The Intersection of Environmental Factors and the Valuation of Rural Properties

The value of rural properties can be affected by an interplay of forces, which are continually changing, often in a cyclical pattern. These forces include social trends (population); economic circumstances (supply-side economic indicators); and environmental forces (potential contaminants).

There is a growing need for potential consideration of hazardous substances and their impact on property value. The consideration of environmental conditions is fundamental to the appraisal of rural real property.

Environmental Factors

Some situations where contaminants and hazardous substances may be involved in the appraisal of rural properties include soil contamination due to an abandoned industrial plant, groundwater contamination due to a leaking underground storage tank and pesticide runoff from farmland to rivers and streams. According to The Appraisal of Real Estate, 14th Edition, potential contaminants and hazardous substances may include asbestos, polychlorinated biphenyl (PCB), dioxin, trichloroethylene (TCE), radon, petroleum hydrocarbons, and lead.

Environmental liabilities associated with industrial plants are well known, but many other liabilities may be present in rural properties. Farmers once commonly used long trenches filled with DDT-treated fuel oil, called “cattle vats,” to rid cattle of mites and other insects. Once this practice fell out of use, the trenches were simply filled in. Farms often have aging underground storage tanks that held gasoline for farm machinery, and farmland also may be contaminated from an accumulation of fertilizers and pesticides.

In most cases, all environmental forces that effect land value must be considered. These issues can be specific to a property or considered external to a property. Appraisers should determine the type of detrimental factors present on the property. These include potential hazardous wastes.

Specialized Methods And Techniques

Over the past 25 years, the valuation profession has developed a set of recognized and generally accepted specialization techniques for estimating the effect of possible contamination and environmental risks on prices, markets, and values. These specialized methods are based on the three traditional approaches to value which include the sales comparison approach; the income capitalization approach; and the cost approach. These methods involve one or more of the following:

Paired Data Analysis Of Impacted and Potentially Impacted Areas

In paired data analysis, prices paid for properties that sold in an impacted area are compared to prices paid for otherwise similar properties that sold outside the impacted area to estimate the effect of the location on the sale price. More than one pairing is typically necessary to understand the effect of the location in the impacted area on the prices paid.

Analysis Of Environmental Case Studies

Environmental case studies are typically useful when a source site is being appraised or in a situation involving an impacted neighborhood or area where there are insufficient sales to understand the effect of the environmental issue on prices and values.

Multiple Regression Analysis Of Property Sales In Potentially Impacted Area

When property is specified and developed, a multiple regression model can be used to determine if the environmental issue is affecting the sales prices. The model can be designed to interpret the effect of issues such as remediation status, location in a contaminated area, distance from the site source, and other factors.

 The Role Of The Appraiser

Engaging the most competent appraiser is key in achieving a reliable, credible opinion of value for rural properties. Effort should be made to find a valuation professional with experience in rural valuations, particularly if there is a possibility of contamination. Appraisers are not required or expected to have the knowledge or experience required to detect the presence of hazardous substances or to measure the quantities of such substances. Like buyers and sellers on the open market, appraisers typically rely on the advice of others in matters that require special expertise.

Appraisers must be, at a minimum, licensed or certified for Federally-Related Transactions. If the client is a federally-regulated institution and the intended use of the appraisal report qualifies as a FRT, the appraiser will have to conform to the Uniform Standards of Professional Appraisal Practice and the Federal Institutions Reform and Recovery Enforcement Act.

For complex assignments, it may be prudent to engage a more experienced or credentialed appraiser. At the Appraisal Institute, for example, Designated Members have demonstrated a higher level of education and experience and received designations that include MAI and SRA.

 Key Steps

There are five key steps in an appraisal assignment involving possible contamination.

 Step 1: Determine the location of the possible contamination.

In determining the source of the potential contamination, appraisers identify whether it is from:

· A source site: A site on which the contamination is, or has been generated;

· A non-source site: A site onto which the contamination, generated from the source site, has migrated;

· An adjacent site: A site that is not contaminated but shares a common property line with a source site; or

· A proximate site: A site not contaminated and not adjacent to the source site, but that is near the source site.

The distinction is especially important in determining who is responsible for investigation and remediation costs, and whether that responsibility accompanies ownership of the property being appraised.

 Step 2: Determine the type of contaminant and the regulatory requirements.

The appraiser considers the type of contaminant and applicable regulatory requirements (permitted or accidental discharge, level of required cleanup); migration (soil contamination confined to the source site, groundwater contamination spreading off site); and remediation (soil removal, installation of a cap, groundwater pumping, vapor removal) characteristics.

Step 3: Determine the status of the property in the remediation lifecycle.

A remediation lifecycle consists of three stages of clean up: before remediation or cleanup; during remediation; and after remediation. The appraiser determines the status of the property in the remediation lifecycle. A contaminated property’s remediation lifecycle stage is an important determinant of the risk associated with environmental contamination.

The effect of contamination and environmental risk on property prices and values changes over time, typically decreasing as a site works its way through discovery and investigation, remediation and post-remediation stages.

 Step 4. Consider cost, use and risk effects as of relevant date and point in the remediation cycle.

Appraisers consider the cost, use and risk effects as of the relevant date and point in the remediation cycle as they relate to the type of property (source, non-source, adjacent or proximate).

Step 5. Estimate the “as is” value.

Finally, appraisers estimate the impaired, or “as is,” value. In most assignments, appraisers also are asked to compare the impaired value to the unimpaired value under hypothetical condition that the contaminant was not present.

Standards of Professional Practice

Reaching a credible and reliable opinion of value when dealing with potential contamination of rural properties can be a complicated procedure. Among the tools available to valuation professionals are two Appraisal Institute guide notes that may be particularly useful in the valuation of potentially contaminated properties including Guide Note 6: Consideration of Hazardous Substances in the Appraisal Process and Guide Note 15: Assumptions and Hypothetical Conditions.

Guide Note 6: Consideration of Hazardous Substances in the Appraisal Process

The purpose of Guide Note 6 is to provide guidance in the application of USPAP in the appraisal assignment. It is not to provide technical instructions or explanations concerning the detection or measurement of the effect of hazardous substances.

An extraordinary assumption presumes as fact otherwise uncertain information about physical, legal, or economic characteristics of the subject property, or about conditions external to the property, such as market conditions or trends, or about the integrity of data used in an analysis. An example of an extraordinary assumption could be suspected but not confirmed that there may be underground storage tank contamination. An environmental assessment by a qualified environmental professional would be required for such conclusions or determinations.

Guide Note 15: Assumptions and Hypothetical Conditions

In an example of a hypothetical condition, the subject property is the former site of heavy industrial use and the appraiser is aware that it might be contaminated, but this isn’t known for certain. The value opinion reflects the property as though the subject site is not contaminated on the date of value, which is the current date. This value is premised on the special/extraordinary assumption that the site is not contaminated.

The appraisal report would need to include a clear disclosure of this special/extraordinary assumption, and state that its use might have affected the opinions and conclusions.

Conclusion

Rural properties can be impacted by environmental contamination resulting in the release of hazardous substances into the air, surface water, ground water, or soil. These factors may complicate real estate financing decisions. The ability for appraisers to accurately identify environmental issues, and factor them into property valuation can, benefit consumers buying and selling land, lenders, and the valuation profession.

This article originally appeared in the 2018 Winter Terra Firma Magazine, the official publication of the REALTORS® Land Institute.

About the Author: James L. Murrett, MAI, SRA, is the 2018 president of the Appraisal Institute, the nation’s largest professional association of real estate appraisers. Based in Chicago, the Appraisal Institute has nearly 19,000 professionals in almost 60 countries. Murrett will be hosting a break out session diving further into this topic at the 2018 National Land Conference in Nashville, TN, in March.