Court Provides Guidelines on Valuing Natural Resources in Eminent Domain Proceedings

by Nossaman LLP

Valuing mineral rights in eminent domain proceedings is inherently speculative and can lead to wide swings in property valuations.  So how do appraisers best deal with the uncertainty involved in mineral exploitation?  The California Court of Appeal recently provided some guidance in San Diego Gas & Electric Company v. Arnold J. Schmidt et al. (2014) 2014 Cal. App. Unpub. LEXIS 5090.  

In Schmidt, the Court allowed the introduction of the property owner’s appraiser’s valuing 115 acres of vacant in San Diego based on the projected future income the property would generate for mining operations.  This approach resulted in a jury awarding approximately $8,000,000 to the owners as a result of a condemnation by SDG&E for its Sunrise Powerlink Project.  SDG&E valued the property at approximately $700,000.  This huge difference in valuation turned on the highest and best use of the property, and permissible methods for determining the proper amount of just compensation for losing the ability to exploit the property’s natural resources.

The Court began by noting some well-established principles of California’s eminent domain law, including: that owners of private land are entitled to just compensation for property taken for public use; that the measure of this just compensation is the property’s fair market value; and that this fair market value includes the right to exploit the natural resources located on or under the land in the future.  So, “[i]n determining just compensation in eminent domain proceedings, the existence of valuable mineral deposits in the land taken… influences the market value of the land.”  The Court noted that while valuation of a mineral estate is inherently difficult, and to some degree speculative, that doesn’t preclude the mineral estate from having and ascertainable market value.

To properly determine this value, the Court explained the first step is to present evidence that the exploitation of minerals is compatible with the highest and best use of the property.  Following that, the next step is determining the proper valuation method for the property.  Usually, the comparable sales approach is the easiest and most reliable method, but if there are no comparables, other valuation approaches may be used.  In such cases evidence of income that may be generated from the land may be considered, even though evidence of income generated from a business conducted on the land may not.  Evidence of income that may be generated from the land can be presented by expert testimony regarding “(1) the existence of the deposit, (2) the quantity and quality of the deposit, (3) whether a market exists for the deposit, and (4) the net income projected over the life of the deposit.”  However, given the time value of money, that projected income must be capitalized and discounted to its present day value.

In this case, the property owners’ expert determined the average income that the owners could realize by leasing the property for mining purposes (approximately $3.3 million per year), and then discounted the future income stream in order to reduce it to its present day value.  The Court rejected SDG&E’s argument that the discounted cash flow method used by the owners’ expert violated Evidence Code section 819, which permits use of the capitalization of income approach only for the land and the existing improvements thereon.  The Court explained that the statute allows "the capitalized value of the reasonable net rental value attributable to the land," which included the capitalized value of the income stream from the potential lease of the property to a mining operator.

While the court ultimately acknowledged that the valuation of a mineral estate will necessarily involve some speculation, its decision provides some guidance as to how to properly value a mineral estate for the purposes of determining its fair market value in an eminent domain proceeding.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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