Special Use Properties: How Do You Measure the Impact of the Easement?
By: John T. Schmick
In the previous issue of Valuation Viewpoint, we pointed out that appraisers use a variety of methodologies when valuing utility easements. The dilemma this presents is clear; it results in a wide range of values for the same piece of land. How can the client judge the validity of an appraiser's value? In Part Two, we present an objective, USPAP compliant, market-based approach for measuring the impact of a utility easement in a railroad right-of-way.
Our firm has appraised the impact of utility easements in railway right-of-ways. These are unique assignments because railroad right-of-ways are limited market properties that are difficult to appraise under the best of circumstances. Measuring the impact of a utility easement on the right-of-way makes the appraisal assignment even more complicated.
To review, in simple terms, an easement grants the right to use a parcel of land for a specific purpose. It can be granted for either a set time period or it can run in perpetuity. In general, the fee simple owner grants the right to use all, or some portion of the land. Before starting an appraisal assignment involving an easement, it is important for the appraiser to understand the value being requested. Is it the value of the easement to the buyer (benefit to buyer), the value of the easement to the seller (capitalized rent), or is it the impact of the easement on the land (diminution of value caused by the easement)? In this article, we will focus on the diminution of value caused by the easement.
The starting point in measuring the impact of a utility easement in a railroad right-of-way is to identify the larger parcels. Larger parcel is defined as that portion of land that is contiguous, has unity of title and unity of use, including unity of highest and best use. These are described in the Spring 2001 Issue of Valuation Viewpoint. A brief summary follows.
Contiguity of the Land: The most obvious component of the larger parcel concept is continuity of the land. The appraiser identifies the physical characteristics that determine a larger parcel by identifying the land area needed for the continued operation of the rail line and the 'excess' land on either side of the tracks. Typically, this is the minimum safety clearance for trains (often established by state law). The railroad may maintain any width of R.O.W. it wants, but the appraiser must apply the highest and best use (HBU) principle of value maximization. Dolman and Seymour recognized this issue when they stated, "If it is wide enough to perform its function, additional width, although increasing the area, adds little or nothing to value." ¹
Unity of Ownership: The second component of the larger parcel is unity of ownership. Ownership is often erroneously based on the assumption of a fee simple ownership of the R.O.W. by the railroad. However, the railroad does not always own the fee simple interest or it may own something less than a fee simple interest. In some cases, railroads may not have the right to grant an easement for any use to another party. Therefore, title must be carefully examined both for ownership and property interests vested in other entities such as pre-existing easements or uses.
Unity of Use: The last component of a larger parcel is unity of use. Unity of use refers not just to the current use, but also to the unity of highest and best use which in turn is affected by local zoning codes.² As railroad property extends through multiple municipalities, it will fall under multiple zoning classifications. Unity of highest and best use may be different on the two sides of an active rail line and different from one municipality to another.
With the completion of the larger parcel analysis, right-of-way maps can be marked to indicate the appraiser's decisions for the parcels as to which have physical contiguity, unity of ownership and unity of use. Each parcel must then be analyzed to determine its highest and best use (HBU).
Highest and Best Use
The highest and best use analysis focuses on four categories of use: those which are physically possible, legally permissible, economically feasible, and maximally profitable.³ It is during the highest and best use analysis of the appraisal assignment that the appraiser develops an understanding of the market supply and demand factors that influence value.
Physically Possible
From a physical viewpoint, railroad R.O.W.s come in many shapes and sizes. Placement of the tracks and the corresponding statutorily-required safety margins will determine the width necessary to support any operating railroad tracks and that portion which is excess R.O.W. (available for secondary use). On a typical 100-foot R.O.W. with a single operating track located in the center, the required minimum width is an 8.5-foot safety clearance on either side of the center line, or a total of 17 feet minimum width for the operating tracks. Zoning setback requirements further restrict physical uses and may severely limit the number of potential secondary users.
Legally Permissible
When we look at zoning codes and land use regulations governing the possible uses of excess railroad R.O.W., there are some common legal issues. One of these is height restriction. Typically, a railroad R.O.W. will be zoned either for industrial use or the same as or similar to the adjacent land. When there is a height restriction on development, the railroad has the right to use land from the ground to the predetermined height only. Damages are limited to those occurring within the area controlled by the railroad.
Financially Feasible
The financial feasibility component of the HBU analysis focuses on identifying those who could use the property, how it could be used, and what the market conditions would require them to pay. In essence, this is an attempt by the appraiser to identify and quantify demand for the railroad R.O.W., or its excess land, by both longitudinal users and adjacent property owners within the context of a free and open market. This assumes private parties as the willing buyers and willing sellers. Public entities that possess the right of eminent domain adopt the prices set by willing private buyers and sellers; they do not make the market. In fact, transactions involving public utilities and government entities are often not acceptable as comparable market data under current federal appraisal standards. The appraiser must carefully review all transactions to determine whether or not the parties involved meet the definition of free market participants, or if they are participating in a public utility transaction consummated under threat of eminent domain.4
Maximally Profitable
Following an analysis of physically possible, legally permissible and financially feasible potential uses, the appraiser identifies that use which is maximally profitable to the railroad. It is not uncommon to conclude that the HBU of excess R.O.W., resulting in maximum value, is for sale and assemblage with adjacent land for some future use.
Highest and Best Use and Demand Analysis
A two-step approach is used to determine the HBU when analyzing railroad R.O.W.s. Karvel's "decision tree" provides us a macro approach which looks at four possible outcomes for use of the entire railroad right-of-way. These are:
- Liquidation of the R.O.W. if the tracks are abandoned.
- Continued operation of the rail line with exclusive use for rail purposes.
- Use of excess land for transportation/communication/utility corridor.
- Sale of excess R.O.W.
Initially, the appraiser searches for data to either confirm or deny the existence of demand for the railroad's land. If there is no excess land in the railroad R.O.W., this step is irrelevant because the appropriate measure of damage caused by a secondary user, such as a public utility easement, is equal to the loss of revenue or the increased operating expense to the operating railroad.5For the other three possibilities, the appraiser determines the demand for the excess R.O.W. (or in the case of abandonment, the full R.O.W.). Demand can be from longitudinal users, adjacent property owners, or other potential non- contiguous users. If demand exists, it must be identified as demand from private users (without the power of eminent domain) or as demand from public users (with the power of eminent domain). The results of a R.O.W. demand study will differ in each market, but generally there is little or no evidence of market-based longitudinal demand for R.O.W. by private users (willing buyer/ willing seller) and only limited evidence of non- longitudinal demand for R.O.W. by private users. There may be significant market demand involving certain shorter sections of a long R.O.W. for non-longitudinal use, but this type of demand is generally limited to a few highly concentrated urban areas. A review of the history of the specific section of R.O.W. being appraised may uncover sales of small sections of excess land to adjacent property owners, which indicates both the presence of excess land and the historical non-longitudinal demand for that excess land.
Demand
Sales data, whether for longitudinal use or for assembled railroad-right-of-ways, is often very limited or non-existent. The few transactions available involving railroad R.O.W.s often do not provide adequate data from which to draw any meaningful conclusions. In the absence of any measurable private market longitudinal demand, the next most logical users are the adjacent property owners. Determining the highest and best use for these smaller parcels constitutes the micro approach. Depending on the type of land use adjacent to the railroad R.O.W., interest in acquiring the excess R.O.W.s will vary greatly.
In developed urban areas, many adjacent sites may have been previously improved with buildings and other facilities based on the existing site size and topography. Generally, excess R.O.W.s are long, narrow strips of land that offer limited functional utility to the developed, adjacent property. Where interest is found, it is mostly for additional parking, outside storage or turnaround space. Owners of adjacent undeveloped land have a higher interest level because the excess R.O.W. can be incorporated into a future development plan and has the potential to increase the density of development and its corresponding value.
A demand study is an integral part of the HBU analysis. If demand exists for the excess R.O.W., the appraiser must identify in what form (unified corridor vs. individual pieces) and by whom. In either case, a "reasonable marketing period" for the subject parcels should be estimated which can then be used in the valuation of the property.
When the initial HBU analysis (prior to the new easement) is complete, the appraiser's maps should be marked with any factors affecting the larger parcels based on demand and potential use of the excess R.O.W. These include: properties adjacent to the R.O.W., location of known environmental problems, existing R.O.W. users and easements, significant landmarks, all streets and highways that come in contact with the R.O.W., outdoor advertising signs, landfill sites, drainage ditches, pedestrian bridges, areas used for parking and outdoor storage lots, locations of adjacent buildings, all bodies of water, etc. The result is a very useful exhibit which shows multiple users in some sections of the railroad R.O.W. and a complete lack of users in other sections.
Valuation
When the HBU analysis of the larger parcels is complete, the process of selecting comparable sales and making adjustments resembles any other standard appraisal assignment. There are, however, some additional issues the appraiser should address. These include marketability, title and survey costs, and the sell-off period (time value) of the individual parcels. Marketability is a product of the demand study. Adjacent property owners will have varying degrees of interest in the excess R.O.W. Those who need more land for expansion will be willing to pay more than those who do not need more land. Marketability adjustments must not be confused with the discounting process associated with the reasonable sell-off period. One must also acknowledge title and survey expenses. Quite frequently, we find that the railroad's interest in the land is unclear, or that no one knows the exact location of the R.O.W. and tracks within the land. Legal descriptions which rely on physical landmarks that no longer exist make it difficult to accurately locate the railroad land and tracks or easements within the corridor.
The sell-off period of the individual parcels (absorption) is based on information developed during the analysis of larger parcel and HBU. As with all real estate, demand varies from parcel to parcel and some will sell more quickly than others, depending on market conditions. Information developed during the survey of adjacent property owners will guide the appraiser in estimating a reasonable expectation of sell-off time, even at steeply discounted prices. In today's real estate markets, there may be some R.O.W. parcels which have no market at any price.
After the valuation has been completed for all larger parcels, it is a simple matter to add the various values to arrive at the estimated market value of the excess railroad R.O.W. unencumbered by the proposed public utility easement. The second part of the appraisal process is to repeat the highest and best use analysis for each larger parcel as encumbered with the easement and then repeat the valuation process.
After the Easement
The HBU of the individual larger parcels, as encumbered by the public utility easement, may be adversely impacted by that easement. We qualify this statement by saying "may" be adversely impacted because clearly it depends on the various attributes of the land, market demand, and the HBU unencumbered (before taking situation). Additional considerations are the purpose, size, type and placement of the easement.
Generally, the greatest damage will be found where there are excess R.O.W. areas that result in larger parcels which could be developed as independent lots. Here, the placement of an easement is critical because of the risk of changing one of these lots into an undevelopable tract. For example, a parcel large enough to accommodate a single-family house will lose most of its value if an easement is placed through the middle of the lot. At this point, the HBU changes from independent development to assemblage with adjacent lots and the demand changes from many possible buyers to perhaps one or two at best. If the same easement were placed at the edge of the lot, an unencumbered lot area (large enough to develop independently) might still exist, thereby minimizing the impact on value caused by the easement.
After completing a second valuation of the excess R.O.W. as encumbered, it becomes a simple matter of applying the general "Before and After Rule" 6typically used in condemnation cases. The comparison of the unencumbered and encumbered values of the larger parcels produces a measurement of the easement's impact on value. This is synonymous with the damage caused by the easement. The result is an appraisal which is a market-based, rational analysis of maximum productive use of the railroad R.O.W. and any damage caused to that maximum productive use and value.
Conclusion
Easements on railroad right-of-ways involve a complex analysis of larger parcels, highest and best use, and a search for market demand and data to support a realistic valuation conclusion. We have presented a market based approach which measures the impact of a utility easement in such a right-of-way. Karvel's decision tree model results in an unbiased, well-grounded valuation estimate. 
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