Valuing a Temporary Takings Claim: ‘Every Which Way but Right’ in spite of

Kimball Laundry

ALI-ABA Conference Inverse Condemnation and Related Government Liability Scottsdale, April 14, 2007 William W. Wade, Ph. D.

Energy and Water Economics

Presentation Outline

1 Tahoe Sierra missed the point.

2 Lost Use Values are not measured by Before and After Appraisals.

2 Fair Market Value is an over used concept.

4 Kimball Laundry Supreme Court Decision faulty trial court Fair Rental Value notion.

overturned

5 So, why do so many subsequent decisions struggle with different ways to measure FRV?

6 Federal Claims Court finally got it right with lost earnings and end date as valuation benchmark.

7 Tulare Lake Basin got it right with owner’s prejudgment

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interest rate at owner’s opportunity cost. 2

1 TAHOE-SIERRA PRESERVATION COUNCIL, INC., et al. v. TAHOE REGIONALPLANNING AGENCY et al . 535 U. S. 302,330 (2002 ) “A permanent deprivation of the owner’s use of the entire area is a taking of the parcel as a whole.

A temporary restriction that merely causes a diminution in value is not. Logically, a fee simple estate cannot be rendered valueless by a temporary prohibition on economic use, because the property will recover value as soon as the prohibition is lifted.” DUH! That misses the point: temporary prohibitions on economic use involve lost income or at least time values of lost income.

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2 Remedial Note on Valuation of Temporary Loss of Use Values

Total Economic Value = Tangible Asset Values + Intangible Asset Values Tangible Assets = Real Property. Valued typically by real estate appraisal methods.

Intangible Assets = the business operations that USE the property.

E&WE Value is Present Value of Net Cash Flows

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3 Fair Market Value is an over used concept.

Partial or temporary takings of income producing properties must be valued to establish economic prongs of Penn Central test and to estimate damages. Before and After appraisals to estimate the change in market values of the property continue to be used by government counsel.

WHY?

This approach fails to measure the true economic loss to the plaintiff – the foregone cash flows.

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3 Fair Market Value is an over used concept. (2)

Real property valued from the perspective of buyers and sellers makes sense only for real property transaction.

Plaintiff in a partial or temporary taking case has lost income from the use of his property

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Plaintiff’s factual basis for that income, not hypothetical property market comps, matter.

Factual record must capture plaintiff’s foregone marginal revenues less marginal operating costs . E&WE

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4 Kimball Laundry started things off

right.

1. Fair Rental Value

FMV of Taken Property $1,000,000

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Assumed Rental Rate Annual Rental Value 10% $100,000 Period of Temporary Take 3 Just Compensation $300,000

Kimball Laundry

, 166 F.2d 856, (8 Cir.,1948).

Reversed and remanded for lost earnings @

Kimball Laundry v. United States

, 338 U.S. 1, 19-21 (1949)

No. Supremes overturned rental value and remanded for an evaluation of lost earnings due to lost trade routes.

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5 What went wrong? Rental Rate of Delayed Incremental Development

2. Fair Rental Value of Development

FMV w/o Restriction FMV w/ Restriction Value of Lost Use Right $1,000,000 $200,000 $800,000 Assumed Rental Rate Annual Rental Value 10% $80,000 Period of Temporary Take Just Compensation Assumes FMV of Lost Opportunity 3 $240,000

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5 What went wrong? Nemmers.

3. Market Rate of Return on Lost Use

FMV Planned Project FMV w/ Restriction Value of Lost Use Right $1,000,000 $200,000 $800,000 Assumed Market interest comp.

10% Period of Temporary Take 3 Just Compensation (compound)

Nemmers

, 764 F.2d 502, (1985) $264,800 Nemmers applied 15% to difference between existing use of property and value at light industrial Errors: Lost use values determined by difference in comps. Delayed cash flows were not considered in evidence.

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5 What went wrong? Wheeler.

4. Return on Equity Interest only

Value of Developed Project $1,000,000 Value of Land Value of the Lost Use Right % of Owner's Equity Lost Equity Value of the Right $100,000 $900,000 25% $225,000 Assumed Market Return Period of Temporary Take 10% 3 Just Compensation Wheeler, 833 F.2d 267 (1987) $67,500

Wheeler Error: Plaintiff's Deprived of Leverage

Assumed Market Return 10%

Just Compensation (10% compound)

$297,900

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M&M Separation Theorem: Value of a business is independent of financing. Financial structure has nothing to do with value or damages. 10

5 What went wrong? Miller Brothers.

5. Miller Brothers Fair Rental Value @ WACC

Pre-Taking Fair Market Value Market Rate = WACC $1,000,000 10% Period of Temporary Take Just Compensation Miller Brothers v. MI DNR, 4 Mich. Cl. Ct., 1995.

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WACC is only a floor value of owner’s loss. Actual estimated lost earnings of the asset is the proper measure. Firm’s cost of capital may reflect wholly different risk profile from the asset at issue. 3 $1,331,000 11

5 What went wrong? SDDS.

6. SDDS Fair Rental Value

NPV Cash Flows w/o Delay NPV Cash Flows w/ 36 Month Delay Owner's Property Loss due to delay "Appropriate interest rate" Period of Temporary Take Just Compensation

SDDS Inc. v. State

, SD 90, 2002, FN 15

Bass IV

, Fed. Cl. Ct. No. 95-52 L, Feb., 2001 $1,000,000 $700,000 $300,000 10% 3 $90,000

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Interest on the lost cash flow does not replace the lost cash f low.

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6 Federal Claims Court Got it right in 2004.

Lost Cash Flows benchmarked to end date.

7. Independence Park Apartments

NPV Cash Flows w/o Delay NPV Cash Flows w/ Delay PV Lost Rental Income @ Start of Take Assume Risk-Weighted Discount Rate PV Lost Rental Income @ End of Take @ 3-yr compound factor (1.1)^3 Just Compensation @ End of Take Period Independence Park v. U.S, Fed. Cl. Ct., No. 94-1A-C, August, 2004 Cienega Gardens v. United States, 67 Fed. Cl 434 (Ciendga IX) CCA Associates v. United States, Court of Federal Claims No. 97-334C, January 31, 2007) $1,000,000 $700,000 $300,000 10%

Chancellor Manor, Cienega Gardens and CCA (2007) followed Independence Park.

1.331

$399,300

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7 Pre Trial Interest Rate: risk free or Plaintiff’s lost opportunity rate?

8. Effect of Tulare Lake on Payment of Damages

Damages at End of Take Period Assumed years from end of take to payment Typical Court-Mandated 52-week Treasury bill Owners' Demonstrated "prudent investment" opportunity $399,300 5 4% 10% Damages at 52-week T Bill Damages at opportunity cost of capital Tulare Lake v. U.S., Fed. Cl. Ct., No. 98-101L, August 20004.

$485,810 $643,077

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If regulatory delay imposes no loss in values, has there been a taking?

Date Investments Total 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 ($1,735,014) ($1,838,078) ($1,838,078) ($1,838,078) ($7,249,248)

Has there Been a Temporary Taking?

Planned Project Revenues Start up 1998 Revenues $2,000,000 $2,060,000 $2,121,800 $2,185,454 $2,251,018 $2,318,548 $2,388,105 Cash Flow Planned

($1,735,014) ($1,838,078) $161,922 $221,922 $2,121,800 $2,185,454 $2,251,018 $2,318,548 $2,388,105

$2,000,000 $2,060,000 $2,121,800 $2,185,454 $2,251,018 $2,318,548 $2,388,105 $15,324,924 $15,324,924 $8,075,676 Cash Flow Delayed

($1,735,014) ($1,838,078) ($1,838,078) ($1,838,078) $0 $0 $0 $0 $0 $2,000,000 $2,060,000 $2,121,800 $2,185,454 $2,251,018 $2,318,548 $2,388,105

$8,075,676

E&WE IRR 26%

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7%

What if during the restriction prices rise to increase delayed cash flows?

Date 1989 1990 1991 1992 1993 1994 1995 1996 1997 Total 1998 1999 2000 2001 2002 2003 2004 Investments ($1,735,014) ($1,838,078) ($1,838,078) ($1,838,078) ($7,249,248)

Has there Been a Temporary Taking?

Delayed Price Increase during delay Planned Project Revenues Start up 1998 Revenues Cash Flow Planned

($1,735,014) ($1,838,078)

Cash Flow Delayed

($1,735,014) ($1,838,078)

$2,000,000 $2,060,000 $2,121,800 $2,185,454 $2,251,018 $2,318,548 $2,388,105 $15,324,924

IRR

$2,435,867 $2,484,584 $2,534,276 $2,584,961 $2,636,660 $2,689,394 $2,743,182 $18,108,923

$161,922 $221,922 $2,121,800 $2,185,454 $2,251,018 $2,318,548 $2,388,105

$8,075,676

26% ($1,838,078) ($1,838,078) $0 $0 $0 $0 $0 $2,435,867 $2,484,584 $2,534,276 $2,584,961 $2,636,660 $2,689,394 $2,743,182

$10,859,675

9% E&WE

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Effect of opportunity cost of capital on Penn Central DIBE and damages.

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Date 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

What Are the Damages?

Discount Factors

Start Date

@ 15% Start Date 1.323

1.150

1.000

0.870

0.756

0.658

0.572

0.497

0.432

0.376

0.327

0.284

0.247

0.215

0.187

0.163

@ 15% End Date 3.518

3.059

2.660

2.313

2.011

1.749

1.521

1.323

1.150

1.000

0.870

0.756

0.658

0.572

0.497

0.432

Present Value Planned ($2,294,556) ($2,113,790) $161,922 $192,976 $1,604,386 $1,436,971 $1,287,027 $1,152,728 $1,032,444 Damages @ Benchmark Date

$2,460,107

1991 Present Value Delayed ($2,294,556) ($2,113,790) ($1,838,078) ($1,598,329) $0 $0 $0 $0 $0 $915,733 $812,215 $720,399 $638,963 $566,732 $502,667 $445,844

($3,242,200) ($5,702,307)

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Measure damages at start or end of taking?

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Date

What Are the Damages? Effect of Benchmark Date on Damages.

Discount Factors

Start Date End Date

@ 15% Start Date 1.323

1.150

1.000

0.870

0.756

0.658

0.572

0.497

0.432

0.376

0.327

0.284

0.247

0.215

0.187

0.163

@ 15% End Date 3.518

3.059

2.660

2.313

2.011

1.749

1.521

1.323

1.150

1.000

0.870

0.756

0.658

0.572

0.497

0.432

Damages @ Benchmark Date

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Present Value Planned ($2,294,556) ($2,113,790) $161,922 $192,976 $1,604,386 $1,436,971 $1,287,027 $1,152,728 $1,032,444

$2,460,107

1991 Present Value Present Value Delayed ($2,294,556) ($2,113,790) ($1,838,078) ($1,598,329) $0 $0 $0 $0 $0 $915,733 $812,215 $720,399 $638,963 $566,732 $502,667 $445,844

($3,242,200) ($5,702,307)

Planned ($6,103,565) ($5,622,723) $430,716 $513,319 $4,267,698 $3,822,373 $3,423,516 $3,066,280 $2,746,320 $6,543,935 1998 Present Value Delayed ($6,103,565) ($5,622,723) ($4,889,324) ($4,251,586) $0 $0 $0 $0 $0 $2,435,867 $2,160,508 $1,916,277 $1,699,654 $1,507,519 $1,337,104 $1,185,953

($8,624,316) ($15,168,251)

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Doesn’t matter if owner’s opportunity cost of capital governs pretrial interest.

Damages @ Benchmark Date Damages @ Trial Date (2006) Damages @ Trial Date (2006)

Start Date

1991 @15% @ 6%

($5,702,307) ($46,400,026) ($13,665,911)

End Date

1998

($15,168,251) ($46,400,026) ($28,075,374)

Damages at start date or end date become equal if compounded to payment date at discount rate, not risk free rate. Prejudgment interest is not lower risk than operating risk. Owner’s demonstrated opportunity cost of capital governs discount rates during both time periods. [or, prudent investor’s return?]

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Arguing for risk free interest rates is a waste of court and expert time.

“The government argues that a single, risk-free rate interest rate should be used to bring cash flows forward, not only to the date the taking ended or to the date the judgment is entered, but to the date the judgment is paid. . . . [T]he government contends that the defendant’s debt rate should be used because an owner’s claim at the time of the taking is against the government, and such a claim bears no risk. The government’s approach, however, does not adequately ‘adjust the value of [CCA’s lost] cash flow stream to account for risk.’” (CCA @ 45-46.)

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