidence, that the Associations owned RDB Properties LLC v. City of Berwyn fee simple title to their properties extending to US Court of Appeals, Seventh Circuit the mean high-water mark. The Associations February 1, 2021 also produced all of the deeds in those respective 2021 WL 318235 chains of title, beginning with the March 1882 deed, which was common to all of the Associa- tions’ chains of title. Town’s reservation of specific use After a trial, the trial court dismissed the com- of beach does not confer broader power plaint, and the Associations appealed. to issue use permits The NY Supreme Court, Appellate Division began by explaining the history of the proper- The Town of East Hampton, New York, is located ties. In 1882, the Town and its trustees were at the eastern tip of Long Island and includes empowered to validly convey to the Associa- miles of oceanfront beaches. A collection of tions’ predecessor-in-interest the title to the dis- homeowners associations, including Seaview at puted portion of the beach, and they did so. The Amagansett Ltd. (Seaview, and collectively with March 1882 deed, however, contained a reserva- the others, the Associations), claim to own prop- tion, specifically reserving to the inhabitants of erty that includes a portion of the beach lying the Town “the right to land fish boats and [nets] landward of the mean high-water mark of the and spread the [nets] on the adjacent sands and Atlantic Ocean. care for the fish” on the south shore of the Town Since 1991, the Town has issued permits autho- lying west of the conveyed premises. rizing their holders to operate and park vehicles None of the deeds in the chains of title were on the beach, a term codified as including “all invalid, and the fact that certain of the convey-

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ances in those chains of title were made through fishing and fishing-related purposes. The reserva- quitclaim deeds did not, in itself, undermine the tion does not, however, confer upon the Town Associations’ title claims. But the Town asserted lawful governmental or regulatory power to issue that even if the Associations established their permits allowing the public to operate or park respective title claims, the Town nevertheless vehicles on any portion of the beach owned by retains the right to allow the public to operate the Associations. and park vehicles along the entire beach, includ- Accordingly, the court modified the judgment ing the portion owned by the Associations, based of the trial court and remitted the case for the on the reservation in the March 1882 deed. entry of an appropriate judgment. While the trial court agreed with the Town that the March 1882 deed should be construed Seaview at Amagansett Ltd. v. broadly, the Appellate Division did not. To the Town of East Hampton Appellate Division, the reservation is in the NY Supreme Court, Appellate Division nature of an easement allowing the public to use February 3, 2021 the Associations’ portion of the beach only for 191 A.D.3d 717

About the Author Benjamin A. Blair, JD, is a partner in the Indianapolis office of the international law firm of Faegre Drinker Biddle & Reath LLP, where his practice focuses on state and local tax litigation for clients across the United States. A frequent speaker and author on taxation and valuation issues, Blair is licensed to practice law in Indiana and Oregon. Blair holds a juris doctor from the Indiana University Maurer School of Law, where he also serves as an adjunct professor. Contact: [email protected]

84 The Appraisal Journal • Spring 2021 www.appraisalinstitute.org Peer-Reviewed Article

Valuation of Private Golf and Country Clubs for Ad Valorem Taxation by Laurence A. Hirsh, MAI

Abstract This article examines relevant issues in the valuation of private golf and country clubs, specifically for ad valorem tax assessment purposes. One of the more challenging elements of valuation is the value of the business intangible property, and there are sometimes disputes as to what is golf club intangible personal property. Much of the focus is on the differences between daily-fee and private golf facilities and the issue of isolating (or allocating) real property value from the going concern, which is how most golf properties are traded. This article summarizes the widely known methods of estimating the value of intangible personal property. It also suggests an approach for valuing a golf club as a going concern and allocating the real and personal property for the purpose of developing a value conclusion for the real property to be assessed. The article examines some case law that relates to these properties and identifies multiple options for solving this unique appraisal problem.

Introduction income attributable to the real property and are often excluded at some point in the analysis The valuation of private golf and country clubs when seeking real property value. is a complex and specialized undertaking. In In comparison, public access courses depend appraisal assignments related to an ad valorem on less reliable and durable daily fees and serve tax assessment appeal there are a number of golf a different market segment. More importantly, club–specific issues that must be considered. the physical characteristics of private clubs and daily-fee facilities are typically quite different. Golf Club Operations Golf and club facilities are made up of land, Private clubs have a different business opera- golf course improvements, other athletic facili- tions model than daily-fee, semi-private, and ties, and building improvements (real property). resort golf facilities. There also are fundamental There are significant differences in the real prop- differences relating to the nature of the real erty characteristics of private clubs and daily- property being appraised (versus the operations). fee facilities. The economics of private clubs rely on long- One of the first questions a golf course archi- term annual memberships, which come in a tect or clubhouse architect raises in develop- variety of forms. Private clubs may have mem- ment or renovation is how the course will bership categories for golf, sports, and social be used and who will be playing it. For the activities, along with variants based on age, appraiser, these factors are components of the marital status, and geography. Many clubs also analysis. The table in Exhibit 1 shows market have entrance fees that come in multiple forms, segmentation and summarizes the different types including equity (where members can resell of golf operations. their interest), initiation fee, and refundable Whether a golf course is planned as a private deposits. The treatment of entrance fees in the course or a daily-fee course has significant impact appraisal is not without debate. While the on the course design. The daily-fee golf course entrance fees may be considered part of the is designed and built with pace and volume of going concern, they are not usually considered play in mind. Most daily-fee courses host a

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considerably higher volume of rounds than pri- volume. Economics dictates that most daily-fee vate clubs; thus, routing, hazards, and sequence of courses host more rounds and have tee time inter- holes are designed to accommodate this volume vals at ten minutes or less. Many private clubs of golfers and to minimize the time necessary to have tee time intervals at ten, twelve, and even get around the course. Conversely, the private fifteen minutes, enhancing the experience and course has more hazards and a routing focused on limiting membership to provide easy access. creating the ideal golf holes for challenge and Private and daily-fee courses also have very dif- scenery, while not necessarily anticipating high ferent physical infrastructure. Private clubhouses

Exhibit 1 Golf Market Segments

Market Segment Demand Sources Characteristics

DAILY FEE

Resident Based (incl. municipal)

Affordable Daily-Fee Price-conscious residents nearby Limited maintenance and services

Value Daily-Fee Value-conscious residents nearby Moderate maintenance and services

Upscale Daily-Fee Higher income, greater distance, Upscale maintenance, services, corporate clientele and design

Specialty

Theme Course Wider market area, tourists, Replica holes, themed atmosphere corporate (NFL, College, Opryland)

SEMI-PRIVATE

Includes all the daily-fee characteristics above but typically with some form of membership/annual pass option

PRIVATE

Resident Based (incl. both stand-alone and community amenity clubs)

Affordable Country Club Local residents seeking the best deal Limited services, maintenance, and amenities; geared to individuals

Middle-Market Country Club Local residents seeking lifestyle Family friendly

Upscale Country Club Local high-income residents seeking Highest level of maintenance and family, social, and business use service; more social activities

Specialty

Destination Clubs—Residential Non-resident high-income users; Vacation/second home or usually a second club wealthy clientele

Destination Clubs Resident or non-resident, often Limited, selective membership or corporate entertainment national membership; excellent facilities, maintenance, and services

Resort (w/ lodging)

Urban Resort Corporate and upscale tourist Usually affiliated with upscale hotel

Leisure Resort (Non-Urban) Families and corporate retreats Vacations and meetings

Note: Based on Stephen F. Fanning, “Segmentation of Golf Course Markets,” The Appraisal Journal (January 2003): 65.

86 The Appraisal Journal • Spring 2021 www.appraisalinstitute.org Valuation of Private Golf and Country Clubs for Ad Valorem Taxation usually have large locker facilities and can have The Golf Course Itself fitness, banquet, and dining area options. Dai- Texts on golf course design offer clues as to how ly-fee facilities rarely have the typical amenity the courses at private and daily-fee facilities are choices found at private clubs. Very few daily-fee very different—and therefore not appropriately courses have swimming, tennis, or other sports comparable to each other—despite both being facilities enjoyed by most private clubs that are designed for playing golf. not exclusively golf facilities. Some private clubs In his famous 1927 book, Golf Architecture in (and resorts, of course) also have on-site lodging America: Its Strategy and Construction, George for members and guests, which is another amen- Thomas Jr. notes that, ity not often found at daily-fee facilities. According to the American Society of Golf The Municipal [daily-fee] course should first of all con- Course Architects, no matter what the level sider congestion; everything hinges on that, for there is of a golf facility, there are certain elements that the absolute necessity of getting as great a number of are common to all. These basic real property players around the course as possible between daylight components of a golf facility (private or daily and dark, and those many persons are all hammering fee) are: golf balls in diverse ways both as to length, direction • Land and execution, and like all golfers, are doing it with • Parking lot implements ill-suited to the purpose. In the opinion of • Pro shop (minimum of a few hundred the Municipal greenkeeper, all such impeding obstacles square feet) as long grass, traps, hazards, one shot holes, and so • Restroom(s) (minimum unisex and forth are best elsewhere, and there is much truth in his handicap accessible) belief.1 • Maintenance storage building (minimum of two-car garage) In Turf Management for Golf Courses, James Beard • Maintenance equipment similarly writes, • Golf course improvements (tees, greens, fairways, irrigation, drainage) Public fee and municipal courses may exhibit only the • Clubhouse elemental concepts of strategy, having few bunkers and other hazards, whereas courses designed specifically for While these components are found at both hosting major championships usually have numerous daily-fee and private facilities, there are differ- bunkers and water hazards to accentuate the strategic, ences in the specific extent and quality of the heroic or penal nature of each hole and to create a high components; for example, the clubhouses are level of excitement during competition. The normal pri- usually very different. Also, private clubs often vate club or resort course falls somewhere in between.2 have a wide variety of additional amenities and facilities that can include the following: Furthermore, in Golf Architecture: Evolution in • Racquet sports Design, Construction, and Restoration Technology, • Aquatics Michael Hurdzan states: “A public golf course • Fitness can expect to host golfers with a wider variety of • Equestrian skills than an upscale, invitation-only country • Trap shooting club. This suggests that the public course might • Multiple meeting and function rooms have more gentle hazards than those found at the • Larger, more elaborate locker facilities private club.” 3 • Club storage As these texts suggest, daily-fee courses do • Private dining not always provide the strategic design, playing

1. George C. Thomas Jr., Golf Architecture in America: Its Strategy and Construction (Los Angeles: Times-Mirror Press, 1927), 1. 2. James B. Beard, Turf Management for Golf Courses (New York: MacMillan Publishers, 1982), 41. 3. Michael J. Hurdzan, Golf Course Architecture: Evolution in Design, Construction, and Restoration Technology (Hoboken, NJ: John Wiley and Sons, 2006), 48.

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surfaces, or conditions that private clubs do. characteristics to be successful. The differences Private club players demand quality playing are clear to the golf and club consumers, and they conditions and are willing to pay for it. Conse- make choices accordingly. The data shows that quently, private courses have better components, investors see them differently as well. such as the following: Thus, given the fundamental differences • More and larger hazards (bunkers, ponds, between the various types of golf facilities, trees) care should be taken to analyze them accord- • Different cultivars of turfgrass ingly—within their specific markets and market • More extensive and lush rough areas segments. • Better maintenance practices throughout, including tighter cutting heights and faster, firmer greens and fairways. Going Concern Value and Allocation • More elaborate on-course amenities (bath- rooms, water fountains, turn stations) The valuation of golf and club properties is chal- • Better and more elaborate irrigation and lenging in that sales of such properties almost drainage systems4 always include both real and personal property • More extensive golf practice facilities (going concern). Only the real property value is relevant for ad valorem tax assessment. Accord- As this list suggests, golf course maintenance ingly, the value of the real property must be iso- practices are more complex at private clubs, lated using one of the several methods available. which results in healthier, more dense turf, and Key to this issue is the practice in the specific more manicured, precisely mowed playing sur- jurisdiction. Allocation approaches and method- faces. Because of the more intense grooming and ologies are handled differently, usually based on care of private courses, private clubs usually have case law. In New York, for instance, a method larger and more complex maintenance facilities, known as the “market rent approach” is used often with multiple buildings, and storage areas whereby in theory a market rent for the real for sand and chemicals as well as improved fuel property is estimated from comparable rents and facilities, wash areas, and turf nurseries. then capitalized into what is represented as real Physical (real property) differences in the vari- property value only. ous types of golf facilities are summarized in In South Carolina and Florida, revenues and Exhibit 2. expenses from food and beverage, golf cart rent- As clearly demonstrated from the preceding als, and pro shop sales are typically removed from discussion, all golf facilities are not alike. An the analysis, and then of the spe- analogy might be demonstrated using restaurants. cific real estate spaces used for food and beverage, McDonald’s and Ruth’s Chris Steak are golf cart storage, and pro shop is added back to both chain restaurants; however, they are not the income/expense pro forma. comparable. They serve dramatically different Also, depending on the jurisdiction, the products, in very different environments, with appraiser may have to consider an alternative use different facilities. It is unlikely that an appraiser if the local rules stipulate valuation based on would use one as a comparable for the other. Like highest and best use and the club does not repre- restaurants, golf courses are segmented into sub- sent the highest and best use. There are a variety markets. While it is easy for the unfamiliar to of guidelines for determining this, which are dic- segment golf markets by operations, it should be tated by state case law or statute. For example, emphasized that each submarket has different the courts of New York State have reaffirmed the real property characteristics and improvements custom where the property must be appraised necessary to meet the demands of the submarket. based on continued present use. This promotes While the typical daily-fee golf course can oper- the use of an approach relying on lease transac- ate and even thrive with more limited facilities, tion data to estimate economic rent, which is the private club requires dramatically different then capitalized into an indication of value.

4. For example, the trademarked Better Billy Bunker modern drainage system for sand bunkers; that design company reports that 90% of its customers are private clubs; see https://www.billybunker.com/.

88 The Appraisal Journal • Spring 2021 www.appraisalinstitute.org Valuation of Private Golf and Country Clubs for Ad Valorem Taxation

Exhibit 2 Comparison of Physical Characteristics by Facility Type

Type Golf Course Amenities

DAILY FEE

Resident Based (incl. municipal)

Affordable Daily-Fee Minimal hazards, wide open Small clubhouse, snack bar to expedite pace of play

Value Daily-Fee Moderate hazards and interest Clubhouse, pro shop, banquet facility

Upscale Daily-Fee Name architect, excellent Larger clubhouse, restaurant, banquet, maintenance, many features lockers, pro shop

Specialty

Theme Course Name architect, excellent Larger clubhouse, restaurant, banquet, maintenance, many features lockers, pro shop

SEMI-PRIVATE

Includes all the daily-fee characteristics above but typically with some form of membership/annual pass option

PRIVATE

Resident Based (incl. both stand-alone and community amenity clubs)

Affordable Country Club Moderate hazards and interest Clubhouse, pro shop, banquet facility, swimming, tennis

Middle-Market Country Club Moderate hazards and interest, Clubhouse, pro shop, banquet facility, better conditions swimming, tennis

Upscale Country Club Name architect, excellent Excellent facilities, dining, banquet, maintenance, many features other sports, swimming, tennis, squash, paddle, fitness

Specialty

Destination Clubs—Residential Name architect, excellent Good amenities but often limited maintenance, many features locker space

Destination Clubs Name architect, excellent Variety of amenities depending on maintenance, many features, golf- membership, often large locker rooms, centric, all-walking sometimes bars, limited dinner service

Resort (w/ lodging)

Urban Resort Name architect, excellent Lodging, water parks, attractions maintenance, many features, sometimes not walkable

Leisure Resort (Non-Urban) Name architect, excellent Lodging, water parks, attractions, maintenance, many features, adventure courses, shooting, tennis sometimes not walkable

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There are two flaws in this approach, however, as and the use of affordable, daily-fee golf course it is typically employed in New York with regard leases to estimate market rent for upscale private to private golf and country clubs: clubs is akin to comparing McDonald’s to Ruth’s 1. The presumption of a sale is inherent in the Chris Steak House. definition of market value and few, if any, In the federal courts, “Daubert tests” can deter- golf or club sales are predicated on the capi- mine whether an expert witness’s testimony is talization of an estimated economic rent. A admissible in court.7 The four Daubert tests con- very limited number of private club proper- sidered in evaluating whether expert testimony is ties are leased to operators.5 admissible are 2. As previously illustrated, private clubs and 1. Whether the theory can be and has been daily-fee golf facilities are inherently differ- tested; ent properties. Although both have golf 2. Whether the theory has been subjected to courses, their similarities in physical charac- peer review and publication; teristics end there. Much like a small town- 3. Whether, as to a particular scientific tech- house and a large mansion are both nique, there is a known rate of error the residences, they serve different markets and court should consider; and demonstrate different economics. Private 4. Whether the technique is generally accepted clubs and daily-fee golf courses may both in the relevant scientific community.8 have golf courses, but they have significant differences and serve different markets. These tests are useful in evaluating the New York court’s approach. For example, there is min- Furthermore, the notion that market rent can imal market evidence that the Sleepy Hollow be exclusively indicative of real property value Country Club market rent technique can be tested (as opposed to the going concern) is flawed in its in the marketplace. Accordingly, this approach is customary application, because the comparable theoretical and not indicative of market activi- rentals and ultimately the economic (market) ties. It does not meet the presumption of sale rental estimate for the subject property usually requirement in the definitions of market value are based on a percentage of operating revenues in various jurisdictions. That said, the author (going concern). The 2020 New York Supreme acknowledges that there have been sales of leased Court decision in Sleepy Hollow Country Club v. fees that may or may not be indicative of fee sim- Ossining6 supported and reaffirmed this problem- ple market value. One significant question in atic approach, using “comparable rentals” from such sales is whether equipment, leases, and affordable daily-fee and municipal golf facilities other personal property were included in the sale to develop estimates of value for upscale private of the leased fee, or in using rental comparables, country clubs. Few, if any, golf clubs or facilities if such personalty is included in the lease. are sold based on capitalized economic rent. The Appraisal Institute has discussed a number They are normally predicated on a multiple of of methods of allocation of real property and per- gross operating revenues or capitalization of net sonal property.9 Those methods considered appli- operating income. The disconnect is obvious, cable to golf properties10 are summarized next.

5. In over forty years of analyzing golf and club property sales, the author has not encountered a transaction price based on a capitalized . 6. Sleepy Hollow Country Club v. Town of Ossining and Briarcliff Manor Free Union School District, Index 66855/12, 65431/13, 66118/14, 66569/15, 64361/16, State of New York Supreme Court, County of Westchester. 7. Daubert v. Merrill Dow Pharmaceuticals, Inc., 125 L. Ed. 2d 469 (1993). 8. Larry Hirsh, “Litigation Support Appraisals for Golf and Club Properties” (blog), March 15, 2017, https://bit.ly/3yWgfEb. 9. For example, see Appraisal Institute, “Valuation of Real Property with Related Non-Realty Items,” chapter 37 in The Appraisal of Real Estate, 15th ed. (Chicago: Appraisal Institute, 2020), 663–679; and Appraisal Institute course, Fundamentals of Separating Real Property, Personal Property, and Intangible Business Assets. 10. See Laurence A. Hirsh, Golf Property Analysis and Valuation: A Modern Approach (Chicago: Appraisal Institute, 2016).

90 The Appraisal Journal • Spring 2021 www.appraisalinstitute.org Valuation of Private Golf and Country Clubs for Ad Valorem Taxation

Tangible Personal Property unless it is based on contributory value or value Tangible personal property (furniture, fixtures, in use. This is one area where the various tan- and equipment) at golf properties typically gible personal property methods mentioned are includes maintenance equipment; tools and sup- of considerable value. In some jurisdictions, it is plies; golf carts; kitchen equipment; furniture; customary to simply deduct the personal prop- dishes and silverware; and other items needed to erty assessment (where applicable) from the run a club. The methods of measuring their value going-concern value. are usually based on some type of cost analysis. These methods include the following. Intangible Personal Property • Book Value Method—Balance sheet entries One of the more challenging elements of any are used to determine the book value of per- golf property valuation is estimating the value sonal property. of intangible personal property (IPP), which • Modified Book Value Method—The is often referred to as business intangible per- appraiser makes an adjustment from Book sonal property. The intangible personal property Value based on observation of all the assets might include a brand’s influence on professional to arrive at a market value estimate. management (ClubCorp, Kemper, Troon), the • Comparable Course Method—This method high-profile reputation of a club by virtue of utilizes costs from comparable facilities to hosting major events or being highly ranked, determine a cost new and then employs an the assembled workforce (most notably the golf estimate of depreciation by percentage course superintendent, general manager, golf based on the age and expected remaining pro, or chef), business name, non-realty con- life of the assets. tracts (favorable cart and equipment), non- • Asset Grouping Method—This method realty leases, membership, and innovations. groups assets by department and an average There is sometimes disagreement as to what is cost is estimated. Depreciation is also esti- intangible personal property and what is real mated by department to compile an esti- property. For instance, many cases dispute mate of market value. whether equity memberships in private clubs • Income Method—This method utilizes an constitute ownership in real property (the club) analysis of the required rates of return on or licenses to use (rent through dues), which and return of investment for the tangible would be considered intangible personal prop- assets to make an adjustment to the proper- erty. Some of the more widely known methods ty’s net income in the income approach. of estimating the value of intangible personal property are summarized below. None of these methods considers the actual Excess Profits Technique. In the excess profits market for used equipment, which is a weakness technique, a stabilized net income is calculated that is subject to scrutiny. Though not usually after removing expenses that may be unique to available to appraisers, or part of the scope of the owner, and required returns are calculated most appraisal assignments, a personal property for each asset, with the residual being income appraisal would result in the most accurate attributed to the intangible personal property. method of valuation. Total Excess Earnings Model (TEEM) and A question that arises in the personal prop- Enhanced Total Excess Earnings Model (ETEEM). erty analysis is whether it is more appropriate to A 2011 Appraisal Journal article by Ross and measure the value of tangible personal property Alessi11 explains the TEEM technique, which based on value in use or value in exchange. Since dates to the 1920s. TEEM is presented as a the golf course is generally sold as a going con- method that can be used effectively in assign- cern, the issue is not the value in exchange of ments to more easily develop real estate value, the equipment but rather its contributory value and also to identify and estimate accurately the to the going concern. This would seem to dilute values of tangible and intangible personal prop- the credibility of the personal property appraisal erty. This is somewhat different than most golf

11. Franz H. Ross and Adam A. Alessi, “Using TEEM-Work to Extend Your Reach to the Real Estate/Business Value Continuum,” The Appraisal Journal (Summer 2011): 229–240.

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property assignments, where the appraiser seeks Administrative Law Judge Division in Sea Pines to isolate real property value from the going Plantation Co., Inc. vs. Beaufort County Asses- concern. TEEM suggests starting with the cost sor.14 In that case, some interesting observations approach to value the real property and working were made. First, according to the court, golf through development of rental estimates and carts and the revenue generated from golf carts developments to solve for are already taxed from sales taxes, personal prop- intangible personal property. For golf properties erty tax, and federal income tax on the revenues. this is problematic because of the limited reliabil- Further, the judge found that the county’s ity of the cost approach. The ETEEM technique, appraiser erred in including revenues from per- presented in a 2015 article by Ross and Tellatin,12 sonal property, such as pro shop merchandise, interestingly introduces the term real estate– food and beverage, and golf cart rentals. The centered enterprises (RECE), which golf courses taxpayer’s appraiser calculated net operating most definitely are. ETEEM starts by solving for income (NOI), then subtracted revenues attrib- the value of the going concern (GC) first, but utable to personal property, and then added back only develops a real estate capitalization rate an imputed rent for the pro shop operation, food (and real property value) after using the cost and beverage, and golf cart operation. From this approach and its limitations. “restated revenue,” operating expenses directly Sales of Golf Course Business Opportunities. attributable to the real estate were deducted, Analyzing sales of golf course business opportuni- specifically excluding all expenses directly ties would likely be the best method for estimat- related to the golf cart, food and beverage and ing intangible personal property. However, the pro shop operations. In this case, the taxpayer’s number and frequency of such sales are limited appraiser then estimated and deducted corporate since golf properties generally trade as going con- expenses from the restated revenues to arrive at cerns, including real property, tangible personal an NOI. The judge found this imputed rent property, and intangible personal property. approach to be a proper method. In testing this Residual/Segregated Value Technique. The method on several examples, it was observed residual sale value method is simply a technique that with limited NOI properties, there often where the real property is valued by cost was no income left to be attributable to the approach, and the residual remaining from the intangible personal property; however, when the purchase price or value of the going concern is property was a higher-income property with the intangible personal property. With golf prop- considerable NOI, it worked more effectively. erties, the speculative nature of estimating depre- Management Fee Technique. Golf course man- ciation makes this method a challenge to support. agement firms market their services on the basis Bridge Model. The bridge model, originally that enhanced performance will exceed the discussed by Benson in The Appraisal Journal in amount of the management fee. Accordingly, 1999,13 uses a residual method to measure the with the management fee technique, a relatively business value by deducting the value of the real simple capitalization of the management fee can estate from the value of the going concern—an account for the value of at least some of the established, common practice. This would appear intangible personal property. The weakness in to be a reliable option for estimating the value this method is that it fails to recognize some of of intangible personal property but would likely the other intangible personal property compo- require the tangible personal property value to be nents, most notably business value to the owner. estimated and deducted, probably by some varia- This method suggests that all business value is tion of a depreciated cost analysis. retained by management, who might have no Imputed Rent. Of particular interest for golf investment. Thus, it fails to recognize any return club valuation is the imputed rent, as observed on and return of investment, which most would in the 2002 decision of the South Carolina assume as necessary to any acquisition.

12. Franz H. Ross and James K. Tellatin, “Asset Allocations: Are You Reconciling?” The Appraisal Journal (Summer 2015): 201–217. 13. Martin E. Benson, “Real Estate and Business Value: A New Perspective,” The Appraisal Journal (April 1999): 205–212. 14. SC Administrative Law Judge Division, Sea Pines Plantation Co., Inc. vs. Beaufort County Assessor, Docket No. 01-ALJ-17-0018-CC, 2002 WL 1486969.

92 The Appraisal Journal • Spring 2021 www.appraisalinstitute.org Valuation of Private Golf and Country Clubs for Ad Valorem Taxation

Market Rent Method. Among the more recent New York, comparisons of private to private, and methods of allocation for golf properties is the daily-fee to daily-fee, properties would be indi- market rent method. This method, described by cated due to the previously discussed differences Dugas15 as a derivative of sales of golf course busi- in the markets, courses, facilities, and amenities ness opportunities method is slightly different. of each category of golf property. This approach uses an estimate of market rent In each real property valuation, the formula is that is then capitalized into the value of real the same: property. Advocates of the market rent method suggest that it addresses real property value more Real Property Value = Going Concern directly than the other methods by isolating a less Tangible Personal Property rental estimate for the real property, exclusively. less Intangible Personal Property Opponents of the method claim that rental data or for golf course properties is too inconsistent to be (RPV = GC – TPP – IPP) reliable and that the breakdown of revenues (when used instead of a percentage of total reve- After reviewing numerous articles advocating the nue) often employed in this method to develop various methods of allocation, what is clear is that rental estimates for each department are too each has at least one quirk. Therefore, it becomes speculative and not supportable. incumbent upon the appraiser to tailor the analy- The market rent method is currently accepted sis to the specific property being appraised. If the in New York State in tax certiorari matters goal of the assignment is identifying market value involving golf course properties but with an inter- (real property), in accordance with the inherent esting variation. When this method is used to presumption of a sale, it is incumbent upon the value private clubs in New York, the market rent appraiser to employ valuation methodologies and is often estimated with comparables of daily-fee techniques that reflect market conditions and the and municipal courses. For now, the market rent actions of market participants from the transac- method is limited largely to New York, and it is a tions taking place. This would mean first valuing tool for appraisers in situations where there is an the going concern (as that is how golf properties ample supply of rental comparables and where are generally bought and sold) using a methodol- that data is consistent enough to indicate conclu- ogy reflective of the market and then allocating sive trends. If used in jurisdictions other than between real and personal property.

About the Author Laurence A. Hirsh, CRE, MAI, SGA, is president of Golf Property Analysts, a leading golf and club property consulting, appraisal, and brokerage firm based in Philadelphia. Hirsh has performed consulting and appraisal assignments on more than 3,500 golf and club properties in forty-five US states, Canada, and the Caribbean. He is the author of the text Golf Property Analysis and Valuation: A Modern Approach (Appraisal Institute) and a coauthor of Residential Golf Community Development (Urban Land Institute). He has previously written two articles on golf and club property valuation in The Appraisal Journal and authored many articles for a variety of industry publications. Hirsh is a frequent speaker on golf and club property valuation, including presentations at seminars, meetings, and universities; he is a member of the education faculty for the PGA of America. A founder and first president of the Society of Golf Appraisers (SGA), Hirsh has also developed a golf course and brokered more than $135 million in golf course and club properties. He is a graduate of The Pennsylvania State University. Hirsh is also a licensed commercial pilot, certified flight instructor, and an active competitive golfer.Contact: [email protected]

SEE NEXT PAGE FOR ADDITIONAL RESOURCES >

15. Jeffrey Dugas, “The Appraisal Institute’s Analysis and Valuation of Golf Courses and Country Clubs,” New England Real Estate Journal, October 30, 2015; available at https://bit.ly/3p5BfDM.

www.appraisalinstitute.org Spring 2021 • The Appraisal Journal 93 Peer-Reviewed Article

Additional Resources Suggested by the Y. T. and Louise Lee Lum Library

Appraisal Institute • Lum Library, Knowledge Base [Login required] Special use properties/sports, recreation, and entertainment/golf courses

• Publications • Analysis and Valuation of Golf Courses and Country Clubs • Golf Property Analysis and Valuation: A Modern Approach

Lincoln Institute of Land Policy—Research and data https://www.lincolninst.edu/research-data

National Golf Foundation • Golf industry facts https://www.ngf.org/golf-industry-research/

• Reports and publications https://www.ngf.org/report-publication-catalog/

Urban Land Institute Urban Land—Golf https://urbanland.uli.org/search-results/?q=golf

94 The Appraisal Journal • Spring 2021 www.appraisalinstitute.org Peer-Reviewed Article

Land Values and External Obsolescence by Stanley D. Longhofer, PhD

Abstract External obsolescence is perhaps one of the most challenging aspects of implementing the cost approach in appraisal. Loss due to external obsolescence is driven by factors outside the property, and it can be difficult to distinguish between external obsolescence of the improvements and a reduction in value of the land. In other words, external obsolescence is prone to double counting. The purpose of this article is to provide guidance as to when such value loss is attributable to the land and when it is attributable to the structure. The discussion demonstrates that external obsolescence can only arise when the existing structure is not the site’s highest and best use. As a result, external factors that affect the property’s value are attributable to the land if the current use is the property’s highest and best use and are attributable to external obsolescence of the building otherwise.

Introduction terms of both property type and scale—is the property’s highest and best use. If the answer is Estimating the external obsolescence of a struc- “yes,” then no external obsolescence of the struc- ture is a challenging aspect of implementing ture is present, and any value change due to the the cost approach in appraisal. Because external external factor is attributable to the land. obsolescence is driven by factors outside the Second, this analysis can help validate the property, it is difficult to distinguish between magnitude of estimated external obsolescence if external obsolescence of the improvements it is present. As shown in the discussion that fol- and reductions in value of the land. If the lows, as long as land value is positive, external appraiser is not careful, it would be easy to inad- obsolescence is simply the difference between vertently double count these outside influences, the value of the land in its optimal use and its with their effects showing up both in the land value in the current use. When an appraiser uses value estimate and the estimated value of the traditional methods to estimate external obsoles- improvements. cence, the resulting figure can be compared with This article shows that external obsolescence this benchmark to verify its reasonableness. arises only when the existing structure is not the Finally, this analysis provides external confir- site’s highest and best use. As a result, external mation of the land value estimate that may factors that affect the property’s value are attrib- have been derived from another source. If the utable to the land when the current use is opti- property’s current use is its highest and best use mal and to the external obsolescence of the and a large estimate of external obsolescence building otherwise. By paying careful attention is required in the cost approach, it may imply to the highest and best use of the site, the that the external land value estimate needs to appraiser can more accurately allocate the be reevaluated. impact of external factors to the land and build- ing value estimates. Defining and Measuring This has several important implications for External Obsolescence practicing appraisers. First, it provides the ana- The Dictionary of , sixth edi- lyst with a simple and theoretically rigorous test tion, defines external obsolescence as “a type of for determining whether external obsolescence depreciation; a diminution in value caused by should be applied in the cost approach. A key negative external influences and generally incur- consideration is whether the current use—in able on the part of the owner, landlord, or

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tenant.” 1 In his Appraisal Journal article, Thomas ing external obsolescence and clearly demon- Williams, MAI, discusses three categories of strates that it is inappropriate to simply allocate external obsolescence: locational (e.g., a neigh- the impact of external factors based on a land- borhood whose properties are transitioning into to-cost or other arbitrary ratio. All of the book’s a new highest and best use), environmental (e.g., examples, however, are developed assuming an properties affected by a noxious nearby use), and accurate external land value estimate. The pres- economic (e.g., property rent changes in a loca- ent analysis therefore augments this book by tion due to changing economic conditions such providing a benchmark for validating that the as oversupply).2 Because each of these external external land value estimate is reasonable given factors may also affect land values, it can be chal- the parcel’s highest and best use. lenging to determine how they actually affect At the heart of the analysis is the residual the- structure values as opposed to the land itself.3 ory of land values, wherein the value of a parcel The Appraisal of Real Estate, fifteenth edition, is the difference between its market value and suggests two methods for estimating external fair compensation to the other factors of produc- obsolescence.4 When sufficient data is available, tion. A direct implication of this theory is that the appraiser might use paired data analysis to the outside factors that might cause obsolescence directly compare similar properties with and affect land values first, with structure values without external obsolescence. Second, external being affected only as a byproduct. obsolescence might be estimated by capitalizing Indeed, the urban economic theory that under- the income loss due to the external factor, either lies much of appraisal practice is built on the pri- through direct capitalization or discounted cash macy of land values. Thus, to understand external flow analysis. obsolescence, we must first understand how these Some authors have proposed more specific outside factors affect land values. methodologies for estimating external obsoles- cence due to special influences such as oversup- ply within a market5 or market-wide downturns.6 Land Values and Highest and Best Use At the end of the day, however, each of these methods essentially involves estimating the total Appraisers and others involved in real estate gen- value loss due to the external factor and then erally are quite familiar with the dictum that a allocating it between the land and the building parcel’s land value is determined by its value under in a relatively arbitrary way. The purpose of this its highest and best use as though vacant, regard- article is to provide guidance as to when this less of its current use. An important implication value loss is attributable to the land and when it of this idea, however, is less well understood. If is attributable to the structure. the building or structure present on the parcel Perhaps the most practically relevant and the- maximizes the land’s value—that is, if the current oretically satisfying treatment of external obso- use is the parcel’s highest and best use—then any lescence can be found in In Defense of the Cost loss in value due to external factors is attributable Approach: A Journey into Commercial Deprecia- to the land, not the building. In other words, tion.7 In this excellent book, Nelson Bowes, MAI, external obsolescence of the structure arises if and provides straightforward techniques for estimat- only if that building is wrong for the site.

1. Appraisal Institute, The Dictionary of Real Estate Appraisal, 6th ed. (Chicago: Appraisal Institute, 2015), s.v. “external obsolescence.” 2. Thomas P. Williams, “Categorizing External Obsolescence,” The Appraisal Journal (April 1996): 148–154. 3. Throughout this article, the term “external factors” is used to refer to anything outside the property that might affect the property’s value, either by affecting the value of the land or the value of the structure. In contrast, “external obsolescence” refers only to situations where the external factor affects the value of the structure. Thus, some but not all external factors may result in external obsolescence. 4. Appraisal Institute, The Appraisal of Real Estate, 15th ed. (Chicago: Appraisal Institute, 2020), 591–597. 5. MacKenzie S. Bottum, “Estimating Economic Obsolescence in Supply-Saturated Office Markets,” The Appraisal Journal (October 1988): 451–455. See also MacKenzie S. Bottum and Scott D. Evans, “Supply-Saturation-Induced External Obsolescence: Two Techniques for Quantifying Value Loss,” The Appraisal Journal (October 1993): 545–552. 6. Mark Galleshaw, “Market-Wide External Obsolescence,” The Appraisal Journal (October 1991): 519–525. 7. E. Nelson Bowes, In Defense of the Cost Approach: A Journey into Commercial Depreciation (Chicago: Appraisal Institute, 2011), e-book.

96 The Appraisal Journal • Spring 2021 www.appraisalinstitute.org Land Values and External Obsolescence

Exhibit 1 Case Study Example: Vacant Parcel with Office and Retail Potential Uses

Scenario 1 Scenario 2 Retail rents fall, no change Retail rents fall, change Potential Uses in highest and best use in highest and best use

Office Retail Office Retail Office Retail Net operating income (NOI) $360,000 $280,000 $360,000 $252,000 $360,000 $224,000 Capitalization rate (R) 8.00% 8.00% 8.00% 8.00% 8.00% 8.00%

Market value (VO = NOI / R) $4,500,000 $3,500,000 $4,500,000 $3,150,000 $4,500,000 $2,800,000 – Construction cost (C) $2,500,000 $1,000,000 $2,500,000 $1,000,000 $2,500,000 $1,000,000

= Land value in use if vacant (VL use) $2,000,000 $2,500,000 $2,000,000 $2,150,000 $2,000,000 $1,800,000

Total value (VO ) $3,500,000 $3,150,000 $2,800,000

– Land value in highest and best use (VL) $2,500,000 $2,150,000 $2,000,000

= Building value (VB = VO – VL) $1,000,000 $1,000,000 $800,000

External obsolescence (EO = VL office – VL retail) $200,000

To see this, consider a vacant parcel of land market value as a retail building would be $3.5 with two potential uses that are legally permissi- million ($280,000 ÷ 0.08). Assuming the retail ble, physically possible, and financially feasible: improvements would cost $1 million to build, the office and retail. The details of these uses are land’s value in a retail use would be $2.5 million summarized in the first column of Exhibit 1. If ($3.5 million – $1 million). Because a retail use the property is developed as an office building, brings the highest total economic return to the its annual net operating income (NOI) would land’s owner, the parcel’s highest and best use is be $360,000. Assuming a market capitalization retail. Indeed, if these two uses were proposed by rate of 8%, the office’s total market value would different developers, the land would be sold to be $4.5 million ($360,000 ÷ 0.08). If it costs the retail developer because of their willingness $2.5 million to build the office building (and to pay more for the parcel. assuming it would be built without any physical Suppose that the owner develops the land deterioration or functional obsolescence), this for retail as described above and then factors implies that the land is worth $2 million if it is external to the property change. The question developed as an office building (the $4.5 million that needs to be addressed is when such factors overall value less the $2.5 million in construc- would be captured in the land value estimate tion costs). and when an adjustment for external obsoles- Alternatively, the owner could develop the site cence should be applied to the estimated value as a retail building. A breakdown of land and of the structure. building values where retail is the highest and For example, suppose a change in retail demand best use is depicted in Exhibit 2. This use would at this location causes rents (and hence NOI) to generate annual NOI of $280,000, and assuming fall by 10%.8 This scenario is depicted as Sce- the same 8% market cap rate, the property’s total nario 1 in Exhibit 1, which shows that the prop-

8. In this example, it is assumed that the external factor affecting the parcel is a change in market demand. All of the analysis would remain the same if the change in rents (property value) were due to a different external factor such as a change in traffic patterns, environmental concerns, or another externality.

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Exhibit 2 Case Study Example: Land and Building Value with Retail as Highest and Best Use

6

5.5

5

4.5

4

3.5 VL office = 2

3

2.5 Coffice

2

1.5 VL retail = 2.5 VB office = 2.5

1 Cretail

0.5 VB retail = 1.0

0 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 5.5 6

VO retail VO office

Notes: VO use is the overall value of property in the given use (office or retail); VL use is value of land in that use; VB use is value of building in that use; and Cuse is construction cost new of building in that use. Retail is the highest and best use of this parcel because the value of land under this use (VL retail = VO retail – VB retail) is higher than its value in an office use.

erty is now worth $3.15 million ($252,000 ÷ value is $2.15 million, or $350,000 less than it 0.08). In other words, market conditions have was before rents fell, as shown in Exhibit 3. caused the property’s value to drop by $350,000. Thus, the entire value loss is attributable to the In this case, all of the lost value is attributable land, and the “external factors” affecting the to the land. To see this, note that the cost of property do not result in any external obsoles- constructing the retail building has not changed cence to the building. (it is still $1 million), so if the land were vacant This will be true as long as retail remains it would be worth $2.15 million to a retail devel- the property’s highest and best use. Suppose, oper ($3.15 million – $1 million). This is still however, that retail rents fall even more dramat- more than what the land is worth as an office ically, so that the property’s annual NOI falls (assuming that has not changed), so the proper- to $224,000; this is shown through Scenario 2 ty’s highest and best use remains retail. Since the in Exhibit 1 and illustrated in Exhibit 4. In this land’s value is, by definition, its value under its case, the property’s total value falls to $2.8 mil- highest and best use as though vacant, the land lion ($224,000 ÷ 0.08), making the land worth

98 The Appraisal Journal • Spring 2021 www.appraisalinstitute.org Land Values and External Obsolescence

Exhibit 3 Case Study Example: Falling Retail Rents, No Change in Highest and Best Use

6

5.5

5

4.5

4

3.5 VL office = 2

3

2.5 Coffice

2

1.5 VB office = 2.5 VL retail = 2.15

1 Cretail

0.5 VB retail = 1.0

0 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 5.5 6

VO retail VO office

Notes: VO use is overall value of property in the given use (office or retail); VL use is value of land in that use; VB use is value of building in that use; and Cuse is con­struction cost new of building in that use. When rents decline for retail use, the property’s overall market value in this use falls as well. Nevertheless, because the highest and best use of parcel remains retail, all of value loss is attributable to land value.

$1.8 million ($2.8 million – $1 million) in a in its highest and best use. As long as the current retail use if the property were vacant. This is use is the highest and best use, any external now lower than what the land would be worth in factors that change the property’s value will an office use (still $2 million). As a result, the affect the land value, not the structure value. parcel’s highest and best use is now “office,” meaning that the land value is $2 million, its External Obsolescence value under the parcel’s highest and best use as and Development Scale though vacant. The remaining value loss of On the surface, it might seem that external obso- $200,000 is attributable to the building in the lescence rarely occurs given that many if not form of external obsolescence (denoted in most appraisal assignments involve parcels that Exhibit 4 as EO). are already in their highest and best uses. It is These two scenarios demonstrate a simple but important to note, however, that if market con- important fact: a building only suffers from ditions change such that the property is no lon- external obsolescence when the property is not ger developed to the right scale, this too can be a

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Exhibit 4 Case Study Example: Falling Retail Rents, Change in Highest and Best Use

6

5.5

5

4.5

4

3.5 VL office = 2

3

2.5 Coffice

2

VL = 2 1.5 VB office = 2.5

1 C EO = 0.2 { retail 0.5

VB = 0.8 0 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 5.5 6

VO retail VO office

Notes: VO use is overall value of property in the given use (office or retail); VL is value of land; VB is value of building; Cuse is construction cost new of building in that use; and EO is building’s external obsolescence. If retail rents fall enough that retail is no longer the property’s highest and best use, additional value loss accrues to the building in the form of external obsolescence.

form of suboptimal use. That is, if the current and age, the house would rent for $1.10 per structure is not the same size as one that would be square foot per month. Assuming a gross rent built now if the property were vacant, external multiplier (GRM) of 100, the property’s market obsolescence will occur as well.9 value using the income approach is $110,000 To see this, consider the residential example ($1.10 psf × 1,000 sf × 100). shown as the “Baseline Scenario” in Exhibit 5. Suppose that the cost of new construction is In that example, the subject property is an $150 per square foot. In this case, the existing older, 1,000-square-foot, single-family home. house would cost $150,000 to construct new. The home’s effective age is 30 years out of an Using the age-life method, the property’s physi- economic life of 50 years. Based on its condition cal deterioration is estimated to be $90,000

9. Some might argue that the incorrect size of a building should be categorized as functional obsolescence. If the missize is entirely internal to the property, this would be correct. In most instances, however, problems of scale arise because market conditions change the optimal floor-area ratio for a site. These changes in market conditions are external to the site and therefore their impact should be categorized as external obsolescence.

100 The Appraisal Journal • Spring 2021 www.appraisalinstitute.org Land Values and External Obsolescence

Exhibit 5 Highest and Best Use (HBU) and Development Scale

Baseline Scenario Market Rents Rise Current Structure HBU as Vacant Current Structure HBU as Vacant Building size 1,000 sf 1,500 sf 1,000 sf 1,500 sf Effective age 30 years 0 years 30 years 0 years Economic life 50 years 50 years 50 years 50 years Rent (psf) $1.10 psf $2.00 psf $1.50 psf $2.40 psf Monthly rent $1,100 $3,000 $1,500 $3,600 (GRM) 100 100 100 100

Total value (VO = Rent × GRM) $110,000 $300,000 $150,000 $360,000

Construction costs $150 psf $150 psf $150 psf $150 psf Construction cost new (sf × cost psf) $150,000 $225,000 $150,000 $225,000 – Physical deterioration $90,000 $0 $90,000 $0 = Remaining physical value (RPV) $60,000 $225,000 $60,000 $225,000

Land value under current use (VLc = VO – RPV) $50,000 $75,000 $90,000 $135,000

External obsolescence (VL – VLc) $25,000 $45,000

Remaining physical value (RPV) $60,000 $225,000 $60,000 $225,000 – External obsolescence (EO) $25,000 $0 $45,000 $0

= Structure value (VB) $35,000 $225,000 $15,000 $225,000

+ Land value (VL) $75,000 $75,000 $135,000 $135,000

= Total value (VO) $110,000 $300,000 $150,000 $360,000

Notes: VO denotes the overall value of the property, VB the value of the structure, VL the value of the land (under its highest and best use), VLc the value of the land under the current use, and RPV the remaining physical value of the structure (construction cost new less physical deterioration).

[$150,000 × (30 ÷ 50)], while the property’s rent for $2.00 per square foot per month.10 This remaining physical value is $60,000. Assuming structure would cost $225,000 to build ($150 psf no functional obsolescence, what remains to be × 1,500 sf) and, recalling that the gross rent mul- estimated in order to apply the cost approach is tiplier is 100, the property’s market value would (1) the value of the land and (2) any external be $300,000 ($2.00 psf × 1,500 sf × 100). Given obsolescence of the building. this, the implied value of the land under its high- The land value is determined by the parcel’s est and best use as though vacant—and hence the highest and best use as though vacant. Suppose land’s correct value—would be $75,000. that because of changes in market conditions From this it is straightforward to determine the from when the property was first developed, that structure’s external obsolescence. The remaining if this were a vacant lot today its optimal structure physical value of the existing building is its would be a 1,500-square-foot house that would $150,000 construction cost less the physical dete-

10. An astute reader will wonder how this relates to the rent on the existing structure. For internal consistency, here it is assumed that the existing structure’s rent is the highest and best use (HBU) rent reduced to account for the property’s effective age. Specifically, Current Rent = HBU Rent × [1 – (Effective Age ÷ Economic Life) × (Cost New of HBU ÷ Value of HBU)] = $2.00 psf × [1 – (30 ÷ 50) × ($225,000 ÷ $300,000)] = $1.10 psf.

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rioration of $90,000, or $60,000.11 Subtracting pens because the existing structure is not the this from the total market value of the parcel structure that would be built if the land were shows that the land’s value under the current use vacant. As market rents increase, the “penalty” is $110,000 – $60,000 = $50,000. But as shown or value loss from having the wrong structure on above the actual land value is $75,000—its value the site increases as well. Because this value loss under the highest and best use as though vacant. has nothing to do with the land, it is rightly The difference, $25,000, is therefore attributable attributed to the structure in the form of exter- to the structure in the form of external obsoles- nal obsolescence. cence. Once again, the external obsolescence This phenomenon is directly related to tear- exists only because the current use is different downs. If rents continued to rise, land value from the property’s highest and best use. In this would rise as well and external obsolescence example, however, the suboptimal use is due to would increase until the structure value became the size of the structure, not its intended purpose. negative. Eventually, the structure’s external It is worth noting that when the suboptimality obsolescence would become sufficiently large of the existing structure is due to the wrong scale that it would pay the owner to tear it down and of the building, a rise in market rents can actually replace it with a new, correctly sized structure (in serve to increase the structure’s external obsoles- this case, one that is 1,500 square feet).14 cence. To see this, consider what happens in the example above if market rents for a new structure increase by 20% to $2.40 per square foot; this sit- Practical Implications and Conclusions uation is depicted by the “Market Rents Rise” scenario in Exhibit 5. In this case, the optimal The purpose of this article has been to highlight structure (highest and best use as vacant) will be the underlying source of external obsolescence. worth $360,000 ($2.40 psf × 1,500 sf × 100). The A structure suffers from external obsolescence if increase in rents has no impact on construction and only if the current use is not the property’s costs, so the entire value increase is attributable highest and best use, whether this is based on to the land, increasing the parcel’s land value to the functional use or the scale of the building $135,000.12 within a given use. Of course, the parcel is not vacant; it has an This idea can be applied in a wide variety of existing structure. The increase in rent causes the situations where allocating the impact of external market value of the property in its existing use factors between land and structure values might to rise to $150,000 ($1.50 psf × 1,000 sf × 100).13 otherwise be difficult. For example, in many cases Given the remaining physical value of the externalities can have opposite impacts on two structure (which remains unchanged at $60,000), different potential uses. Consider a single-family the value of the land under its current use would home on an arterial street. As traffic on the street be $90,000. Nevertheless, the land’s actual value increases, it may lower the value of the parcel as is $135,000, its value under its highest and best a single-family home but increase its value for a use as though vacant. The difference between retail or office use. Such a change will simultane- these two values, $135,000 – $90,000 = $45,000, ously increase the value of the land (assuming is the structure’s external obsolescence, or its the office or retail use is now the highest and best value loss due to having the “wrong” structure use) but decrease the value of the existing single- on the site. family structure. The techniques outlined here It may seem unusual to have external obsoles- can help an appraiser estimate these effects more cence increase when market rents rise. This hap- accurately and transparently.

11. For simplicity, it is assumed that the structure has no functional obsolescence. If it did, this would be subtracted here as well. 12. Notice that the parcel’s land value rises by more than 20%. This is because the overall value increase is magnified into its land value because of the property’s “land leverage”; see Raphael W. Bostic, Stanley D. Longhofer, and Christian Redfearn, “Land Leverage: Decomposing Home Price Dynamics,” (Summer 2007), 183–208. 13. Once again, the new rent of the property is related to its highest and best use rent as outlined in footnote 10. 14. It is worth noting that in cases like this, external obsolescence could exceed the remaining physical value of the structure so that the total structure value is negative. Suppose in the example that the cost of tearing down the existing structure is $15,000. In this case, the structure value could never fall below –$15,000; if it did, the property owner would simply tear down the existing structure and rebuild the optimal one.

102 The Appraisal Journal • Spring 2021 www.appraisalinstitute.org Land Values and External Obsolescence

Alternatively, consider how the imposition of hence, whether an estimate of external obsoles- rent controls might affect the value of an apart- cence will be needed. If the current use is the ment property. To the extent that the rent con- property’s highest and best use in both type and trols do not change the property’s highest and scale, no external obsolescence can be present. best use, the entire loss in value from this change All external factors will be captured in the esti- in the legal environment will be attributable to mated value of the land. the land value. If, on the other hand, the parcel’s Second, if external obsolescence is present, this highest and best use changes, at least part of the analysis provides a reference point for the magni- value loss will be attributable to the structure in tude of the estimated external obsolescence. In the form of external obsolescence. theory, as long as land value is positive in all Finally, suppose that a parcel is affected by a potential uses, external obsolescence must be nearby environmental catastrophe. As long as equal to the difference between the value of the the land still has some positive value after this land in its optimal use and its value under the cur- event, the external obsolescence of the structure rent use. When an appraiser uses traditional meth- will simply be the difference between the land ods to estimate external obsolescence, the resulting values in the highest and best use and the current figure can be compared to this benchmark to help use. If, however, the land becomes worthless validate the reasonableness of the estimate. because of the catastrophe, all remaining value Finally, the ideas here can help the appraiser loss will accrue to the structure in the form of determine whether the independent land value external obsolescence. estimate derived by other means is internally To restate this article’s central thesis, external consistent. If the property’s current use is its obsolescence arises when and only when the highest and best use and the appraiser cannot existing structure is not the site’s highest and best reconcile the cost approach without applying sig- use. This simple fact can help practicing apprais- nificant external obsolescence to the structure, ers in three ways. First, it allows an appraiser to this raises the question of whether the land value quickly and simply determine whether external estimate is correct, since all external influences factors are affecting the structure value and, in this instance must be attributable the land.

About the Author Stanley D. Longhofer, PhD, is a full professor and holds the Stephen L. Clark Chair of Real Estate and Finance in the W. Frank Barton School of Business at Wichita State University. He is also the founding director of the WSU Center for Real Estate, through which he provides research and educational services to real estate professionals in the Central Plains region, and is the author of the Center’s annual Kansas Housing Markets Forecast series. He holds a BBA in economics from Wichita State University and MS and PhD degrees in economics from the University of Illinois. Contact: [email protected]

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Environmental Dead Zones: The Evaluation of Contaminated Properties

by Michael Tachovsky

Abstract There are numerous environmentally contaminated sites throughout the world. The most seriously contaminated areas are typically those with pathways to human exposure and Class III land use restrictions. Land use is one of many components a buyer may consider when purchasing real estate. Where environmentally contaminated sites pose health risks, environmental agencies often impose land use restrictions. These restrictions fall into three classifications: (I) activity restrictions, (II) building restrictions, and (III) restrictions. When environmental land use restrictions are implemented, real estate appraisers may be asked to consider whether or not there is an impact to property value. This article discusses the evaluation of contaminated properties from a real estate valuation perspective. It sets forth the term “environmental dead zone” to describe certain environmentally contaminated sites, and it discusses environmental land use restrictions within a framework of three restriction classifications.

Environmentally Contaminated Sites studying environmentally contaminated proper- ties, including three classifications of land use Environmentally contaminated sites are part of our restrictions related to contamination: (I) activity industrial and post-industrial society, as society restrictions, (II) building restrictions, and (III) demands commodities produced at many of these occupancy restrictions. sites. However, society has become increasingly This article also discusses what will be referred aware of the spread of environmental contamina- to as “environmental dead zones” (EDZs). The tion beyond the commercial and industrial source term “environmental dead zone” does not appear sites. Today, there are more than 1,300 active “sites in any official environmental documentation or of concern” identified on the National Priorities in any academic or professional literature, but it List (NPL),1 but there are even more sites that are is used here to describe environmentally contam- unidentified or yet to be identified. In addition, the inated areas with pathways to human exposure number of sites identified by the US Environmen- and Class III (occupancy) land use restrictions.2 tal Protection Agency (EPA) is small compared to Thus, for purposes of the discussion in this arti- the number identified by local and state governing cle, the category EDZ has two defining factors: boards. Such sites include gas stations, dry clean- exposure and land use restrictions. When it ers, landfills, agricultural farms, and more. comes to environmental contamination, expo- This article outlines considerations that real sure is the condition under which a potentially estate valuation professionals can make when harmful material (e.g., radiation, hydrocarbons,

1. “Superfund Site Information,” US Environmental Protection Agency (EPA), search April 20, 2021, https://bit.ly/34CFFbR. 2. The EPA and scientific community use the term “dead zone” on its own as an ecological term to describe areas of water bodies where aquatic life cannot survive because of low oxygen levels, generally caused by significant nutrient pollution. See “The Effects: Dead Zones and Harmful Algal Blooms,” EPA, https://bit.ly/3wU6Gnj. The term “EDZ” used in this current article is broader than the ecological term for nutrient pollutants in bodies of water and refers to toxic pollutants on land.

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PFCs) is contacted.3 Land use restrictions are lim- asbestos was a focus of concern as well as air qual- itations to the conventional use of land. Land use ity with passage of the Clean Air Act Amend- “represents the economic and cultural activities ments and release of the EPA’s Green Book on air (e.g., agricultural, residential, industrial, mining, quality.9 PFAS chemicals became a concern in and recreational uses) that are practiced at a the 2000s, with the recent and ongoing research given place” 4 and may also be defined as “the on these chemicals’ health effects.10 Concerns employment of a site or holding to produce reve- surrounding toxic chemicals and environmen- nue or other benefits.” 5 Land use is one of many tally contaminated sites continue today. components that a buyer may consider when pur- Lawmakers have responded to the heightened chasing real property. When environmentally environmental awareness by drafting compre- contaminated sites pose human health risks, hensive legislation.11 Exhibit 1, partially adapted environmental agencies often implement land from Real Estate Damages, third edition,12 pro- use restrictions,6 which may influence a buyer’s vides a selected chronology of US environmental purchasing decision. When land use restrictions acts, laws, regulations, and policies. are implemented, real estate valuation profes- The government’s role in regulation of prop- sionals may be asked to consider whether or not erty use is explained in The Appraisal of Real there is an impact to property value. Estate, fifteenth edition, as follows:

US Environmental Policy All laws and operations of government are intended to US environmental policies were established serve the public. Thus, in the public interest, govern- before awareness of the detrimental health and ment may impose building restrictions, zoning and environmental concerns of contamination building ordinances, development and subdivision reg- emerged on a widespread public scale. However, ulations, and other land use controls. These controls environmental concerns became more promi- affect what may be developed, where development nent during the 1960s.7 In 1962, the book Silent may occur, and what activities may be permitted subse- Spring, by Rachel Carson, brought increased quent to development. Since the 1960s, the federal awareness of the detriments of toxic exposure. government, in cooperation with the states, has Carson reported on the insecticide DDT and increased its efforts to regulate the air and water emis- how it entered the food chain, causing the thin- sions from manufacturing processes and to reduce pol- ning of eggshells, which in turn caused eggs to lution caused by dirt, chemicals, and noise. Land use break before hatching. In the late 1970s, public regulations have been expanded to wetlands, beaches, concern increased regarding potentially cata- and navigable waters and to preserve the habitats of strophic accidents with nuclear power facilities, endangered species. and because of the chemical waste effects at Love As the nature and extent of land use controls change, Canal, public concern emerged over the storage so do the nature and extent of private land ownership. of hazardous waste in the 1980s.8 In the 1990s, Such changes may affect markets and, ultimately, real

3. T. F. Long, M. L. Gargas, R. P. Hubner, and R. G. Tardiff, “The Role of Risk Assessment in Redeveloping Brownfields Sites,” in Brownfields: A Comprehensive Guide to Redeveloping Contaminated Property, 2nd ed., ed. Todd S. Davis (Chicago: American Bar Association, 2002), 285. 4. “Land Use: What Are the Trends in Land Use and Their Effects on Human Health and the Environment?” EPA, https://www.epa.gov/report-environment/land-use. 5. Appraisal Institute, The Dictionary of Real Estate Appraisal, 6th ed. (Chicago: Appraisal Institute, 2015), s.v. “land use.” 6. “Report to Congressional Requestors—Hazardous Waste Sites: Improved Effectiveness of Controls at Sites Could Better Protect the Public,” US Government Accountability Office (January 2005). 7. Howard Zinn, A People’s History of the United States (Harper Perennial, 2015), 441–442. 8. Louis Harris, Public Opinion (April/May 1980), 26. 9. “Nonattainment Areas for Criteria Pollutants (Green Book),” EPA, https://www.epa.gov/green-book. 10. See “PFOA, PFOS and Other PFAS,” EPA, https://www.epa.gov/pfas/basic-information-pfas; and C8 Science Panel website, http://www.c8sciencepanel.org/. 11. George P. Bernhardt, “Environmental Issues in Real Estate Purchase and Sale Agreements,” Probate and Property 34, no. 5 (September/ October 2020): 54. 12. Randall Bell, Real Estate Damages, 3rd ed. (Chicago: Appraisal Institute, 2016), 210.

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Exhibit 1 Chronology of Selected Environmental Acts, Laws, Regulations, and Policies

Year Act, Law, Regulation, or Policy Year Act, Law, Regulation, or Policy

1899 Rivers and Harbors Act (The “Refuse Act”). Designed to 1987 Federal Water Quality Act protect navigable waters, especially the Mississippi River Air Toxics “Hot Spots” Information and Assessment Act system, from floating debris that constituted hazards to navigation. 1990 Oil Pollution Act Clean Air Act Amendments 1947 Federal Insecticide, Fungicide, and Rodenticide Act (FIFRA) Pollution Prevention Act 1948 Federal Water Pollution Control Act (Old Clean Water Act) Hazardous Waste Operations and Emergency Response Act 1954 Atomic Energy Act Fleet Factors—A lender does not even have to hold title 1956 Clean Water Act to have liability under CERCLA. If the lender exerts control over a business, then it may become liable. 1957 Price-Anderson Act. Designed to provide compensation for damages from potential nuclear accidents. 1992 OSHA Process Safety Management Standards

1963 Clean Air Act (CAA) Title X Housing and Community Development Act (lead-based paint) 1966 National Historic Preservation Act EPA issues Lender Liability Rule—Attempted to protect lenders, 1967 Clean Air Act Revision etc., and struck down by Appeal Court 2/4/94.

1969 National Environmental Policy Act 1994 ASTM Standard Practice for Site Assessment 1972 Marine Protection, Research, and Sanctuaries Act Federal Actions to Address Environmental Justice in Minority Populations and Low-Income Populations Federal Coastal Zone Management Act (Executive Order 12898) Federal Water Pollution Control Act Amendments (Clean Water Act) 1995 EPA Officially Begins Brownfields Programs Federal Environmental Pesticide Control Act Contaminated Aquifer Policy Prospective Purchaser Agreements 1973 Federal Endangered Species Act Comfort Letters 1974 Safe Drinking Water Act (SDWA) EPA issues Lender Liability Policy. Attempts to protect still 1976 Resource Conservation and Recovery Act (RCRA). Defined unconvinced lenders. what was hazardous and drew a distinction between 1997 The Kyoto Protocol results in 38 industrialized nations hazardous material and hazardous waste. agreeing to reduce greenhouse emissions. The United States Toxic Substances Control Act (TSCA) agrees to reduce emissions by 7%.

1977 Clean Water Act Amendments 2000 The Everglades obtain $7.8 billion in aid to restore the 1978 Uranium Mill Tailings Radiation Control Act ecosystem.

1979 Hazardous Liquid Pipeline Safety Act 2001 The Bush Administration refuses to sign the Kyoto Protocol. It is ratified in 2005; however, the United States and Australia 1980 Comprehensive Environmental Response, Compensation, do not sign the treaty. and Liability Act (CERCLA) “Superfund.” Intended to take care of cleanups at sites that were no longer being operated. 2005 Price-Anderson Act amended.

1984 Hazardous and Solid Waste Amendments 2009 EPA releases Health Advisories of 400ppt for PFOA and 200ppt for PFOS. 1985 US Supreme Court support of Adjacent or Isolated Wetlands as “Waters of the U.S.” 2014 The United Nation’s Intergovernmental Panel on Climate Change (IPCC) releases a major report concerning climate 1986 Safe Drinking Water and Toxic Enforcement Act (California change. Proposition 65) 2016 EPA establishes new Health Advisories of 70ppt for PFOA Superfund Amendment and Reauthorization Act (SARA) and PFOS in drinking water. Maryland Bank and Trust—Superfund liability can attach to a lender that takes title to a property through foreclosure.

Source: Adapted and updated from Randall Bell, Real Estate Damages, 3rd ed. (Chicago: Appraisal Institute, 2016), Exhibit 8.3.

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estate values. Consequently, real estate valuation pro- nation at these sites, and established a trust fund fessionals ought to be familiar with the regulations and to provide cleanup when no responsible party can restrictions that apply to land use and understand how be identified.17 CERCLA addresses the protection these regulations may affect a specific property.13 of human health by managing the cleanup of the nation’s worst environmentally contaminated Environmental Land Use Restrictions sites and responding to significant environmental As Exhibit 1 shows, many seminal US environ- emergencies.18 It also frames the discussion about mental laws were enacted between 1960 and pathways to human exposure, how to identify 1980. These laws include the Clean Air Act them, and their potential routes.19 When human (CAA, 1963), the Federal Water Pollution Con- exposure pathways are identified, and a risk to trol Act Amendments (Clean Water Act, 1972), human health is established, environmental land the Federal Environmental Pesticide Control Act use restrictions are typically implemented through (1972), the Safe Drinking Water Act (SDWA, institutional controls.20 Environmental agencies 1974), the Resource Conservation and Recovery implement institutional controls using land use Act (RCRA, 1976), the Toxic Substances Con- control (LUC) strategies, as such institutional trol Act (TSCA, 1976), and the Comprehensive controls are a subset of LUCs (Exhibit 2).21 Environmental Response, Compensation, and In the United States, land use regulations as Liability Act (CERCLA, 1980).14 Environmental controls to promote public health and safety in contamination policies largely stem from the urban areas date back to the Massachusetts Bay RCRA and CERCLA.15 RCRA and CERCLA Company in the 1600s.22 Local and state govern- are similar and seek to achieve consistent out- ing agencies have since adopted similar land use comes, such as limiting exposure to hazardous regulation strategies, commonly through zoning. substances. Nonetheless, there are differences. As The Appraisal of Real Estate, fifteenth edition, For example, RCRA’s approach is management of notes, “It is important for appraisers to consider solid and hazardous waste at facilities that are cur- all known restrictions imposed on development, rently in use, while CERCLA is focused on the which may include not only zoning but other management and remediation of abandoned, land use restrictions as well.” 23 non-operating sites.16 LUCs are the chief approach for environmen- CERCLA was a modern tipping point in envi- tal agencies. Controls can be engineered (e.g., ronmental policy as it marked the beginning of barriers, fences, and security guards) or non- the Superfund. CERCLA established prohibi- engineered. Agencies use institutional controls tions and requirements concerning closed and as part of an overall site cleanup plan and as abandoned hazardous waste sites, provided liabil- mechanisms to ensure that the engineered con- ity of persons responsible for releases of contami- trols remain intact and operational;24 they also

13. Appraisal Institute, The Appraisal of Real Estate, 15th ed. (Chicago: Appraisal Institute, 2020), 13. 14. Bernhardt, “Environmental Issues in Real Estate Purchase and Sale Agreements,” 54. 15. Bell, Real Estate Damages, 3rd ed., 209. 16. “Qs & As on RCRA vs. CERCLA at the DuPont Pompton Lakes Works Site,” EPA (February 2011). Another piece of legislation leading up the environmental policies of 1960 to 1980 is the Price-Anderson Act, which was first introduced in 1957 during the growth of nuclear energy in the private sector. This act is designed to provide compensation for damages from nuclear accidents. 17. “Superfund: CERCLA Overview,” EPA, https://www.epa.gov/superfund/superfund-cercla-overview. 18. “Superfund: CERCLA Overview,” EPA, https://www.epa.gov/superfund/superfund-cercla-overview. 19. “Superfund Human Exposure Dashboard,” EPA, https://bit.ly/3wfosl3. The Appraisal of Real Estate, 15th ed., 187, also discusses environ- mental exposure pathways, including, but not limited to, air, surface, subsurface, vapor, well water, and safe storage. 20. “Superfund: Institutional Controls,” EPA, https://bit.ly/3gdOmjq. 21. “Institutional Controls: A Guide to Planning, Implementing, Maintaining, and Enforcing Institutional Controls at Contaminated Site,” EPA Office of Solid Waste and Emergency Response (December 2012). 22. Roy P. Drachman, “Land Use Under Current Restraints,” The Appraisal Journal (April 1974): 166. 23. The Appraisal of Real Estate, 15th ed., 394. 24. Thomas O. Jackson and J. Michael Sowinski Jr., “Institutional Controls and Contaminated Property Valuation,” The Appraisal Journal (Fall 2006): 328–332.

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help modify or guide human behavior at a site.25 remains on site. As such, informational devices There are four categories of institutional con- generally do not provide enforceable restrictions. trols: proprietary controls, government controls, Typical informational devices include state regis- enforcement and permit tools, and information tries of contaminated sites, notices in deeds, devices.26 Each category has numerous subtypes tracking systems, and fish/shellfish consumption that can be implemented. Of the four categories, advisories.30 three restrict land use, and one is an advisory. In certain instances, LUCs can result in a Proprietary controls refer to controls on land restriction on the use of a property or group of use that are considered private in nature because properties. As such, environmental land use they tend to affect a single parcel of property and restrictions affect the use of real estate and are are established by private agreement between restrictions typically implemented through envi- the property owner and a second party who, in ronmental agency strategies. Environmental turn, can enforce said controls. Common exam- agencies can employ a variety of land use restric- ples include easements that restrict use (also tions. Some environmental land use restrictions known as negative easements) and restrictive are temporary, some are ongoing, some are man- covenants.27 datory, and some are voluntary. Economic and Government controls impose restrictions on cultural land use might be impacted when such land or resource use via the authority of a gov- restrictions are implemented, raising the ques- ernment entity. Typical examples of governmen- tion as to whether land use restrictions impact tal controls include zoning, building codes, state, real estate value.31 tribal, or local groundwater use regulations, In evaluating any potential impacts on real commercial fishing bans, and sports/recreational estate value, three general classifications can be fishing limits. The controls may be posed by fed- used; these are described in this article as Class I, eral, state, and local resources and public health activity restrictions; Class II, building restrictions; agencies.28 and Class III, occupancy restrictions. Exhibit 3 Enforcement and permit tools are legal tools, shows each category with the typical land use such as administrative orders, permits, federal restrictions for the class and a description of the facility agreements, and consent decrees, that aim of the restrictions. The environmental land limit certain site activities or require the perfor- use classifications represent different categorical mance of specific activities (e.g., monitor and types of restrictions. Class III represents the most report on institutional control effectiveness). serious restrictions; for purposes of the current These legal tools may be issued unilaterally or discussion, properties with Class III restrictions negotiated.29 may be considered “environmental dead zones,” Information devices provide information or or “EDZs.” Each category is independent, but notification often as a recorded notice in prop- more than one category may apply to a property. erty records or as advisories to local communi- For example, a property might have both a restric- ties, tourists, recreational users, or other tion on growing crops (Class I) and a restriction interested persons that residual contamination limiting residential development (Class II).

25. “Institutional Controls: A Guide to Planning, Implementing, Maintaining, and Enforcing Institutional Controls at Contaminated Site,” EPA Office of Solid Waste and Emergency Response (December 2012). 26. “Institutional Controls: A Site Manager’s Guide to Identifying, Evaluating and Selecting Institutional Controls at Superfund and RCRA Corrective Action Cleanups,” EPA Office of Solid Waste and Emergency Response (September 2000). 27. “Institutional Controls: A Guide to Planning, Implementing, Maintaining, and Enforcing Institutional Controls at Contaminated Site,” EPA Office of Solid Waste and Emergency Response (December 2012): 3. 28. “Institutional Controls: A Guide to Planning, Implementing, Maintaining, and Enforcing Institutional Controls at Contaminated Site,” EPA Office of Solid Waste and Emergency Response (December 2012): 4. 29. “Institutional Controls: A Guide to Planning, Implementing, Maintaining, and Enforcing Institutional Controls at Contaminated Site,” EPA Office of Solid Waste and Emergency Response (December 2012): 4. 30. “Institutional Controls: A Guide to Planning, Implementing, Maintaining, and Enforcing Institutional Controls at Contaminated Site,” EPA Office of Solid Waste and Emergency Response (December 2012): 4. 31. Land use as described in “Land Use: What Are the Trends in Land Use and Their Effects on Human Health and the Environment?” EPA, https://www.epa.gov/report-environment/land-use.

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By reviewing past environmental contamina- Exhibit 2 Land Use Controls (LUCs) Flowchart tion incidents, the nuances of classifications become apparent. For example, in the case of Three Mile Island, voluntary evacuation and Environmental Agency Land Use Controls (LUCs) numerous activity restrictions were set in place on March 28, 1979, resulting in both Class I and Class III land use restrictions. Once the evacua- tion warning was lifted, most of the residents returned to their homes within three weeks,32 Non-Engineered Controls Engineered Controls ceasing the Class III restriction. Like Three Mile Island, the residents of Chernobyl were evacu- ated, leading to a Class III or an environmental dead zone restriction. Since then, certain Cher- nobyl residents have been allowed to resettle in Institutional Controls (ICs) E.g., portions of the previous exclusion zone; however, 1. Proprietary Controls • Barriers most of the area surrounding the reactor remains (restrictions—e.g., easements) • Fences an exclusion zone. • Security Guards Brownfield redevelopment projects also illus- 2. Governmental Controls (restrictions—e.g., zoning) trate changing environmental land use restric- tion classifications; however, restrictions and 3. Enforcement and Permit Tools classifications do not always change over time. (restrictions—e.g., consent decrees) For example, the uranium mining town of 4. Information Devices Uravan, Colorado, has mostly continued as a (advisories—e.g., notice in deeds) Class III environmental dead zone site since its evacuation and demolition in 1986, with occu- pancy restrictions remaining in place. Another Sources: “Institutional Controls: A Guide to Planning, Implementing, Maintaining, and Enforcing example is the Love Canal neighborhood, which Institutional Controls at Contaminated Sites,” EPA Office of Solid Waste and Emergency Response encompasses both Class III and Class II restric- and Office of Enforcement and Compliance Assurance (December 2012); “Strategy to Ensure Institutional Control Implementation at Superfund Sites,” EPA (September 2004); “Memorandum: tions. Rings 1 and 2 of the Love Canal signifies Sample Federal Facility Land Use Control ROD Checklist with Suggested Language (LUC Checklist),” Class III restrictions and an environmental dead EPA Office of Solid Waste and Emergency Response (January 4, 2013); “Report to Congressional zone, because it is a fenced off exclusion zone Requestors, Hazardous Waste Sites: Improved Effectiveness of Controls at Sites Could Better where conventional occupancy is restricted. Ring Protect the Public,” US Government Accountability Office (January 2005). 3 of the Love Canal area illustrates a Class II restriction, where a few residential homes await demolition and there are discussions of potential Brownfields and Land Revitalization Program is light industrial or retail redevelopment.33 designed to prevent, assess, safely clean up, and Since the inception of CERCLA, thousands of sustainably reuse brownfields,35 and it may environmental contamination sites have been address a site with Class II residential develop- identified across the United States.34 When ment restrictions. Through cleanup efforts and evaluating environmentally contaminated sites, changes in zoning, Class II residential zoning it is important for real estate valuation profes- restrictions may be lowered to Class I restric- sionals to convey the period of time and the tions or to none at all. In terms of real estate environmental land use restriction classification valuation, this relates to a contaminated proper- at the time of the valuation analysis. As the ty’s remediation lifecycle stage, which consists of examples have demonstrated, a site might have three stages of cleanup: before, during, and after Class I and Class III restrictions at one time, remediation. The remediation lifecycle stage and only Class I restrictions later. The EPA’s can be an important determinant of risk associ-

32. Susan Cutter and Kent Barnes, “Evacuation Behavior and Three Mile Island,” Disasters 6, no. 2 (June 1982): 116–124. 33. Bell, Real Estate Damages, 3rd ed., 243. 34. “What Is Superfund?” EPA, https://www.epa.gov/superfund/what-superfund. 35. “Overview of EPA’s Brownfields Program,” EPA, https://bit.ly/3wiepeK.

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Exhibit 3 Land Use Restriction Classifications

Class Category Type of Restriction Description

I Activity Crops and Farming, Excavation, Groundwater Activity land use restrictions involve impacts to the typical and Drinking Water, Gardening, etc. day-to-day human uses of a property. This type of restriction aims to reduce human exposure by limiting pathways to exposure.

II Building Residential, Commercial, Industrial, etc. Building land use restrictions are designed around what can be physically and legally developed on a property. These types of restrictions are typically legally imposed regulation such as zoning ordinances. Human exposure is limited by reducing exposure time and limiting overall pathways to exposure.

III Occupancy Evacuations, Exclusion Zones, Restricted Occupancy land use restrictions are typically the most restrictive Normal Human Exposure, etc. of the land use restriction classes. They generally aim to almost completely eliminate normal human exposure, although in cases “safe” human exposure might be designated for testing and remediation efforts. Occupancy restrictions can be short-term (e.g., evacuations) or long-term (e.g., exclusion zones).

Source: Developed by Michael Tachovsky.

ated with environmental contamination, as Market Awareness environmental risk can be expected to vary with When measuring environmental risk effects, if the remediation stage of the property.36 any, on property values, an analysis of market awareness in the study area may be necessary to determine whether market participants are Research Methodologies and EDZs knowledgeable of the detrimental condition. Robinson and Lucas observe that Classifying environmental land use restrictions and identifying EDZs can help real estate valua- a sometimes-overlooked component of market value is tion professionals in the development of an opin- the extent that seller disclosure and buyer knowledge ion of value. As a real estate research method, affect property value. Sellers and their intermediaries this shares similarities with comparative research, may have a legal obligation to disclose certain informa- which compares and contrasts multiple features tion about a property, but failure to do so is not uncom- and characteristics among data.37 It is also similar mon. As a result, buyers may unknowingly purchase to tools such as the Detrimental Conditions properties with a serious condition, such as environ- (DC) Matrix, which serves as a practical tool for mental contamination.39 organizing the numerous issues that accompany detrimental condition assignments.38 By classify- A seller may not know that their property is con- ing environmental land use restrictions and iden- taminated, and disclosure of the contamination tifying EDZs, a real estate valuation professional may not occur. Although the market participants can better organize and analyze any issues that are not aware of the contamination issues, an accompany contaminated sites. appraiser may later be provided with scientific

36. Appraisal Standards Board, Advisory Opinion 9 (AO-9), “The Appraisal of Real Property That May Be Impacted by Environmental Contami- nation,” in USPAP Advisory Opinions, 2020–2021 (Washington, DC: Appraisal Foundation, 2020), Lines 93–96. 37. Randall Bell and Michael P. Bell, “Real Estate Research Methods,” The Appraisal Journal (Fall 2015): 316. 38. Orell Anderson, “Environmental Contamination: An Analysis in the Context of the DC Matrix,” The Appraisal Journal (July 2001): 331. 39. Rudy R. Robinson III and Scott R. Lucas, “Seller Disclosure and Buyer Knowledge: How They Affect Market Value,” The Appraisal Journal (Spring 2007): 134.

110 The Appraisal Journal • Spring 2021 www.appraisalinstitute.org Environmental Dead Zones: The Evaluation of Contaminated Properties evidence and must consider accounting for this “verify information with a party to the transac- knowledge in an assignment. tion to ensure its accuracy and to gain insight into Accordingly, if a market lacks awareness of a the motivation behind each transaction.” 44 detrimental condition, that does not automati- Market value does not require that a market cally mean that the detrimental condition has no have perfect knowledge of a detrimental condi- impact on market value. Robinson and Lucas tion. However, market participants should be state that an “appraiser cannot use the transac- well-informed of a detrimental condition for a tion as an impaired sale to measure the condition’s transaction to be consistent with the definition of effect on value” if a buyer lacks awareness of the market value and requisite of an arm’s-length detrimental condition.40 However, Valuing Con- transaction.45 When a real estate market has taminated Properties notes that “those sales actu- become knowledgeable of environmental influ- ally do reveal the effect of that condition on prices ences (or other detrimental conditions) on prop- and therefore values in that particular market” 41 erties in the study area, that market will either and furthermore, “the knowledge standard against react or not react in its pricing decisions, based on which that is determined is actual knowledge of its perception of risk and potential impact of the typical buyers and sellers in the marketplace.” 42 contamination (or detrimental condition).46 Rob- The anecdote of “actual knowledge” can be a inson and Lucas suggest the use of a questionnaire false premise when an appraiser is provided con- to determine market awareness of a detrimental flicting evidence regarding a detrimental con­ condition.47 Additionally, market awareness of a dition. Contrary to the anecdote of “actual detrimental condition can be studied by analyzing knowledge,” there are thousands of lawsuits filed documents and marketing every year claiming real estate damages for the material, such as transfer disclosure statements non-disclosure of detrimental conditions. In these and records, when avail- lawsuits, property owners often state, “I would not able. If transactions are identified that disclose have paid the same price had I known about the nature and extent of the detrimental condi- the detrimental condition” or even “I would not tion, then those transactions can be studied to have purchased the property had I known about measure impacts, if any, of the condition. the detrimental condition.” Consistent with the Furthermore, some detrimental conditions are property owner narratives, the definition of mar- self-evident; for example, a recent wildfire will ket value in The Appraisal of Real Estate, fifteenth likely have burn zones that act as visual cues to edition, is premised on a knowledgeable buyer market participants. Nonetheless, some environ- and seller.43 Simply stating that “actual knowl- mental issues may be less evident to market par- edge” reflects the knowledge standards does not ticipants, as general detrimental cues may be address market value when contrary evidence of a absent; for instance, contaminants themselves detrimental condition exists. A real estate valua- may be colorless, odorless, and tasteless. Even if tion professional should study market awareness some cues of a detrimental condition exist, mar- to determine if a market or parties of a transaction ket awareness of the condition may still be lack- are well-informed of the nature and extent of a ing or not be recognized by all market participants. detrimental condition that is being studied, and For example, local media coverage of a property

40. Robinson and Lucas, “Seller Disclosure and Buyer Knowledge,”136. 41. Richard Roddewig, ed., Valuing Contaminated Properties: An Appraisal Institute Anthology Volume II (Chicago: Appraisal Institute, 2014), 196. 42. Roddewig, Valuing Contaminated Properties, 196. 43. Market value is the most probable price, as of a specified date, in cash, or in terms equivalent to cash, or in other precisely revealed terms, for which the specified property rights should sell after reasonable exposure in a competitive market under all conditions requisite to a fair sale, with the buyer and seller each acting prudently, knowledgeably, and for self-interest, and assuming that neither is under undue duress. [Emphasis added.] The Appraisal of Real Estate, 15th ed., 48. 44. The Appraisal of Real Estate, 15th ed., 358. 45. Robinson and Lucas, “Seller Disclosure and Buyer Knowledge,” 137. 46. Thomas O. Jackson, “Surveys, Market Interviews, and Environmental Stigma,” The Appraisal Journal (Fall 2004): 303. 47. Robinson and Lucas, “Seller Disclosure and Buyer Knowledge,” 135. They note that a questionnaire is distinct from a formal survey.

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condition does not necessarily create an informed icine, and political science.51 Case studies have market, because a limited percentage of a popula- been defined as “the study of an issue through tion may read or watch local news, media cover- one or more cases within a bounded system,” 52 age on an issue may be time sensitive and covered and numerous case studies may be considered in for only a short period of time, and buyers from an analysis. outside the area are less likely to have witnessed When using more than one case study, real local news stories on the issue. estate valuation professionals may choose to As such, a real estate valuation professional employ another comparative method: an adjust- “should be careful not to assume that the mere ment grid. Adjustment grids draw on the use of existence of media attention indicates wide- market grids like in the sales comparison spread public knowledge,” 48 when other indica- approach. A case study grid can be developed to tors of a detrimental condition are lacking. draw comparisons between the subject proper- Moreover, if indicators of a detrimental condi- ty(ies) and case studies.53 With environmental tion are lacking, and market awareness of the case studies, a real estate valuation professional detrimental condition is lacking in a study area, may consider using the relevant property charac- then real estate valuation professionals may con- teristics in USPAP Advisory Opinion 9 to draw sider techniques such as case studies, surveys, and comparisons.54 However, the use of an adjust- literature reviews to measure environmental risk ment grid is not necessary;55 nevertheless, valua- effects, if any, on property values. tion professionals should reconcile their data. In sciences, the reconciliation process of mul- Case Study Approach tiple sets of data is referred to as triangulation, The Appraisal of Real Estate, fifteenth edition, which is a well-known strategy to increase the advises that “environmental case studies are typ- reliability and validity of a study.56 When apply- ically useful when a source site is being appraised ing the results of environmental case studies, an or in a situation involving an impacted neighbor- appraiser should consider whether the case studies hood or area where there are insufficient sales to are similarly situated with respect to the subject understand the effect of the environmental issue property(ies) and environmental condition57— on prices and values.”49 As such, when market however, when using case studies, things do not awareness of an environmental condition is lack- have to be identical or similar. For example, case ing in a study area, there may be insufficient data studies do not need to be in the same area as the to evaluate price effects, if any, of the detrimental subject property(ies), and data limitations usually condition. necessitate searching a broad geographical area.58 The case study approach itself is a comparative It is rare, if not impossible, to find identical case method50 and a common approach throughout studies; however, the objective is to find case sciences, having a distinguished history across studies that are similar on some level. The identi- many disciplines including law, psychology, med- fication classification of land use restrictions and

48. Robinson and Lucas, “Seller Disclosure and Buyer Knowledge,” 135. 49. The Appraisal of Real Estate, 15th ed., 188. 50. Bell and Bell, “Real Estate Research Methods,” The Appraisal Journal (Fall 2015): 316. 51. John W. Creswell and Cheryl N. Poth, Qualitative Inquiry and Research Design: Choosing Among Five Approaches, 4th ed. (Thousand Oaks, CA: Sage Publications, 2018), 97. 52. John W. Creswell, Qualitative Inquiry and Research Design: Choosing Among Five Approaches, 2nd ed. (Thousand Oaks, CA: Sage Publications, 2007), 61. 53. A similar sales comparison approach is illustrated in Thomas O. Jackson, “The Effect of Previous Environmental Contamination on Industrial Real Estate Prices,” The Appraisal Journal (April 2001): 200–210. 54. The Appraisal of Real Estate, 15th ed., 188. Also see discussion in Thomas Jackson and Randall Bell, “The Analysis of Environmental Case Studies,” The Appraisal Journal (January 2002): 86–95. 55. The Appraisal of Real Estate, 15th ed., 361. 56. Robert Yin, chapter 4 in Case Study Research: Design and Methods, 5th ed. (Thousand Oaks, CA: Sage Publications, 2014). 57. Jackson and Bell, “The Analysis of Environmental Case Studies,” 87. 58. Michael V. Sanders, “Post-Repair Diminution in Value from Geotechnical Problems,” The Appraisal Journal (January 1996): 61.

112 The Appraisal Journal • Spring 2021 www.appraisalinstitute.org Environmental Dead Zones: The Evaluation of Contaminated Properties identification of EDZs can assist in drawing on mate damages subsequent to recognition of the similarities among environmental conditions. government’s right to sue for natural resource damages under CERCLA; nevertheless, real Survey Approach estate valuation professionals have contested its The Appraisal of Real Estate, fifteenth edition, validity as a real estate valuation technique. The discusses the use of surveys as a valuation tech- National Oceanic and Atmospheric Adminis- nique, noting that surveys “need to be properly tration (NOAA) organized a panel to address developed.” 59 A survey is a “market analysis pro- CV issues that resulted in a number of recom- cedure used to identify consumer preferences.” 60 mendations in designing CV surveys. The gen- Surveys are generally formal,61 and different eral recommendations include developing an from informal market interviews,62 and both are appropriate sample type and size, minimizing different from transactional verification. Formal nonresponses, conducting surveys face-to-face surveys are typically distinguished by structured or over the telephone, pretesting survey effects, and standardized questions and may include a reporting and archiving survey details, and pre- statistical analysis of survey responses. A par- testing the CV questionnaire.66 These general ticular concern with some surveys is hypothet- guidelines should be followed if a real estate val- ical bias, which is the potential error that arises uation professional chooses to use contingent from not confronting an individual with a real valuation surveys. situation.63 With hypothetical survey scenarios, As stated in Real Estate Damages, third edition, there is no economic consequence to respon- “Informal market interviews with knowledgeable dents who overstate or understate values. How- subjects often provide valuable information and ever, research indicates that private-good survey have long been a staple of research.” 67 In addi- studies result in less hypothetical bias than tion to informal interviews, formal market inter- studies in which public goods are valued, and views can be conducted. Jackson cautions that one way to mitigate hypothetical bias is to ask a when conducting formal market interviews, follow-up question.64 “there are three important elements: selection of Within the scope of formal surveys are two participants to be interviewed, development of specialized approaches: contingent valuation unbiased information about the subject property (CV) and conjoint analysis; both approaches use and its environmental condition [or detrimental survey data from participants responding to condition], and construction of a structured hypothetical scenarios.65 Contingent valuation questionnaire and interview protocol.” 68 Jackson involves surveying a sample population about also notes that market interviews are “closely the economic impact of an issue under a hypo- akin to what appraisers refer to as sales confirma- thetical situation. Conjoint analysis involves tion or verification interviews.” 69 They should respondents ranking various attributes of a good not be considered the same however. USPAP or service by preference. Contingent valuation Standards Rule 1-4 sets forth that “an appraiser received increased interest as a method to esti- must collect, verify, and analyze all information

59. The Appraisal of Real Estate, 15th ed., 188. 60. The Dictionary of Real Estate Appraisal, 6th ed., s.v. “survey.” 61. Bell, Real Estate Damages, 3rd ed., 53. 62. Thomas O. Jackson, “Surveys, Market Interviews, and Environmental Stigma,” The Appraisal Journal (Fall 2004): 300. 63. Bell, Real Estate Damages, 3rd ed., 53. 64. Champ, Moore, and Bishop, “A Comparison of Approaches to Mitigate Hypothetical Bias,” Agricultural Economics Review (October 2009): 166. 65. Bell, Real Estate Damages, 3rd ed., 53. 66. Kenneth Arrow et al., “Report of the NOAA Panel on Contingent Valuation January 11, 1993” (May 9, 2001): 29–32, available at https://bit.ly/3q2SupC. 67. Bell, Real Estate Damages, 3rd ed., 10. 68. Jackson, “Surveys, Market Interviews, and Environmental Stigma,” 304. 69. Jackson, “Surveys, Market Interviews, and Environmental Stigma,” 301.

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necessary for credible assignment results.” 70 As published market data studies can be used as such, a verification interview involves the con- part of the reconciliation process in an assign- firmation of the details in a transaction, when ment, and as a starting point to help identify necessary. For example, in a nondisclosure state potential case studies. The professional litera- this may involve verifying a sale price through a ture serves as a resource that appraisers can use broker or another party involved in the trans­ to expand their wealth of knowledge and pro- action. With an environmentally contaminated vide a meaningful evaluation of environmen- property, verification may involve confirming tally contaminated properties. the details of a noted deed restriction. Insights Moreover, in conjunction with the techniques such as these can provide useful information in a described in this article and throughout profes- real estate valuation professional’s overall analy- sional appraisal literature,73 real estate valuation sis. When something does not appear valid in a professionals can provide a meaningful evalu­ation data set, a simple phone call verification may of environmentally contaminated sites for a vari- help clear up any data concerns. In analyses that ety of intended uses. Some intended uses include involve large data sets, such as regressions, the litigation matters, tax appeal, lending, land use data verification and confirmation process can be impact studies, environmental impact studies, extensive, necessitating substantial research. insurance claims, and a variety of other instances.

Literature Review The Appraisal of Real Estate, fifteenth edition, Professional Guidance on states that “relying on published articles as a Environmentally Contaminated Sites basis for a value opinion is not a recognized appraisal technique in the absence of indepen- USPAP Advisory Opinion 9 (AO-9), “The dent investigation and verification of the accu- Appraisal of Real Property That May Be racy of the market data and conclusions.” 71 This Impacted by Environmental Contamination,” language may come across as misleading when provides guidelines for real estate professionals used out of context, however. As a result, real appraising environmentally contaminated prop- estate valuation professionals might limit their erties. USPAP Advisory Opinion 9 outlines ten approach in the development of an opinion. A relevant environmental contamination property literature review is an established real estate characteristics, and characteristic nine relates research method that is grounded in hermeneu- to identifying environmental land use restric- tics. Hermeneutics simply means “the art and sci- tions, i.e., “potential limitations on the use of ence of interpretation.” 72 It is an approach the property due to the contamination and its practiced by numerous professionals in a wide remediation.” 74 variety of fields. For real estate valuation profes- Advisory Opinion 9 is not the only guidance sionals, the practice of hermeneutics might start for real estate valuers. The Appraisal of Real Estate, with texts such as USPAP. In addition to USPAP, fifteenth edition, Real Estate Damages, third the valuers may consult the accumulated large edition, and Appraisal Institute Guide Note 6, body of professional knowledge and literature. Consideration of Hazardous Substances in the The professional literature provides numerous Appraisal Process, also offer advice and discuss market data studies, including those involving methodologies for appraising environmentally environmentally contaminated properties. Such contaminated properties.

70. Appraisal Standards Board, Standards Rule 1-4 in Uniform Standards of Professional Appraisal Practice, 2020–2021 (Washington, DC: Appraisal Foundation, 2020), Lines 518–519. 71. The Appraisal of Real Estate, 15th ed., 188. 72. See Bell, Real Estate Damages, 3rd ed. (Appraisal Institute, 2016), 8–9; and Valerie Malhotra Bentz and Jeremy J. Shapiro, Mindful Inquiry in Social Research (Thousand Oaks, CA: Sage Publications, 1998), 105. 73. Some of these appraisal techniques are recognized in The Appraisal of Real Estate, 15th ed., and Real Estate Damages, 3rd ed. The techniques include, and are not limited to, regression, paired sales, sale/resale, case studies, literature review, market trends, income and yield capitalization rate analysis, loss of use, project delay, and many more. While there are numerous techniques available to real estate valuation professionals, it is not necessary to use them all; some or even one technique can produce credible opinions in an assignment. 74. Appraisal Standards Board, Advisory Opinion 9 in USPAP Advisory Opinions, 2020–2021, Line 117.

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Since some environmental characteristics Board released USPAP Advisory Opinion 9 out- require scientific expertise, and an appraiser is lining applicable cost, use, and risk effects to usually not an expert in the scientific aspects of consider when analyzing the impacts, if any, of contamination, it is acceptable for experts from environmental contamination; however, cost, other fields to provide the necessary information. use, and risk effect considerations are applicable Likewise, an appraiser may rely on assistance from to all detrimental condition studies.80 The appropriate agencies and regulators when assess- appraisal profession has acknowledged the con- ing the effects, if any, of contamination on prices sideration of cost, use, and risk effects in detri- and market value.75 Appraisers are not expected mental condition assignments, and the Appraisal to have the knowledge or experience needed to Standards Board should consider developing new detect the presence of contaminants or to mea- guidance that expands on the topic of environ- sure their quantities or remediation costs. None- mental contamination assignments to all detri- theless, an appraiser can gain the competence and mental condition assignments. skills needed to provide an opinion of the effects of the contamination on prices and market values Cost Effects by properly considering reports and data prepared Advisory Opinion 9 notes that “cost effects pri- by environmental specialists.76 marily represent deductions for costs to remediate Where environmental land use restrictions are a contaminated property” 81 [or detrimental con- part of the scope of an assignment, but restric- dition]. In some cases, the seller is deemed the tions do not exist, an appraiser should employ a responsible party and funds the remedial plan. hypothetical condition that is clearly conveyed In others, the buyer will be left with the responsi- to the intended user(s). This is similar to using bility for funding or completing the cleanup to hypothetical conditions or extraordinary assump- regulatory standards and in accordance with an tions to indicate that a property is free of con- approved remedial action plan.82 When evaluat- tamination.77 Depending on the scope of work ing a contaminated property, costs such as reme- developed in an assignment, such as a prospec- diation are deducted from the unimpaired value tive highest and best use analysis, if there are of the subject property if they are to be borne by land use restrictions inherent in any applicable the subject property or buyer, whereas costs borne codes, ordinances, and regulations, a real estate by the seller or a party other than the subject valuation professional should investigate whether property or buyer should not be deducted from there is a reasonable probability of a change rela- the unimpaired value. An exception would exist tive to the subject property(ies) along with any in those locations or jurisdictions where the prop- timing and cost considerations related to poten- erty owner owns the subsurface and contaminated tial change.78 media and has a contingent liability for the reme- Early professional appraisal literature covering diation if the principal responsible party has not detrimental conditions generally focused on indicated or demonstrated a willingness and/or environmental contamination issues.79 As the the financial feasibility to perform the required discussion progressed, the Appraisal Standards remediation below regulatory requirements.83

75. Appraisal Standards Board, Advisory Opinion 9 in USPAP Advisory Opinions, 2020–2021, Lines 119–121. 76. The Appraisal of Real Estate, 15th ed., 185. 77. Appraisal Standards Board, Advisory Opinion 9 in USPAP Advisory Opinions, 2020–2021, Lines 23–28 and 134–135. 78. The Appraisal of Real Estate, 15th ed., 310. 79. For example, Peter J. Patchin, “Valuation of Contaminated Property,” The Appraisal Journal (January 1988): 7–16; Peter J. Patchin, “Contaminated Properties: Stigma Revisited,” The Appraisal Journal (April 1991): 167–172; and Peter J. Patchin, “Contaminated Properties and the Sales Comparison Approach,” The Appraisal Journal (July 1994): 402–409. 80. Bell, Real Estate Damages, 3rd ed. (Appraisal Institute, 2016), 22–27. 81. Appraisal Standards Board, Advisory Opinion 9 in USPAP Advisory Opinions, 2020–2021, Lines 162–164. 82. Thomas O. Jackson and Chris Yost-Bremm, “Environmental Risk Premiums and Price Effects in Commercial Real Estate Transactions,” The Appraisal Journal (Winter 2018): 49. 83. “Interim Guidance on Settlements with De Minimis Waste Contributors under Section 122(g) of SARA,” EPA (June 19, 1987).

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As Jackson and Yost-Bremm note, “A remedia- uncertainty.” 89 Risk effects include stigma, which tion plan and approach is typically developed to is “an adverse effect on property value produced site-specific, risk-based standards, which may vary by the market’s perception of increased environ- depending on surrounding land uses and other fac- mental risk due to contamination.” 90 Risk gener- tors.” 84 As such, environmental land use controls ally falls into three categories associated with the implemented by government agencies may have three stages of the remediation lifecycle: an uncer- an influence on cost effects because they may dic- tainty factor, a project incentive, and market tate the type and level of remediation. Further- resistance.91 The risk effects related to the proper- more, uncertainties concerning responsibility for ty’s environmental condition include “risks related future costs are generally reflected in risk effects.85 to remediation requirements; unknown or uncer- tain costs; and other factors.” 92 Land use controls Use Effects implemented by environmental agencies, there- Advisory Opinion 9 states “use effects reflect fore, may have a beneficial effect because the con- impacts on the utility of the site as a result of the trols can reduce uncertainty. Nonetheless, the contamination” 86 [or detrimental condition.] For land use controls even after remediation may not example, the Marshall Islands Nuclear Claims result in a return to full market value, as market Tribunal awarded compensation in excess of resistance may still be present. $1 billion to subject atolls where environmental In considering the three detrimental condition land use restrictions limited the use of the atolls approaches, Appraisal Institute Guide Note 6 sets or radioactivity levels exceeded government forth the following simple formulaic framework: standards as a result of the Bikini Atoll atomic bomb testing.87 In that case, compensation was Impaired Value = Unimpaired Value determined using the framework of a “loss of use” – Cost Effects (Remediation and Related Costs) real estate damage model, where market rent × – Use Effects (Effects on Site Usability) time = use effect.88 Use effects, as a result of envi- – Risk Effects (Environmental Risk/Stigma) ronmental conditions, may also be considered with an analysis of project delays, changes in Property Value Diminution = Cost Effects highest and best use, changes to income, and so (Remediation and Related Costs) forth. In some instances, a use effect may be tem- + Use Effects (Effects on Site Usability) porary, such as an evacuation, and others may be + Risk Effects (Environmental Risk/Stigma) ongoing, such as a change in use. Impaired Value = Unimpaired Value Risk Effects – Property Value Diminution93 Advisory Opinion 9 states that risk effects “are derived from the market’s perception of increased environmental [or detrimental condition] risk and

84. Jackson and Yost-Bremm, “Environmental Risk Premiums and Price Effects in Commercial Real Estate Transactions,” 49. 85. Thomas O. Jackson and J. Michael Sowinski Jr., “Institutional Controls and Contaminated Property Valuation,” The Appraisal Journal (Fall 2006): 330. 86. Appraisal Standards Board, Advisory Opinion 9 in USPAP Advisory Opinions, 2020–2021, Lines 165–166. 87. Randall Bell, “Radioactive Contamination of Nuclear Weapons Test Site,” in Applications in Litigation Valuation: A Pragmatist’s Guide, ed. Jeffrey A. Johnson and Stephen J. Matonis (Chicago: Appraisal Institute, 2012), 222–231. 88. Bell, “Radioactive Contamination of Nuclear Weapons Test Site,” in Applications in Litigation Valuation: A Pragmatist’s Guide, 230. 89. Appraisal Standards Board, Advisory Opinion 9 in USPAP Advisory Opinions, 2020–2021, Line 169. 90. Appraisal Standards Board, Advisory Opinion 9 in USPAP Advisory Opinions, 2020–2021, Lines 85–86. 91. Bell, Real Estate Damages, 3rd ed., 26. 92. Jackson and Sowinski, “Institutional Controls and Contaminated Property Valuation,” 332. 93. Appraisal Institute, Guide Note 6: Consideration of Hazardous Substances in the Appraisal Process (Chicago: Appraisal Institute, 2013, rev. 2020), 7, https://bit.ly/2RLm8mN.

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Conclusion be considered when valuing an environmentally contaminated site or property suspected of being Numerous sites of concern have been identified by contaminated. Such considerations include cat- environmental agencies as well as contaminants egorizing sites and market data according to of concern. Additional analytical frameworks and environmental land use restrictions, which may tools can help aid the real estate valuation profes- fall into three general classifications: Class I, sion in assignments involving contaminated prop- activity restrictions, Class II, building restric- erties. The term “environmental dead zones” tions, and Class III, occupancy restrictions. By (EDZs) describes a specific type of environmen- categorizing environmental land use restrictions, tally contaminated property—those environmen- comparisons among market data can be made tally contaminated areas with pathways to human and the condition of a subject property(ies) can exposure and “Class III” land use restrictions. be described, assisting in assignments involving From a real estate professional’s standpoint, the evaluation of environmentally contami- EDZs have defining characteristics that should nated properties.

About the Author Michael Tachovsky is a principal partner at Landmark Research Group LLC. He is a certified general real estate appraiser and PhD candidate who specializes in real estate damage valuation, including environmental contamination, natural disasters, eminent domain, crime scenes, construction defects, and other conditions involving a wide variety of property types. His professional experience includes complex valuation and diminution-in-value studies related to damage issues for government agencies, major corporations, oil and utility companies, developers, and property owners. He has researched disasters such as the Sandy Hook shooting; Uravan, Colorado; radioactive Superfund sites; Chernobyl; and the Love Canal. He has been featured in Forbes and has presented real estate damage seminars for Appraisal Institute chapters, the Urban Land Institute, and tax assessors. Contact: [email protected]

Additional Resources Suggested by the Y. T. and Louise Lee Lum Library

Appraisal Institute Lum Library • Knowledge Base Information Files—Real estate damages • Diminution Valuation Assignments: Enhance the Importance of Highest and Best Use (Conference presentation, 2019)

CCIM Institute—Articles and monographs on environmental issues https://www.ccim.com/search/?srchtext=environmental&gmSsoPc=1

US Environmental Protection Agency • Chemicals and Toxics Topics https://www.epa.gov/environmental-topics/chemicals-and-toxics-topics

• Cleanups at Federal Facilities, Land Use Controls https://www.epa.gov/fedfac/land-use-controls-lucs

• Laws and Regulations https://www.epa.gov/laws-regulations

• Report on the Environment: Land Use https://www.epa.gov/report-environment/land-use

• Superfund: Institutional Controls https://www.epa.gov/superfund/superfund-institutional-controls

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Inflation Outlook and Statistical Analysis Software Resources

About This Column Resource Center is about all types of information resources that may be helpful for real estate market analysts and valuers—from print and online publications to data sources and websites. In this edition of Resource Center, we take a look at the latest resources on the economic outlook, inflation, and the consumer price index. The column also points researchers to the latest statistical software available online—both free and fee-based.

Economic Outlook • changes in work location (office versus remote);5 Many observers of the economy were surprised at • population shifts and changing attitudes the health of the real estate sector of the economy about high-density urban living;6 during the COVID-19 pandemic.1 But as we look • changing warehouse, logistical, and indus- forward, concerns proliferate about issues such as trial real estate needs; • possible interest rate increases;2 • polarization of economic and public policy • shifting retail trends;3 positions; • property re-use alternatives;4 • use of blockchain and cryptocurrencies; and • likelihood of higher or new taxes; • inflation outlook.

For easy, direct access to the URL addresses noted throughout this article, read this column online. Go to https://bit.ly/TAJ_Articles and click on “Latest Issue.”

1. In the first half of 2020, common wisdom was that the pandemic would mean deferral of major spending decisions. However, reports during the 2021 first quarter noted the opposite; see Soma Biswas and Harriett Torry, “Coronavirus Was Supposed to Drive Bankruptcies Higher. The Opposite Happened,” Wall Street Journal, March 29, 2021, https://on.wsj.com/3wf9ewP; Nicole Friedman, “US Home Prices Rise at Fastest Pace in 15 Years,” Wall Street Journal, March 30, 2021, https://on.wsj.com/3m515WO; Nicole Friedman, “The Pandemic Ignited a Housing Boom—but It’s Different from the Last One,” Wall Street Journal, March 15, 2021, https://on.wsj.com/3rwW1vv; and Peter Lan Taylor, “COVID-19 Set America’s Housing Market on Fire,” Forbes, March 11, 2021, https://bit.ly/2QRQWkZ. 2. For reference, the 15-year first mortgage interest rate has been under 4.5% for the past decade, which has stimulated commercial and residen- tial real estate markets. During the prior decade, the rate declined from 8.25% to 4.25% (stated rates vary a little depending on source). 3. For discussion of e-commerce trends, see “A Decade in Review: Ecommerce Sales vs. Retail Sales 2007–2020,” Digital Commerce 360, January 29, 2021, https://bit.ly/3cwff09; Michelle Evans, “Five E-Commerce Trends That Will Change Retail in 2021,” Forbes, January 12, 2021, https://bit.ly/39l1U8S; and Maryam Mohsin, “10 Ecommerce Trends,” Oberlo (blog), April 3, 2021, https://bit.ly/3fed1CW. 4. For example, see Beth Mattson-Teig, “Adapting CRE to Covid-19,” CIRE (Spring 2021), available at https://bit.ly/3fzO8Dx; and Byron Smith, “Surviving Retail in Troubled Times,” CIRE (Spring 2021), at https://bit.ly/3dbVKsV. 5. “Remote Work Trends and Stats for 2021: The Present and Future of Remote Work after COVID,” Remoters (blog), https://bit.ly/3csoLBw; Caroline Castrillon, “This Is the Future of Remote Work in 2021,” Forbes, December 27, 2020, https://bit.ly/2QMcqzH; and Brian Kropp, “9 Trends That Will Shape Work in 2021 and Beyond,” Harvard Business Review, January 14, 2021, https://bit.ly/3dcrw96. 6. For example, see Amanda Barroso, “About Half of Americans Say Their Lives Will Remain Changed in Major Ways When the Pandemic Is Over,” Pew Research Center, September 17, 2020, https://pewrsr.ch/3fmcksB.

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Inflation Rates ued the decline and been under 5% for a decade. Concern about the economy’s outlook for infla- That is why the mortgage rates of the last decade tion arises largely from the widespread thought have looked so attractive. Exhibit 1 illustrates that the COVID-related federal stimulus pack- the inflation rate over a sixty-year period. As the ages7 will be inflationary because of the massive exhibit shows, the US inflation rate has been amounts of money8 put into the economy. Others under 5% for over three decades. By way of com- disagree, however, and believe the Federal parison, Exhibit 2 illustrates the mortgage rates Reserve’s long-term 2% inflation target can and during periods of high and low inflation. will be achieved using Federal Reserve (Fed) and US Treasury tools. The Fed has developed infor- Inflation Impacts mational documents “in plain English” on how Inflation is of importance to the real estate ana- monetary policy tools influence the economy lyst and appraiser because inflation (price changes and inflation: over time) and expectations about inflation affect • “How Monetary Policy Works” the actions and decisions of real estate sector par- (https://bit.ly/3m3sUPA) ticipants. Inflation impacts • “What Is the Fed: Monetary Policy” • buyer and seller confidence, thinking pro- (https://bit.ly/2PDplDz) cess, and motivations; • “Monetary Policy Basics” • pricing (listings and offers); (https://bit.ly/3w7WJmI).9 • strategies in planning and development; • investing motivations, calculation, analysis; The Dictionary of Real Estate Appraisal, sixth • leasing and lease terms; edition, defines inflation as “an erosion of the pur- • relocation decisions; chasing power of currency characterized by price • buy-hold-lease-sell judgments; escalation and an increase in the volume of • discounted cash flow forecasting incomes, money, i.e., the proliferation of monetary units expense, and value change anticipations; and consequent decline in the value of each • borrowing and lending decisions; and unit.” 10 Many people remember the inflation of • considerations of investment risk. the 1970s, when the US inflation rate was into the teens. Mortgage interest rates between 1970 In the aftermath of government measures and 1981 increased from about 7.5% to 18% and designed to offset economic damage during the did not return to about 7.5% until after 2000. pandemic, many analysts, economists, and oth- Since 2000, mortgage interest rates have contin- ers are concerned about the likelihood of rising

7. The stimulus packages as of press time include the following: (1) the $2.2 trillion CARES Act (March 2020)—for details on the CARES Act, see https://www.jpmorgan.com/insights/research/cares-act; (2) the $2.3 trillion Consolidated Appropriations Act (December 2020)—for detail on this act, see https://bit.ly/3rCqgl2; (3) the $1.9 trillion American Rescue Plan (March 2021)—for detail on the Rescue Plan, see https://bit.ly/2QDtkAi. 8. For readers interested in additional information on the cost of the COVID-19 packages, see “How Are We Paying for the Federal Response to the Coronavirus?” Peter G. Peterson Foundation, February 5, 2021, https://bit.ly/2O1XqwB. 9. For additional information on the topic, see Kimberly Amadeo, “Monetary Policy Tools and How They Work,” The Balance (April 30, 2021), https://bit.ly/3syqElw; and Eric Petroff, “The Fed’s Tools for Influencing the Economy,” Investopedia, December 7, 2020, https://bit.ly/3w7xgK1. 10. Appraisal Institute, The Dictionary of Real Estate Appraisal, 6th ed. (Chicago: Appraisal Institute, 2015), s.v. “inflation.”

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inflation. During an inflationary period, con- • CPI Handbook of Methods sumers will see a broad rise in price levels and a (https://www.bls.gov/opub/hom/cpi fall in their purchasing power, i.e., a dollar effec- /home.htm) tively buys less than it did in prior periods. • Core inflation modeling The Consumer Price Index (CPI) is an impor­ (https://bit.ly/2Q84qJd ) tant economic indicator, and the principal • BLS publications measure of inflation (and deflation).11 Inflation as (https://www.bls.gov/opub/) measured by the consumer price index is the annual percentage change in the cost to the aver- There are a number of BLS price indexes— age consumer of acquiring a basket of goods and and thus databases—each made up of different services.12 It examines the prices of consumer items. Therefore, it is important to specify which goods and services, such as trans­por­tation, food, index is being used in any analysis or bench- and medical care, associated with the cost of liv- mark. For real estate, the specific price index is ing. A decline in purchasing power measured critical in contracts, leases, and other references. using the average price level of the basket of The types of CPIs available include the CPI-U selected goods and services indicates inflation.13 (for all urban consumers), CPI-W (for urban The CPI is computed by the US Bureau of wage earners and clerical workers), CPI-E (for Labor Statistics (BLS). The BLS’s CPI homepage,­ the elderly), and C-CPI-U (chained CPI for all https://www.bls.gov/cpi/, offers an overview of the urban consumers). Sometimes the core inflation index, myriad CPI publications, online data, rate is the item of interest. explanations of the measurement methodology, The core inflation rate is the price change of and interactive tools for com­puting inflation over goods and services minus food and energy, time.14 Some key CPI resources available from the because food and energy are relatively volatile BLS include the following: and might tend to distort the inflation rate. The • Factsheets about CPI components core inflation rate is also called the core “CPI for (https://www.bls.gov/cpi/factsheets/) All Urban Consumers Less Food and Energy,” or • CPI databases the core “Personal Consumption Expenditures (https://www.bls.gov/cpi/data.htm) (PCE) excluding Food and Energy.” 15 • Monthly CPI information The most commonly used CPI is the “All (https://www.bls.gov/news.release Urban Consumers (Current Series)”; this index /pdf/cpi.pdf) as well as others may be seen and accessed at • Producer Price Index information https://www.bls.gov/data/. Exhibit 3 shows the (https://www.bls.gov/ppi/) CPI-U for all urban consumers, using 1982 as

11. See “Consumer Price Index (CPI),” Investopedia, https://bit.ly/2PGlyVK. For a very thorough explanation of the CPI see “The Consumer Price Index,” chapter 17 in Handbook of Methods, Bureau of Labor Statistics, available at https://bit.ly/3wmf53x. 12. https://fred.stlouisfed.org/series/FPCPITOTLZGUSA. 13. See “What Is Inflation?” Investopedia, https://bit.ly/3lZUbCg. 14. Background information and a complete discussion of the index is also available from the BLS in its Handbook of Methods, at https://bit.ly/3ue972r. 15. Kimberly Amadeo, “What Is the Core Inflation Rate?” The Balance, https://bit.ly/3dmPHlg. For a discussion of the effect of COVID-19 on price inflation, see Matteao Luciani, “Quantifying the COVID-19 Effects on Core PCE Price Inflation,” February 25, 2021, https://bit.ly/3bpjIRs.

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Exhibit 1 US Inflation Rate, 1960–2019

15.0 Inflation, Consumer Prices 12.5 for the United States

10.0 Period under 5% U.S. recessions are shaded; the most 7.5 recent end date is undecided.

Percent 5.0

2.5

0.0

–2.5 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 Year

Source: https://fred.stlouisfed.org/series/FPCPITOTLZGUSA

Exhibit 2 30-Year Fixed Rate Mortgage Average

20.0 30-Year Fixed Rate Mortgage 17.5 Average in the United States

15.0 Period under 5% U.S. recessions are shaded; the most 12.5 recent end date is undecided.

Percent 10.0

7.5

5.0

2.5 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 Year

Source: , 30-Year Fixed Rate Mortgage Average in the United States [MORTGAGE30US], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/MORTGAGE30US, May 14, 2021.

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Exhibit 3 US CPI-U for All Urban Exhibit 4 US Bureau of Labor Statistics, Consumers 1920–2020 Consumer Price Index Selected (1982 base year) Categories, April 2021

3030 Year CPI 1920 20.0 2525 1930 16.7

1940 14.0 2020 1950 24.1

1960 29.6 1515

1970 38.8 Percent 1980 82.4 1010 1982 100.0 5 1990 130.7 5 2000 172.2 00 2010 219.2 All Items Food Energy All Items 2018 251.1 Less Food and Energy 2020 260.5

Source: US Bureau of Labor Statistics, Consumer Price Index, Source: Bureau of Labor Statistics, Consumer Price Index April 2021, https://www.bls.gov/cpi/ December 2020 (January 13, 2021), https://www.bls.gov/news .release/archives/cpi_01132021.pdf

the base year. The inflation rate is the change For example, “suggested retail prices” differ in CPI from one time period to the next. For from the actual sale price or discounted price, example, the average annual inflation rate from which change over time. Also, price inflation 2000 to 2010 would be 2.73%, computed as may be different for different categories of goods (219.2 – 172.2)/172.2 = 0.2729 = 27.3. and services. Exhibit 4 shows an example of such The concept of CPI is rather simple and price change variation in early 2021. straightforward, but making calculations and In addition to differences in inflation rates for the effort to be consistent over time are more categories of goods and services, the inflation complex. An outline and timeline of the rate may differ in different sectors of the econ- BLS’s efforts to adjust the CPI is available at omy; for example, over the past decade prices https://bit.ly/3eAwI8C. For example, the CPI and costs in the health care, education, con- has some complications related to the “basket struction, and housing sectors of the economy of goods” data. The products’ features and attri- have risen at a higher rate (i.e., had more infla- butes can change from one survey period to tion) than most other sectors. Similarly, as of another as well as change in quality and func- early 2021, sectors with prices outpacing general tionality. Pricing also is subject to variables. inflation were housing, construction, food, and

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Exhibit 5 Comparison Actual and 2% Target Inflation, 2010–2020

2.2

2.0

1.8

1.6

1.4

1.2

1.0 from Yr. Ago*2)/% Ago Yr. from Yr. Chg. from Percent Change from Year Ago, (% Chg. Year Change from Percent 0.8 2010 2012 2014 2016 2018 2020 Year

Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index) (Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index)*2)/Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index)

Graph Source: FRED Economic Data, Federal Reserve Bank of St. Louis (November 9, 2020), https://fredblog.stlouisfed.org/?s=inflation

energy.16 As a result, it is important to consider ment and price stability.18 However, in the past what each of the different price indices includes decade the inflation rate has rarely achieved or excludes from its economic components.17 the target rate (Exhibit 5). The Federal Reserve has a 2% inflation rate There are many excellent resources available objective, as measured by the Personal Con- online for better understanding of inflation— sumption Expenditures price index (https:// the measures of inflation, the various inflation bit.ly/3bnZ2ZT). Its rationale for the 2% indexes, the pros and cons of inflation, target number is that this target maximizes employ- inflation rates, causes of inflation, levels of infla-

16. For an interactive chart and data on inflation without energy costs, see https://bit.ly/3rzKiML. Similarly, states and regions may have inflation rates that are different from the nation rate, particularly in the short term. 17. For example, from February 2020 to February 2021, consumer prices for services less energy increased 1.3% with different rates of increase for shelter, utilities, household, medical care, transportation, recreation, education and communication, and other professional services. 18. The target inflation rate is covered in the Federal Reserve document “Why Does the Federal Reserve Aim for Inflation of 2 Percent over the Longer Run?” available at https://bit.ly/2PnkSFd.

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tion, policies aimed at controlling inflation, www.USdebtclock.org/. This dynamic website deflation, and more.19 In the Appendix to this shows federal spending, revenues, money cre- Resource Center column, you will find links to ation, population, workforce, personal and materials with information and insights on infla- household income, and a lot more. At the bot- tion and its role in the economy. tom of the presentation are tabs for a calculator and home sales data. Inflation Outlook Post-Pandemic Of course, no one knows what inflation will be in Recommendation. Although the economic out- the future, but some forecasting and assumptions look is uncertain, significant information is avail- about the future are necessary for practically all able on trends expected to impact the real estate economic decision making. Real estate market sector. Analysts and valuers should take advan- participants forecast in their decision making, tage of the many resources that are available to and so too must market analysts and valuers.20 help them address issues on the horizon. This is perhaps most obvious in the income approach when preparing operating statements, discounted cash flows, and such, but consider- Statistical Tools ation of the future, whether by projection or fore- casting,21 permeates the valuation process. Statistical analysis is a key element in the work The COVID-19 pandemic caused both wide- of market analysts and valuers. The following ranging economic and societal change. This discusses some useful and popular software to makes the job of forecasting more challenging, enhance the analysis. both in the short term and longer term. Forecasts currently posit that behavior changes will remain Excel Analysis ToolPak Add-in long after the pandemic health crisis has passed Most real estate market analysts and valuers use and impact future economic outcomes.22 There Excel software, the popular Microsoft spread- are a number of wild cards in the post-COVID sheet program. The Excel add-in Analysis Took- economy. As previously mentioned, the final Pak has a variety of helpful statistical tools total is unknown on how much the 2020–2021 including the following: stimulus programs will add to the national debt. • ANOVA (single and two-factor) Also unknown is any impact the national debt • Correlation

18. The target inflation rate is covered in the Federal Reserve document “Why Does the Federal Reserve Aim for Inflation of 2 Percent over will have on real estate markets. For a fascinating • Covariance the Longer Term?” available at https://bit.ly/2PnkSFd. look at the changing national debt (total, per • Descriptive statistics citizen, per taxpayer, ratio to GDP, etc.), see • Exponential smoothing

19. For example, “Inflation,” by Jason Fernando, in Investopedia at https://bit.ly/30U0duH, has a good overview of causes of inflation, demand-pull and cost-push, the idea of built-in inflation, types of price indexes, the formula for measuring inflation yourself, methods of controlling inflation, negative interest rates, quantitative easing, hedging against inflation, and several other topics. 20. Forecasting requires valuers and others to estimate, calculate, or indicate in advance. Forecasts made by appraisers are based on past trends and the perceptions of market participants concerning the trends’ continuation or alteration. For decision makers, market participants, and analysts/valuers it makes no sense to ignore the anticipated future, i.e., expected consequences, costs, benefits, and such. 21. Generally, a projection is a mechanical extension of the past trends into the future; forecasting considers the past trends and adjusts for current and likely future influences. 22. See J. Kozlowaki, L. Veldkamp, V. Venkateswaran, “Scarring Body and Mind: The Long-Term Belief-Scarring Effects of COVID-19,” Working Paper, Federal Reserve Bank of St. Louis, April 2020, available at https://bit.ly/3loW37r.

124 The Appraisal Journal • Spring 2021 www.appraisalinstitute.org Resource Center

• F-test two-sample for variances of-means tests. The site has brief descriptions of • Fourier analysis these free statistical software packages, including • Histograms the types of statistical measures and tools pro- • Moving average vided. Here are the ten that are listed:26 • Random number generation 1. JASP (https://jasp-stats.org/) • Rank and percentile 2. SOFA (https://bit.ly/3tzuyei; uses Python • Regression (simple and multiple) language) • t-tests (various) 3. GNU PSPP (https://bit.ly/2Q7FFwU) • Z-test 4. SCI Labs (https://www.scilab.org/) 5. Jamovi (https://www.jamovi.org/; built on To load Analysis ToolPak, visit Microsoft Sup- R language) port at https://bit.ly/3ro5rJO. However, Analysis 6. MacAnova ToolPak is likely already part of your Excel pro- (http://www.stat.umn.edu/macanova/) gram. An Analysis ToolPak guide is available on 7. PAST (https://bit.ly/2Qkbu5n) the Microsoft website (https://bit.ly/31qE2ws).23 8. Develve (https://develve.net/) Guides are also available from third parties.24 9. InVivoStat (https://invivostat.co.uk/; combines complex and powerful statistical Other Free Statistical Software tools within R with a user interface that is Available Online both easy to use and intuitive to the There are a number of online resources to help you non-statistician) identify free downloadable statistical software. An 10. IBM SPSS internet search of “free software” results in listings (https://www.ibm.com/analytics/spss-trials) of relevant statistical software.25 These sites have brief descriptions of SAS, Excel, SPSS, GraphPad These free statistical programs are some of the Prism, , MATLAB, as well as others. most popular, but others may be available, partic- One of the more comprehensive sites is ularly for certain corporate employees or students GoodFirm’s blog, “10 Best Free and Open Source and faculty. In addition, there are other statistics Statistical Analysis Software” (https://bit.ly programs available that are not free but have a /3qYNMYX). This site provides a brief overview free trial period or online demo. of the four essential types of analyses performed Valuers interested in for-purchase statistical by statistical software: co-relational tests, regres- software may want to visit the Capterra website sion tests, non-parametric tests, and comparison- (https://bit.ly/3tEDAqr). This website includes a

23. To activate this Excel add-in, open Excel, go to File > Options > Add-ins > Analysis ToolPak. Analysis Toolpak is then available under the Data tab and has an icon labeled “Data Analysis” in the Analysis portion of the ribbon. Note this “Analysis ToolPak” icon is not the same as the “Analyze Data” icon in the Analysis section of the ribbon under the Home tab. The Analyze Data icon under the Home tab presents ideas for graphs of a dataset you have highlighted. 24. For example, see Add-Ins.com, https://www.add-ins.com/Analysis_ToolPak.htm; Better Solutions, https://bit.ly/3rzxlmn; Excel Easy, https://bit.ly/2PbWhmF; SpreadSheeto, https://spreadsheeto.com/analysis-toolpak/; and Universal Class, https://bit.ly/31nulyv. 25. For example, see “Top 8 Free Statistics Software of 2020,” https://bit.ly/3vXzQ4y; “Top 20 Free Statistical Software (Statistics and Data Analysis),” https://bit.ly/2Q6AgWX; and “Free Statistical Analysis Software,” https://bit.ly/3vUUeTQ. 26. As noted, some of these programs use the R language in their software. For overview information about R as well as manuals, see “The R Project for Statistical Computing,” https://www.r-project.org/.

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helpful Buyer’s Guide addressing key consider- • Minitab (https://bit.ly/310cihC) ations in purchases of statistical software and lets • MPP BI (https://bit.ly/3vHl2ra) you customize the product search based on your • SAS/STAT (https://bit.ly/2NuZLjg) business size and needs. There is also a descriptive comparison and checklist of business statistical The Capterra website also includes a helpful com- programs available for purchase or licensing. parison table, noting key features and ratings of Among the programs described are the following: each statistical program (https://bit.ly/3cKCSRE). • Tableau (https://tabsoft.co/2Qjnggm) • OriginPro (https://bit.ly/2P7EjS1) Recommendation. If you use extensive statistical • SPC for Excel (https://bit.ly/3c1D0wE) analysis in your work or plan to, a first step is to • Statgraphics Centurion become familiar with the Excel Analysis ToolPak (https://bit.ly/2QnLwhv) add-in. Then, if you need more extensive statisti- • SigmaXL (https://bit.ly/3lrZKJB) cal capabilities, investigate the statistical soft- • Intellectus Statistics (https://bit.ly/3cOGstJ) ware options noted, taking into consideration • Neuton AutoML (https://bit.ly/3cKI1Jf) their ease of use and features.

About the Author Dan L. Swango, PhD, MAI, SRA, is president of Swango Real Estate Counseling and Valuation International in Tucson, Arizona. He is experienced in valuation and consulting involving equity investment, debt security, risk reduction, profit optimization, estate planning and settlement, buy/sell opportunities, and eminent domain. Swango is an instructor and communicator with domestic and international experience. He is namesake of The Appraisal Journal’s Swango Award, past Editorial Board chair and editor-in-chief of The Appraisal Journal, and a current member of the Journal’s Review Panel. Contact: [email protected]

If you know of additional resources of interest to real estate analysts and valuers—or would like to suggest topics for this column—please contact the author.

SEE NEXT PAGE FOR APPENDIX >

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Appendix Additional Reading on Inflation and Economy

Inflation, Prices, and the Economy • “Data: Prices and Inflation,” Bureau of Economic Analysis, https://www.bea.gov/data/prices-inflation, customizable time series data, tables, and calculators by subject. • “Indicators,” https://tradingeconomics.com/indicators, and “Inflation,” https://bit.ly/3srmnjX, Trading Economics, current economic indicators in the United States and international. • “Prices and Inflation,” Bureau of Economic Analysis, https://bit.ly/3fhmZTM, explains different types of price indices. The Bureau’s website also has a variety of other economic information.

Inflation Targeting/Target Rates • “Does the National Debt Matter?” David Andolfatto,” Federal Reserve Bank of St. Louis, https://bit.ly/3ftY15p; see section on inflation targeting. • “The Fed’s Inflation Target: Why 2 Percent?” Kristie Engemann, Open Vault (Federal Reserve blog), January 16, 2019, https://bit.ly/FEDtarget. • “How Inflation Targeting Works,” Kimberly Amadeo, The Balance, November 30, 2020, https://bit.ly/3xwCPSj, explains targeting and its mechanics. • “What Is Inflation and How Does the Federal Reserve Evaluate Changes in the Rate of Inflation?” https://bit.ly/3ho9AfA, Board of Governors of the Federal Reserve, September 9, 2016.

Housing Markets • “America’s Housing Market Is Officially Overheating Everywhere. How Long Will It Last?” Peter Lane Taylor, https://bit.ly/3fi4jUb. • “Economists’ Outlook: Home Prices: A Closer Look at Local Trends,” Nadia Evangelou, National Association of Realtors, January 13, 2021, https://bit.ly/3cxJdkx. • “Housing Supply: A Growing Deficit,” Freddie Mac Research Note, May 7, 2021, https://bit.ly/2RVxZyp. • “Investors and Housing Affordability,” Carlos Garriga, Pedro Gete, and Athena Tsouderou, Working Paper, Federal Reserve Bank of St. Louis, July 2020, https://bit.ly/3loVM4p. Study of how investors affect rents and prices. • “US Home Sales Are Surging. When Does the Music Stop?” Stefanos Chen, April 22, 2021, https://nyti.ms/3booHSs. • “Will the US Housing Market Boom Continue in 2021?” J. P. Morgan. December 2, 2020, https://bit.ly/3wcXtH8.

National Debt • “Charting America’s Debt: $27 Trillion and Counting,” Visual Capitalist, https://bit.ly/3fqebg4. A vivid presentation on elements of national debt. • “Does the National Debt Matter?” Regional Economist series, Federal Reserve Bank of St. Louis, December 2020, https://bit.ly/2PDnqyK. • “Federal Debt: Total Public Debt” (interactive chart), Federal Reserve Bank of St Louis, https://fred.stlouisfed.org/series/GFDEBTN. • “How Much Money Did the Federal Government Collect and Spend in 2020?” Bureau of the Fiscal Service, US Department of Treasury, https://bit.ly/3bl5aC3. CONTINUED >

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Appendix (continued)

• “Making Sense of the National Debt,” Scott A. Wolla and Kaitlyn Frerking, Page One Economics, Federal Reserve Bank of St. Louis, https://bit.ly/38SoAwZ. • “National Debt of the United States,” Wikipedia, https://bit.ly/3bXnOkl. Consolidates information from variety of sources, summarizes issues on national debt, and presents data in helpful graphs.

Projections/Outlook • “Creating Valuations Amid Uncertainty,” Michael Polon, CIRE, Fall 2020, https://bit.ly/3sJgC0Y. • “Instant Reaction: Inflation,” National Association of Realtors, January 13, 2021, https://bit.ly/39naO5W. • “5-Year, 5-Year Forward Inflation Expectation Rate” (daily), Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org/series/T5YIFR. • “How Well Do Consumers Forecast Inflation?” Federal Reserve Bank of St. Louis, March 23, 2021, https://bit.ly/3lZNIY0. • “Inflation Is Coming for Your Wealth. Here’s What Investors Can Do,” Forbes, February 26, 2021, https://bit.ly/3cvDLOR. • “Outlook 2021: Why the Era of Low Inflation Could Last for 50 Years,” Meghnad Desai, Office of Monetary and Financial Institutions Forum, January 14, 2021, https://bit.ly/2PhZ1Pt. • “An Overview of the Economic Outlook: 2021 to 2031,” Congressional Budget Office, February 1, 2021, https://www.cbo.gov/publication/56965. • “Projected Annual Inflation Rate in the United States from 2010 to 2026,” Statista, April 14, 2021, https://bit.ly/3futvZ0. • “Short-Term and Long-Term Inflation Forecasts: Survey of Professional Forecasters” (quarterly), Federal Reserve Bank of Philadelphia, https://bit.ly/3cvvkDn. • “University of Michigan: Inflation Expectation,” survey of consumers (monthly), Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org/series/MICH. • “US Inflation Outlook: Don’t Believe the Hype,” Joseph Brusuelas, The Real Economy (blog), March 3, 2021, https://bit.ly/3sDZ7iD. Website also includes data by market sector, including “Real Estate,” https://bit.ly/2RM8kYW.

128 The Appraisal Journal • Spring 2021 www.appraisalinstitute.org Letters to the Editor

From Our Readers

“The Accuracy of Comparable recorded prices. For example, the MLS might Sales Data in Appraisal Reports: report a sale at $295,050; for recording purposes, Evidence from California” however, the DTT would be $325.05 (55¢ per $500 or fraction thereof), resulting in a recorded To the Editor price of $295,500, a difference of $450 or slightly The recent article “The Accuracy of Compara- over 0.15%. (The maximum discrepancy would ble Sales Data in Appraisal Reports: Evidence be $499, and the percentage of price would be from California” (The Appraisal Journal, Winter lower for more expensive properties.) If an 2021), by Yanling G. Mayer, PhD, and Frank E. Nothaft, PhD, provides a useful look at the accuracy of reported price information for com- With respect to larger differences, parable sales in residential appraisal reports. Referencing a prior study by Allen, Lusht, and the authors allude to concessions that can Weeks that demonstrated price misrepresenta- tion during a declining market in 2007–2008, cause a disconnect between “the final price the instant study documents a more recent period (2015–2016) characterized by increasing and the true value” (more appropriately, price trends and enhanced regulatory oversight of the appraisal process for mortgage lending. the disconnect would be between reported Their conclusions are that the multiple listing service (MLS) is a primary data source for com- and recorded prices). parables sales; 91.4% of reported prices match public records data; and price differences for the remainder are typically small (<0.2%), with only appraiser reported the sale price of the compara- 1.9% of mismatches reflecting a price variance ble property based on MLS data, there would be exceeding 1%. Since neither of the authors are a small difference relative to the price reported in based in California, I can hopefully offer some public records, consistent with the authors’ find- additional explanation for their findings. ings in most cases involving price mismatches. Recorded prices in California are based on a With respect to larger differences, the authors documentary transfer tax (DTT) collected by the allude to concessions that can cause a disconnect county recorder upon deed recordation involving between “the final price and the true value” a change of ownership. All counties, under sec- (more appropriately, the disconnect would be tion 11911 of the California Revenue and Taxa- between reported and recorded prices). From tion Code, collect a tax of $0.55 per $500 experience, this can be a problem, due largely to consideration or a fraction thereof. Where the inconsistencies in how concessions or rebates are actual sale price is an exact multiple of $500, the reported to the MLS by real estate agents. Sup- price reported to the MLS and the recorded price pose a transaction is reported to the MLS with a should be the same (absent an error in computing sale price of $295,000, including a credit for the DTT, which does happen). If not, there will repairs or costs of $5,000. In theory, the be a difference between the actual (reported) and credit does not change the price, which should

www.appraisalinstitute.org Spring 2021 • The Appraisal Journal 129 Letters to the Editor

be recorded in public records at $295,000. In commission (say 6%), which might be reported some cases, however, what is reported as a con- as a rebate of $8,850, while the recorded price cession is actually a price reduction, particularly would be $286,500 (net of commission waiver) with respect to items like repairs, resulting in a based on a DTT of $315.15. recorded price of $290,000, instead of the It obviously is incumbent on appraisers to reported price of $295,000. research and accurately report concessions and Commission waivers are another area where rebates, and to make appropriate adjustments significant discrepancies can arise between as needed. reported and recorded prices. Using the same example with a reported sale price of $295,000, Michael V. Sanders, MAI, SRA a buyer with a broker’s license who represents Seal Beach, California himself/herself would usually waive half the

130 The Appraisal Journal • Spring 2021 www.appraisalinstitute.org

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Since 1932, The Appraisal Journal has been the leading peer-reviewed forum for appraisal professionals. Consider becoming an author for the Journal and use your professional knowledge and experience to benefit yourself and your profession. Articles Needed The Appraisal Journal welcomes manuscripts on all topics related to real estate valuation. Manuscript Review We are especially interested in receiving manuscripts on Each manuscript submitted • Banquet facilities, clubs, and venues to The Appraisal Journal is • Communications tower value considered in a double-blind • Easements review. Manuscripts may be • Fixtures, furniture, and equipment reviewed by members of the • Industrial properties Editorial Board, Review Panel, • Market delineation or Academic Review Panel, • Opportunity zones or by outside specialists when • Recreational facilities appropriate. • Residential appraisal • Value impacts of covenants or deed restrictions See the Manuscript Guide for information about submitting Case study analyses are encouraged. a manuscript. Incentives Awards The Appraisal Journal presents the Armstrong/Kahn Award, the Swango Award, and the Richard U. Ratcliff Award each year for exceptional articles published in the Journal.

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132 The Appraisal Journal • Spring 2021 www.appraisalinstitute.org Manuscript Guide

The Appraisal Journal retains its preeminence Required Elements in real estate appraisal by keeping abreast of the latest • A cover letter with complete address, phone, and email issues of importance and interest to appraisers. Fresh of each author. Authors’ names should not appear ideas are always welcome. We invite you to write for The on any pages of the manuscript. Appraisal Journal. • An abstract of 75–100 words. The abstract should The Appraisal Journal presents three article awards: the not be a repeat of the first paragraph. Armstrong/Kahn Award for most outstanding article pub- • Brief major and secondary headings to emphasize lished in the previous year, the Swango Award for best divisions. article written by a practicing appraiser, and the Ratcliff • Clearly written introduction and conclusion sections Award for best article written by an academic author. explaining the purpose of the article and significance Appraisal Institute professionals are eligible for continu- of the research results. ing education credit in the year of publication. • A brief professional biography for each author, includ- ing present employment, title, degrees, designations, Manuscript Review publishing accomplishments, and preferred email. Manuscripts are considered­ in a double-blind review • Footnotes, numbered consecutively,­ providing all by members of the Editorial Board, Review Panel, and facts of publication­ for sources used. For footnote Academic Review Panel and by outside specialists when style, consult http://bit.ly/ChicagoManualStyle. Foot- appropriate. Manuscripts written by academic authors note numbers should appear in superscript at the point are reviewed by a member of the Academic Review Panel of reference in the text. as well as practitioner reviewers. • Exhibits titled and numbered in the order in which they A manuscript may be returned to the author with spe- appear. The text should specifically refer to each exhibit cific recommendations­ for revisions. Making such revisions number. Original Excel files should be provided for does not guarantee publication. Authors of manuscripts graphs, figures, and regression exhibits. In published will receive notification of the decision by letter or email. articles the exhibits will appear in black and white.

The Manuscript Submission Procedure Style and Content Manuscripts must be in Microsoft­ Word and emailed to • Manuscripts should be interesting, lucid, succinct, and [email protected]. Please title the email “Manu- meaningful to real property appraisers. script Submission.” • Manuscripts should include a review of published liter- ature related to the topic. Authors should cite relevant Confidentiality and Disclosures established concepts and practices and specify how • Authors of manuscripts submitted to The Appraisal they agree or disagree with such concepts and prac- Journal must have specific authorization from their tices. Where applicable, cite the most recent editions clients before disclosing (a) confidential factual data of The Appraisal of Real Estate and The Dictionary of received from a client or (b) the analyses, opinions, or Real Estate Appraisal. conclusions of an appraisal. • Authors are responsible for providing accurate mathe- • Authors must disclose any relationships that may sug- matics and statistics, including proper documentation gest bias in the research and results, including affilia- of specific software used. Editorial staff may request tions or funding. copies of relevant data, spreadsheets, regressions, or computations used. Copyright • Manuscripts should be 3,000–8,000 words and dou- Authors should not submit manuscripts that are being ble spaced without extra spaces between paragraphs. reviewed for publication in other journals. Authors should The Journal’s design staff creates the layout for printed not engage in plagiarism or self-plagiarism, replicating articles; do not spend a lot of time customizing the previously published works. All articles accepted become manuscript. the property of the Appraisal Institute and cannot be • Editorial staff will revise the manuscript to conform reproduced elsewhere without specific permission of the with Appraisal Institute style of capitalization, punc- Appraisal Institute. tuation, spelling, and usage. The editorial staff also will edit for clarity of presentation and for grammar. Manuscripts may be accepted for publication pending completion of revisions.

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