Mitigating factors in appraisal & valuation of contaminated real property

Real Estate Issues, Summer 2000 by Gluck, Allan E, Nanney, Donald C, Lusvardi, Wayne C

This equation has been refined in the literature to break down the cost ("C") factor into three sub-factors, including: 1). the cost to implement an applicable remediation plan; 2). the cost of any applicable use restrictions; and 3). impaired financing costs. Thus, the equation can include more elements, but only as a variation on a theme.

Stigma ("S") can be defined as the incremental loss in value beyond the cost factor due to market perceptions arising from uncertainty and fear associated with the actual or potential presence of contamination.

Unimpaired value ("U") is determined as if there were no contamination, utilizing any of the customary valuation methods: 1). the comparable sales approach (based on recent sales of like properties, with adjustments relevant to the property being appraised); 2). income approach (based on capitalization of income or discounted cash flow); or 3). replacement or reproduction cost.

This equation only refers to the negative or aggravating factors to be deducted from unimpaired value. As a result, mitigating factors that may offset the negatives are often overlooked. Mitigating factors should be considered when using the basic or refined formulas mentioned above, to derive net values.

Both aggravating and mitigating factors generally concern technical and legal aspects of environmental risks and solutions, which likely fall beyond the expertise of an appraiser alone. Thus, it may be necessary to assemble a multi-disciplinary team of environmental consultants, legal counsel, and other relevant professionals to generate the information and analysis necessary to assist an appraiser in placing a value on various aggravating and mitigating factors. The Appraisal Standards Board has approved the use of multi-disciplinary teams for the valuation of contaminated real property, expressly recognizing that appraisers may rely on the professional work of others, as long as each professional acts within the scope of his or her expertise and acknowledges the contributions of the others.1

LIMITING COSTS TO FUTURE OWNERS

A basic premise of value is that it represents the value to a future owner. Contamination affects market value primarily due to environmental liability and costs that may be incurred by future owners. If a future owner may incur little or no cost or loss, there may be little or no reduction in market value.

Cleanup prior to sale.

In many cases, owners clean up sites before sale, as is the general policy of the major oil companies in selling service station sites. This reduces the uncertainty of cleanup costs, hence mitigating or eliminating possible discounts.

Cost recovery from responsible parties.

The market value impact of contamination may be limited by the identification of liable parties, especially those with deep pockets, who may bear remediation costs so that future owners will not be affected or may recover such costs. To illustrate, there may be little or no impact on the value of a property due to contamination from formerly leaking underground storage tanks at a gasoline service station where the responsible parties include a major oil company, but there may be greater impact where the responsible parties are defunct or have limited financial resources.

Environmental laws impose liability on a number of parties. For example, the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA), 42 U.S.C. section 9601 et seq., generally imposes strict liability on present and past owners and operators of contaminated property, as well as on the generators and transporters responsible for the disposal of hazardous waste, subject to limited defenses. It is therefore appropriate to consider the potential for cost recovery from responsible parties.

According to some commentators, 1g]enerally, anticipated recoveries are not considered in the property value estimate."2 This may be the case when an appraiser acts alone, without the expertise necessary to estimate cost recoveries, or where estimation would be purely speculative, in which case the appraisal opinion is subject to an important limitation and may not reflect economic reality. If possible, cost recovery should be considered in order to enhance the validity of the appraisal.

The cost recovery factor may be considered by a multi-disciplinary team including environmental consultants and counsel who can identify potentially responsible parties and advise as to the extent of their potential liability under applicable legal remedies. The availability of such responsible parties and their ability to bear their liability should also be considered.

Insurance recovery.

The costs of remediation may be covered by liability or property damage insurance. While current forms of commercial general liability insurance policies may contain "absolute" pollution exclusions, coverage may be available under older policies that were in effect when contamination occurred. Furthermore, at some cost, it is possible to purchase insurance specifically addressing environmental risk (e.g., pollution liability coverage, first party property damage insurance without a pollution exclusion, and coverage for costs associated with contamination not discovered during a site assessment by qualified environmental consultants). Stop loss/cost cap insurance may mitigate the risk associated with cost overruns in a remediation program. Costs associated with a leaking petroleum underground storage tank may be covered from a state fund for the cleanup of such sites. Thus, the availability of past or present insurance coverage or similar funding sources should be considered as a mitigating factor, and the advice of qualified insurance professionals and legal counsel may be helpful.