VALUATION OF ENVIRONMENTAL DAMAGES TO REAL ESTATE

Kenneth Acks

Copyright 1995, Kenneth Acks

TABLE OF CONTENTS

I. INTRODUCTION
II. USES
III. THE SCOPE OF ENVIRONMENTAL DAMAGES

• Land
  Air
  Water

IV. ENVIRONMENTAL DECISIONS
V. ENVIRONMENTAL FACTORS & TAX ASSESSMENTS
VI. DAMAGE VALUATION TECHNIQUES

• Appraisals
  Examples
  Asbestos
  Toxics
  Hedonic Regressions
  Contingent Valuation
  Other Techniques

VII. PRECEDENTS FOR INTRODUCTION OF HEDONIC ANALYSES
VIII. CONCLUSION

ABSTRACT

Despite considerable attention in recent years environmental factors are often ignored in valuations of real estate and corporations. Environmental hazards can have huge effects upon value. Hedonic valuation techniques and statistical analyses are the most systematic means available to measure values of real estate disamenities. Information from selected sales can also prove useful. Failure to utilize these techniques could expose litigants, buyers, and sellers to significant monetary losses.

VALUATION OF ENVIRONMENTAL DAMAGES TO REAL ESTATE

I. INTRODUCTION

Environmental hazards can reduce huge investments to a pittance--rendering once prized trophy properties unleasable and unsellable. Discovery of environmental dangers can also cause corporate debt ratings and stock prices to plummet. Some analysts have pointed to plausible scenarios under which most of the property and casualty insurance industry would become bankrupt if they were held responsible for many environmental claims. The value of environmental risks to real estate from hazardous and toxic materials has been estimated to exceed $2 trillion. Within the past year, Standard and Poor's lowered the ratings of the Aetna Life and Casualty Company from AAA to AA largely due to environmental claims, and ARCO estimated that environmental cleanups would cost $1 billion more than the $648 million it had already set aside for that purpose.

However, to date, most measures of damages caused by environmental disamenities have been ad hoc and unsystematic. We know the costs of a personal computer due to the actions of buyers and sellers in free marketplaces. Yet, there are no pure markets for clean air, for unpolluted land, for peace and quiet, for reductions in cancer risks, and for clean beaches. Recent advances in economic theory and appraisal technique, as well as the results from empirical studies permit market participants to obtain more informed measures of potential losses. Below we will review the uses of environmental damage valuation, the scope of environmental damages, legal decisions, and measurement techniques.

II. USES

Better measures of environmental damages can improve decisions with respect to 1) investments, 2) loans, and 3) valuations of companies. Improved quantification procedures can help governments and others to assess risks, to analyze the costs and benefits of policies, to prioritize cleanups, to resolve community opposition to projects, and to render property tax assessments more equitable. Damage measures can be used by investors looking to buy potentially distressed properties; by lenders fearful of potential liabilities; by governments faced with the need to evaluate policies; by stock analysts interested in determining the effects of environmental hazards upon balance sheets; by property owners looking to reduce unfair tax burdens on nonperforming real estate; by courts required to assess damages; and by mediators looking to settle neighborhood disputes through negotiation or compensation.

III. THE SCOPE OF ENVIRONMENTAL DAMAGES

Environmental damages can be divided into several categories based on the source of the damage or upon the results. Many of these categories overlap. Sources of damage include both toxic and non-toxic wastes. These sources can affect land, air, or water. The effects upon human beings include diminution of health, of aesthetic pleasures, of appropriate sensory stimulation, and of time. Environmental hazards can also drive species of animals and plants into extinction, and destroy natural resources forever. Below we will discuss the sources of damages: 1) toxic and non-toxic land based wastes, 2) air pollutants and 3) dangers to our waterways

The Land

Researchers suspect thousands of chemicals may play a role in damaging our environment, and/or our health. Sources of toxic pollutants include medical wastes, industrial chemicals, oil spills, leaking underground storage tanks, and asbestos. Major chemicals include dioxin, lead, cadmium, mercury, particulates, sulfur dioxide, nitrogen dioxide, carbon monoxide, benzene, methanol, toluene, formaldehyde, and clorofluorocarbons. Health effects include cancer, immunological disorders, asthma, bronchitis, reproductive difficulties, and nausea. Toxics are regulated by the Conservation Environmental Recovery and Conservation Act (CERCLA or the Superfund), the Resource Conservation Recovery Act (RCRA), the Clean Air Act of 1970 and the Amendments of 1990, the Clean Water Act, state superfund laws and a multitude of additional laws and regulations.

Damage from toxic contamination to land and buildings has been estimated at $2 trillion. Despite extensive cleanups leaking underground storage tanks (LUSTS) continue to pose a serious risk. Approximately 75% of the EPA's recognized 50,000 LUST sites are still under remediation and thousands of tanks remain undiscovered. The Environmental Defense Fund recently calculated that nationally between three million and four million, or 17%, of the total number of children under 6 have levels of lead in their blood that could cause neurological impairment. In the New York area they estimate that 220,000, or 1/3 of all children suffer from lead poisoning. The Federal Lead Based Paint Hazard Reduction Act of 1992, known as Title 10, contains broad requirements for managing lead-based paint, sweeping lead hazard disclosure requirements for the lease or sale of residential properties and establishes deadlines for finding and remedying lead paint hazards in public and other federally assisted housing. In 1987, the EPA estimated that 750,000 buildings or 20% of all commercial buildings in the U.S. contain asbestos in friable (or brittle) firm. Property damage cases related to asbestos are expected to cost insurers $40 billion according to a 1994 report by A.M. Best Corporation. This figure does not include uninsured damage claims, or suits regarding diseases such as cancer caused by exposure. Disposal of toxic ash produced by incineration of garbage looms as a problem throughout the country.

The existence of nonhazardous waste products can also reduce the value of properties directly exposed to these wastes as well as surrounding properties. Similarly, proximity to properties involved with the disposal of nonhazardous wastes including landfills, incinerators and sewage plants can cause property values to plunge.

Air

Air pollutants may be present indoors or outdoors. Key outdoor pollutants are ozone, particulates, sulfur dioxide, nitrogen dioxide, and carbon monoxide. Outdoor air pollutants can reduce property values by nominal amounts, or up by as much as 50%. We present some estimates below. In coming years international agreements and federal laws will also require building owners to institute costly reductions of clorofluorocarbon (CFC) emissions, which will reduce returns to real estate.

The World Health Organization estimates that as many as one in three new or remodelled buildings is sick, and a danger to those who live and work inside them. Symptoms of indoor air pollution, include headaches, dizziness, and fatigue. Among the potential sources of indoor air pollution are 1) biological contaminants such as molds, spores, and pollen; 2) building materials and furnishings, such as damp carpeting; furniture made of pressed wood products that contain formaldehyde and deteriorated asbestos-containing insulation; 3) environmental tobacco smoke; 4) products used for cleaning maintenance and hobbies such as paints, solvents, cleansers and moth repellents; 5) oil, gas, kerosene, coal, or wood combustion sources; central heating and cooling systems and humidifiers; and 6) outside sources such as radon, pesticides and outdoor air pollution.

Impacts include direct medical costs, lost earnings, increased sick days and decreased productivity. The EPA notes that poorly ventilated buildings may cost "tens of billions a years in white collar worker productivity losses plus about $5 billions a year in direct health related expenses". Labor costs may be 10 to 100 times greater than remediation costs, according to the EPA. It is estimated that throughout the United States between 10 million and 25 million workers employed in 800,000 to 1.2 million commercial buildings will claim symptoms typical of building associated illness. It has been estimated that the market for products and services to prevent or correct indoor air pollution will reach $2.5 billion by 1996.

Water

Water related environmental factors which might influence property values include 1) the loss of clean drinking water; 2) elimination of recreational benefits (swimming, fishing, and boating) for properties near bodies of water; 3) restrictions on use due to wetlands preservation, and 4) flooding.

The EPA estimates that 18,770 of the nation's waterways are severely polluted. In 1993, cryptosporidium in drinking water, sickened 400,000 Milwaukee residents, killed at least 40 more, and contributed to illnesses that officials estimate has killed scores more. Developers in Putnam County are suing New York City for $9 billion claiming that attempts to restrict development have reduced the value of their properties. The National Marine Fisheries Service has estimated that more than 40 percent of the nation's commercial fish species are overfished. Part of the decline in supply relative to demand results from watershed damage produced by farm chemicals, dams, development, and logging.

Wetlands have been protected by Section 404 of the Federal Clean Water Act. Wetlands are identified by their characteristic vegetation and divided into four classes. Wetlands legislation seeks to protect these values by regulating any activities that might have a negative impact on wetland benefits. Regulated activities include draining, dredging, filling, building structures, and polluting. In order to pursue a regulated activity a permit must be obtained from the Department of Environmental Conservation. Approximately 300,000 acres of wetlands are lost in the U.S. every year.

IV. ENVIRONMENTAL DECISIONS

Courts have long awarded compensation for a variety of disamenities. In 1944 the New York Court of Appeals ruled in Dixon v. New York Trap Rock Corp. 293 NY 509,581 N.E. 21 517 (1944), that damage awards for a "state of anxiety" resulting from a blasting operation were appropriate since "discomfort and inconvenience caused by the disturbance of property are valid grounds for recovery in an action for a nuisance".

Damages due to increased risk of disease resulting from environmental factors have also been awarded. In Sterling v. Velsico Chemical Corp., F. Supp. 303 (W.D. Tenn 1986) the court recognized "the cellular damage and biological changes caused by the ingestion, inhalation and contact with toxic chemicals to be the genesis of the enhanced risk of disease", and thus awarded damages. Furthermore, in Selective Resources v. Superior Court 700 P.1D 849 (Ariz App 1985) the Arizona Court of Appeals found that a "health hazard created as a direct result of taking through condemnation of which the general buying public is unaware is relevant to issues of just compensation." The New Jersey Supreme Court recognized claims for "diminished quality of life damages due to exposure to toxic chemicals" in Ayers v. Township of Jackson 106 NJ 557,525 A.2d (1987). The Supreme Court of Florida also ruled that the impact on property values of public fears regarding health risks is admissible in eminent domain proceedings in Florida Power and Light Co. v. Jennings 518 So.2d 895 (Fla. 1987).

In Luebke v. Miller Consulting Engineers, 174 Wis2d 66, 496 NW2d 753 (Wis. Ct. App. 1993), and Bixby Ranch Co. v. Spectrol Electronics Corp., Index No. BC052566 (Cal., Los Angeles Co. Super. Ct., Dec. 13, 1993) courts awarded claims for reduced property values to owners of property whose worth was reduced by the stigma of contamination, even in the absence of clear physical harm to the property. However, stigma damages were denied in Adams v. Star Enterprise, No. 94-221-A (E.D. Va May 5, 1994); Vikase v. Monsanto Co., No. CL 93-55263 (Iowa Dist. Ct., Polk Co., June 16, 1993), Stewman v. Mid-South Wood Products of Mena Inc., 993 F2d 646 (8th Cir. 1993), and Berry v. Armstrong Rubber Co., 780 F. Supp. 1097 (S.D. Miss. 1991).

By far, the largest award for environmental damages is the $5 billion in punitive damages given to 34,000 fisherman and other Alaskans for the Exxon Valdez oil spill. In addition, the jury granted fishermen $286.8 million in compensatory damages to fishermen. The awards come on top of the $2.5 billion which Exxon spent to cleanup the damage, $1 billion in Federal and State fines, and other expenditures.

Other recent awards, settlements, and fines include $950,000 in quality of life damages to residents of Pomona New Jersey for leaking underground storage tanks; $5.3 million for an office building contaminated by PCB's in Denver; $3 million for oil spills by AMOCO gas stations in New York; $200 million nationally, and $30 million more in Michigan for damage to schools from asbestos; $20 million for emotional distress, lifetime medical monitoring and legal fees to workers at a uranium processing plant in Fernald Ohio, plus $78 million to 14,000 residents of Fernald for property damages; $17 million for toxic chemicals in groundwater under residential communities near Kodak Park in Rochester; and $500,000 for dumping of oil by an ocean liner.

In Arkansas Power and Light Co. v. Haskins, 528 S.W.2d 407 (Ark. 1975) the Supreme Court of Arkansas held that "no reasonably prudent person should be expected to purchase land without giving heed to . . . possible effects of the hazard upon the uses for which the land was otherwise suitable." The court ruled that severance damages could be awarded for the "danger" element associated with power lines. In 1986 the Supreme Court of Colorado permitted severance damages attributable to the negative aesthetic impact of power lines in three cases--La Plata Electric Association v. Cummins, 728 P. 2d 696 (Colo. 1986), Herring v. Platte River Power Authority 728 P.2d 709 (Colo 1986), Bement v. Empire Electric Assoc., 728 P.2d 706 (Colo 1986). In Cummins the court granted damages for "the unattractiveness of the power line and the impairment of view resulting from its construction."

V. ENVIRONMENTAL FACTORS & TAX ASSESSMENTS

Tax Assessors and real estate tax courts have begun to recognize the effects of environmental damages upon property values.

In January 1991 the New York Supreme Court held that, due primarily to the presence of asbestos, the previous six years of tax valuations for One New York Plaza had to be reduced by approximately $369 million, or 40% of the previously assessed valuation (Bass v. the Tax Commission of the City of New York). As a result, the tax liability for the period in question was cut by more than $35 million. The Court found that the presence of asbestos constituted a "significant physical and functional impairment of the building that has an effect on its market value". Asbestos was found throughout the building. The Court concluded that the asbestos rendered maintenance and repairs more difficult. The petitioners established that the cost in 1984 dollars of abating asbestos was $81,892,800. The court found that this sum was too great to permit repair and still maintain a return on investment. The judge also discussed the effect that the need for constant air testing would have on market value, and the ability to attract tenants. He found that the cost of asbestos surveys, inspections, monitoring and abatement should be included in determinations of expenses and net income.

In October, 1993, The New York State Court of Appeals ruled unanimously that a group of homeowners near power lines had standing to sue for damages because of "cancerphobia", which resulted from "the public's or the market's relatively more prevalent perception...scientific certitude or reasonableness notwithstanding" in Criscuola v. Power Authority, 81 NY2d 649, 602 NYS2d 588". The Court of Appeals also emphasized the stigma problem, and reduced the property taxes for a parcel contaminated by hazardous waste in Allied Corp v. Town of Camillus, 80 NY2d 351 590 NYS 2d 417 (1992).

Also in 1993, an Appellate court held that upstate towns had a cause of action against a polluter for alleged reductions in tax revenues. In State of NY & Town of Moreau v General Electric Company AD2d-604 NYS 2d 355 (3rd Dep't 1993) the governments claimed that assessments were reduced because of pollution at a neighboring GE plant.

In another 1993 case, the Supreme Court of Suffolk County deducted the entire remaining cost to cure a contaminated superfund site in order to determine full market value.

The City of Hackensack refunded $246,000 in taxes paid on an office building because the building owner was able to prove that the presence of asbestos devalued the structure in the case of University Plaza Realty Corp. vs. City of Hackensack (12 N.J. Tax 354). The tax court held that (i) the building owner was entitled to include the cost of asbestos abatement in determining the value of the property, (ii) estimates of anticipated future rent and vacancy allowance had to consider the impact of asbestos contamination and (iii) the direct capitalization approach rather than the sales comparison approach or the discounted cash flow approach should be applied to determine the true value of the property. The Appellate Division of the New Jersey Superior Court affirmed the tax court's decision and the Supreme Court refused to hear the city's appeal. The subject property is a six story multi-tenanted office building containing 125,847 square feet of leasable area on 5.5 acres of land constructed in 1969. The owner had expended $640,000 due to the presence of asbestos beginning in 1987, and the remaining cost was estimated to exceed $2.9 million.

In Northwest Cooperage Company Inc. v. Ruthe Ridder, King County Assessor, Tax Lexis 208, July 12, 1990 #36278-36280 the Washington Board of Tax Appeals found that certain variables which influence value, such as the capitalization rate, can be affected by environmental stigma.

Many reductions for environmental hazards are granted by assessors without major court cases: A 170,000 square foot office building in Mineola received a $2 million tax reduction, part of which arose from the presence of asbestos. In addition, a farm in Duchess County New York which is a National Priorities List (Superfund) site recently had its taxes reduced to nominal amounts due to toxic contamination.

Furthermore, laws and regulations increasingly mandate that assessments incorporate environmental damages. In New York, the state agency in charge of assessment administration has recently issued an opinion that the valuation of a contaminated property requires the evaluation of many factors including its status as a "superfund" site, cleanup costs, the likelihood of obtaining financing, and the stigma remaining after the cleanup.

The Freshwater Wetlands Act (Article 24 of the Environmental Conservation Law was passed in 1975 to preserve, protect, and conserve wetlands in New York State. Wetlands are also covered by Section 404 of the Federal Clean Water Act. Wetlands are identified by their characteristic vegetation and divided into four classes. The Act seeks to protect these values by regulating any activities that might have a negative impact on wetland benefits. Regulated activities include draining, dredging, filling, building structures, and polluting. In order to pursue a regulated activity a permit must be obtained from the Department of Environmental Conservation. Section 24-0905 of the Act states that properties subject to use limitations shall be deemed so for the purpose of property tax evaluation in the same manner as if an easement or right had been acquired. Assessment value shall be based on the uses remaining to the owner.

On June 2, 1994 the IRS ruled that the costs of environmental cleanup may be claimed as tax deductions immediately rather than spread over many years, reversing a technical ruling the agency made in 1993. The government distinguished between soil remediation, which can be immediately deducted as a business expense, and construction for groundwater treatment which must be capitalized because it represents a permanent improvement.

Many owners resist pursuit of tax abatements because they fear that it will alert authorities and community groups to problems. However, lack of disclosure can be extremely costly in environmental affairs. Many laws and judicial decisions mandate disclosure and call for additional penalties if information is not forthcoming.

VI. DAMAGE VALUATION TECHNIQUES

To date, valuations of properties and companies have largely ignored or dismissed the effects of environmental damages. Many analysts make note of contamination and then add disclaimers to absolve themselves of legal liabilities which might arise from their failure to evaluate the economic effects. When adjustments for disamenities have been included, they are generally ad hoc and unsystematic. However, over the past three decades economists and real estate appraisers have developed several tools to quantify the value of disamenities. "Hedonic Valuation Techniques" estimate the pleasures that individuals derive from goods, from characteristics of goods, from natural resources, or from particular aspects of health. These techniques are most commonly employed when markets and prices do not exist, or where distortions cause prices to deviate from true values. Through hedonic valuation economists attempt to determine how much individuals would be willing to pay for deriving benefits, or willing to accept for being exposed to, harmful environments. Some of these techniques can produce questionable results, even if they are applied scrupulously. But they are often the only means to determined values and damages.

Eight types of data have been employed (along with statistical methods) to estimate implicit valuations: 1) classical appraisal techniques, 2) hedonic property regressions through time and across properties, 3) survey questionnaires (the "contingent valuation" method, 4) wage premiums for dangerous jobs, 5) insurance premiums, 6) travel cost data, 7) public expenditures, 8) laboratory experiments, and 9) expenditures on safety equipment.

Appraisals

Real estate appraisals attempt to derive market value: "The most probable price in terms of money which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller, each acting prudently, knowledgeably and assuming the price is not affected by undue stimulus." Appraisers generally use three approaches: The Cost Approach, Sales Comparison, and the Income Approach. All three approaches use information on market transactions to derive value conclusions.

The Cost Approach is based upon the premise that the value of a property is approximated by the investment necessary to replace that property. Replacement costs typically include land acquisition, the cost of site and building improvements, and an allowance for the developer's profit, less accrued depreciation.

The Sales Comparison Approach is derived from sales of properties similar to the subject, each of which is compared to the property appraised and adjusted to reflect the estimated influence of various characteristics.

There are two basic forms of income approaches: 1) Income Capitalization and 2) Discounted Cash Flow. Income Capitalization is a process of measuring future income and translating this income into a total value via capitalization. In employing the Income Capitalization Method, consideration is given to the earning capacity of the property over an anticipated period of time. This time element is measured by an appropriate discount rate commensurate with risk and equity requirements. The time element is revealed in the study of investors activity with respect to the type of property being appraised, as well as in broader measures of investor requirements. Discounted Cash Flow Analysis incorporates year-by-year projections of income and expenses, discounts these cash flows by an appropriate rate, and adds the present value of a sale at some future date. This methodology is applicable to income streams that do not conform to a pattern.

Real estate appraisers can attach values to disamenities by applying the three approaches, and incorporating information on costs to remediate disamenities. Appraisers can include the costs to decontaminate land and buildings into cost and income approaches. They also can attempt to find sales and leases of properties affected by toxic chemicals and compare these to sales of uncontaminated properties.

Many appraisers have accounted for environmental disamenities by increasing capitalization, interest, and discount rates to reflect increased risk. A survey of 101 institutional investors including insurance companies, commercial banks, real estate investment trusts, and mortgage companies with total investments and loans exceeding $27 billion cited by de Silva and Egland (1991) found that approximately one half of the institutions surveyed had specific lending policies for buildings in which asbestos is present in commercial real estate. Over 70 percent of these companies demanded abatement before making an investment or loan.

In the July 1994 issue of The Appraisal Journal Albert Wilson provided a simple framework for analyzing impaired value with the following equation:

I = U - C_NCP - C_R - C_F - M_U

where

I = Impaired Value

U = Unimpaired Value

C_NCP = Cost to implement the remediation plan

C_R = Cost of restrictions on use and or environmental liability prevention

C_F = Impaired financing cost

M_U = Intangible market factors

Examples

Several published examples from appraisal journals illustrate the value of environmental damages estimated by appraisers.

Asbestos

Ragas and Argate (1991) studied the effects of asbestos upon a 50 year old Class A high rise office building near the historic center of the New Orleans Central Business District. ACM abatement was begun in 1989 as part of a much larger renovation project at a cost of $240,000 for abestos removal in the mechanical rooms and the water riser. Additional costs were estimated to be $8,000 per floor for the fifteen remaining floors with some asbestos. To evaluate the effects, the authors utilized a higher equity yield of 25% and a higher debt coverage ratio of 1.4, and concluded that the presence of asbestos added 1% to the terminal capitalization rate. They estimated that the immediate removal of all friable ACM's would result in a valuation that is $531,000 higher, even though the remaining cost to cure was approximately $120,000.

Bill Mundy (1989) examined a 40,000 square foot downtown office building. He estimated a value of $1.32 million if the building's asbestos problem is "manageable" or "controlled"--meaning that there is no contention with the building's management or employees, or widespread public knowledge of the asbestos. Asbestos would be encapsulated and removed upon demolition under the controlled scenario.

If the situation is "uncontrolled" the public, including potential tenants, insurers, lenders, and citizens at large are aware that the building has significant amounts of asbestos, and complete removal is appropriate. He adjusts the rent downward by 20% based on estimates produced by the investment bank Alex Brown & Sons, and his own independent research. He also adds in the cost of additional insurance at $8,000 per year, or 20 cents per square foot, and a sinking fund of $1,000 per month to ensure available resources for litigation expenses. He increases the investor's return on equity by 20% to reflect additional risk, and the debt service constant by 33%, based on a survey conducted by Richard D. Jones, an attorney for Pepe & Hazard (in which 37% of the 140 institutional lenders surveyed indicated that they would not write a mortgage on buildings containing asbestos), and a survey of lenders in the Pacific Northwest. The resulting capitalization rate is 16.5%, and the property value drops to $600,000 a decline of 54.5%--which happens to equal the value of the site as vacant.

The cost to cure the "controlled" asbestos problem on a short term basis with encapsulation is estimated at $20,000. In the uncontrolled situation the asbestos removal costs could run as high as $25 per square foot with a potential removal cost of $1 million. Deducting the $1 million cost to cure from the value of the property as if clean suggests a residual of $320,000, which is less than the value estimated in the full abatement scenario and less than the value of the site as vacant.

Toxics

Gary Nash (1990) presented a case study of an office building with 75,000 square feet of gross building area, 64,500 square feet of net rentable area, and an economic rent of $18 per square foot. The five acre site was formerly utilized as a lawn chemical manufacturing and distribution facility, a truck terminal, and a truck cleaning and repair shop. The site was purchased for $800,000 and demolition costs were $900,000. During excavation workers became ill and required hospitalization. The EPA and local groundwater agency conducted tests and discovered limited contamination. After completion, additional tests revealed that contamination was more widespread and serious than originally thought. The groundwater agency mandated installation of a $150,000 filtration system with a $4,000 monthly monitoring cost. Additional tests discovered that chemicals were seeping through the new asphalt parking lot. The EPA ordered its removal at a cost of $850,000. Nash estimated a value of $7,182,000 if unaffected by contaminants. After incorporating operating cost increases (monitoring at $4,000 per month) and one-time cleanup costs (filtration plus parking lot costs totalling $1 million) resulting from the contamination the value drops to $5,901,000, a decline of 17.8%. Finally, under a third scenario whereby lenders demand a 14% rate of interest rather than the market rate of 12%, and the equity yield remains constant, the value falls to $5,519,000, a decline of 23.2% from the original value.

Peter Patchin (1994) has cited several clever examples which illustrate the loss in value resulting from stigmatization of environmentally damaged properties. First, he noted the 1991 sale of a property in a large Midwestern City which was constructed in 1985 as a supercomputer manufacturing plant. The gross building area was 121,965 square feet and the building was located on a 20.745 acre site. The property was situated on a former coking oven site which leached toxic contamination into the soils and groundwater. The site was thought to have been cleaned up in 1982, but a small amount of groundwater contamination reappeared in 1989. It is being remediated. In October 1989 a contract was signed for purchase of the property at $5.8 million. However, the purchaser cancelled the contract stating that it did not wish to face any liability associated with a contaminated property, even though other parties were responsible. The property was subsequently sold for $4,300,000. Patchin attributed the 25.9% difference in price to stigma.

Another industrial property, also located in a large Midwestern city, consisted of 16 buildings with offices, warehouses and manufacturing operations for the chemical division of a large company. The site area is 56.88 acres, and the gross building area 153,870 square feet. The buildings were constructed between 1931 and 1970. Soil and groundwater contamination occurred between 1947 and 1962, and the site was placed on the National Superfund List in 1983. Operations were discontinued in the late 1980's for reasons unrelated to the contamination. Remediation was complete by 1991. The assessor's opinion of unimpaired market value in 1990 was $1,780,000. The assessor was required by law to maintain values equal to at least 90% of market value. In addition, an appraiser had valued the property at $1,500,000 as unimpaired. The building was sold for only $95,000, a discount of at least 93.7%, even though the cleanup was completed, and two Fortune 500 companies were responsible should any additional contamination be discovered.

A third example from Patchin involved a 248,332 square foot building constructed in a large Midwestern city circa 1983 as a semiconductor facility at a cost of $42 million. The site area was 40.4 acres. The owners closed the facility in 1987 when they consolidated operations elsewhere. An appraisal in early 1988 estimated a value of $9,200,000. In late 1988 TCE contamination was discovered in the groundwater. In October 1989, the owners installed a groundwater treatment system. Remediation was expected to take five years. The property was sold for $6,515,345, including a $400,000 escrow for possible building contamination costs on September 19, 1991. The purchase price was 29.2% below the unimpaired estimate. The seller was fully responsible for all future cleanup costs.

A vacant 81 acre parcel adjoining the latter property was contaminated by the same source. The assessor had valued the site at $100,000 per acre, but an appeal reduced the assessment to $60,000 per acre. At that time the owner commissioned an appraisal which estimated a value of $60,000 per acre. In late 1991 the owner put the property on the market with an asking price of $18,815 per acre, 69% below appraised value. No offers were received for at least three years.

Patchin's results are summarized below

Patchin utilizes these sales to adjust the price of properties for stigma.

Hedonic Regressions

However, appraisal samples tend to be limited, and are subject to ad hoc arbitrary adjustments because property values are subject to a multitude of complicated influences. The examples above occurred when prices were falling. It is difficult for an appraiser to estimate the extent to which declines resulted from stigma or from market weaknesses. Economists have attempted to overcome the problems associated with small samples by using "hedonic regression analyses". Regressions test theoretical propositions regarding relationships among variables, and estimate the degree to which one variable influences another. Researchers specify functional relationships between two or more variables depicting one as dependent because they expect that it will respond to one or more independent variables.

Hedonic regression analyses regress the price of differentiated goods on quantities of characteristics or attributes associated with each good. Under this approach researchers take a large sample of properties and examine the relationship between sale prices and the degree of pollution, the number of bedrooms, the size of the lot, the local crime rate, reading scores, accessibility of employment, and many other variables. Variables employed to explain prices include factors pertaining to individual buildings, as well as to neighborhood influences. The relationship may look something like this:

From this graph it is apparent that high levels of pollution (say sulfur dioxide) tend to be associated with low home prices. Regressions essentially draw a line (or a curve) through the middle of the dots, minimizing the distance between the line and the dots. The slope of the line determines the extent of the reductions. A steep line indicates a large effect, while a slow descent reflects a mild influence. The economist can then conclude that a 10% increase in air pollution is associated with a 1% fall in property values--and is thus worth say $1,000 per home. Regressions constitute the best means available to systematically evaluate causation, and to incorporate the influences of the many factors that affect property values.

Another type of hedonic regression evaluates changes in prices before contamination is known and after. An excellent example of such as study is provided by Kenneth Wise and Johannes P. Pfeifenberger (1994) who studied the Industrial Excess Landfill in Uniontown Ohio. From 1966 through 1980 the site accepted industrial wastes including flyash from industrial boilers and liquid industrial wastes, including spent organic solvents. In March 1984 the Ohio EPA asked the US EPA to investigate the site, and in October of that year the site was proposed for inclusion on the National Priorities List. The authors found that values of properties surrounding the site were not materially lower from 1977 through 1987, but declined significantly in 1988. After that the magnitude of the effect lessened. The values of homes within 2,500 feet of the landfill fell 10% in 1988, but losses were cut to 3% by 1993. The value of homes beyond 2,500 feet fell 3% in 1988, but recovered to predicted levels by 1991.

To date hundreds of these studies have been conducted. Among the disamenities considered in these analyses are the presence of air pollution (i.e. sulfur dioxide, ozone, or dust particles), of airport noise, of water pollution, of nearby nuclear power plants, of public housing projects, of crime, of poor schools, and of inaccessibility.

Table 1, below, presents the results of a classic hedonic regression analysis conducted by Jon Nelson (1975) in the Washington, D.C. SMSA. Nelson derived the following results:

TABLE I

This equation shows that if one room is added to a 100 room mansion the value should increase 1.5%, assuming this relationship would hold for such a house. Additional manipulation of data in the study shows that one extra room in a typical house is worth approximately $6,800. Similarly, if the level of oxidants per million particles of air increase 100% property values should be expected to fall 1.7%. Thus, the owners of a $100,000 home, may be entitled to compensation of $1,700 if a new manufacturing plant increases oxidant pollution by 100%. Likewise, real estate appraisers should consider adjusting comparable sales in areas with twice the level of oxidant pollution downward by 1.7%. Marginal values for these traits can also be derived.

Based upon regressions utilizing data gathered near toxic waster sites, Smith and Desvouges (1986) concluded that the value of moving an additional mile away from a hazardous waste dump was between $330 and $495. De Silva and Egland, on the other hand, cite a hedonic regression study of 151 office buildings in the mid-Wilshire and downtown areas of Los Angeles which found that asbestos did not significantly depress rents, renewal rates, or occupancy rates. In addition, abatement activity did not change these measures. Another study cited by these authors of sales between 1977 and 1986 found no significant impact upon market values.

Michael Elliot-Jones of Foster Associates evaluated an 800 unit apartment complex in northern California which was constructed on a tract that had previously been used for storage of chemicals and for treating lumber. In the construction process contaminants, including TCE and PERC, were uncovered near the surface and in groundwater. An hedonic analysis of 1,200 apartments found that rents at the subject were not diminished by the contamination.

The following table presents a small sample of findings from other studies regarding percentage changes in property values resulting from one percent increases in disamenity or amenity levels.

TABLE II

A bibliography of results is available from the author.

Thus, Krumm's result suggests that a 1 percent increase in reading scores relative to the national average as measured by the California Achievement Test is associated with an increase of .23% in home values. The value of a $100,000 home should increase $230 if reading scores can be raised 1 percent. Naturally, these results must be interpreted with care. Many criticisms have been leveled at hedonic regression analysis.

Many other hedonic results shed light upon the effects of environmental matters upon property values. Asabere and Huffman (1994), for example, found that historic facade easements reduced the value of condominiums by 30% in Philadelphia.

Contingent Valuation

The contingent valuation method attempts to estimate values for public goods by asking individuals, in survey or in experimental settings, to reveal their personal valuations of increments or decrements in unpriced goods by using hypothetical, contingent markets. These markets define very specifically the good or amenity of interest, the status quo level of provision, the offered increment or decrement, the institutional structures, and the methods of payment. They attempt to determine amounts that individuals would be willing to pay, or willing to accept, for preserving resources, or for accepting damages. Techniques range from purely hypothetical direct evaluations asking respondents for dollar bids, to hypothetical questions asked of households and recreators concerning changes in behavior. Preferences are then imputed. Households are confronted with possible changes in an environmental attribute and asked for a valuation.

The method was endorsed in 1992 by an advisory panel of economists including two Nobel laureates. Alaska used the contingent valuation method to calculate that the Exxon Valdez Oil spill had done nearly $3 billion in damage beyond the amount actually spent on cleanup. Brookshire, et. al. (1976) found that the average bid per family to prevent one additional power plant near Lake Powell was $2.77 in 1974 dollars.

The method can also be applied to restricted samples of experts. In "The Effects of Asbestos on Commercial Real Estate: A Survey of MAI Appraisers" Fisher, Lentz, and Tse (1993) found that:

1) the discount in the market value of properties with ACM's typically ranges from about one-tenth to one-third of the value of comparable properties without asbestos;

2) properties with ACM's take on average 8.2 months longer to sell than comparable properties without asbestos, and rentals take an average of 4.88 additional months to lease;

3) the average increase in the discount rate for properties with ACM's was 1.99%; and

4) the average increase in the effective interest rate for mortgages was 73 basis points (.73%) and the median increase was 50 basis points.

The table below summarizes additional results regarding the effects of ACM's in the Fisher, Lentz and Tse survey:

Another limited survey of 15 real estate professionals, lenders and brokers in late 1987, conducted by John Gruenstein of Berkeley Planning Associates found a median effect of asbestos upon property values of seven percent, ranging from 3.3% for an office building with a small amount of asbestos, to 130% for an anchor store in a retail mall, "shot full of asbestos". Gruenstein discovered impacts upon potential sale prices and financing rather than on current net operating income. Most interviewees had no more difficulty renting properties with asbestos, and claimed that it did not significantly impact expenses.

On January 7, 1994 the National Oceanic and Atmospheric Administration said that although contingent valuation could be a valid tool for assessing environmental damage, it would be better to underestimate than to overestimate damage by relying too heavily on that method. The proposal suggested discounting by 50 percent the value that people attach to unspoiled resources, and would require exhaustive and expensive statistical tests among large numbers of respondents to validate results. Environmentalists argued that the proposal would fail to hold polluters fully accountable for the damage they cause and would not provide a strong incentive for prevention.

Such surveys are often the only means to estimate values. However, the method is controversial and is subject to several biases if not carefully applied. After all, it is easier to tell a researcher that one would be willing to pay $100 to save the spotted owl than to actually take that sum out of one's pocket which would provide a true indication of willingness to pay.

Other Techniques

In using insurance premiums and safety expenditures economists derive values by dividing the dollars that consumers are willing to pay for such goods and services as life insurance, smoke detectors, or automobile air bags by an estimate of risk reductions. For example, consumers might be willing to spend $20 for a smoke detector that has one chance in 100,000 of saving a life--which implies a value of life of $20/(1/100,000) or $2,000,000. Wage premium studies utilize multiple regression analyses in a fashion similar to hedonic property studies. Travel cost studies attempt to measure the value of parks, waterways and other free resources by looking at what consumers paid for travel in terms of gasoline, depreciation, and foregone wages. These studies then derive implicit valuations of the resources based upon the travel costs. Public expenditure studies assume that government spending accurately reflects desired spending levels. Actual public spending levels are then used to estimate the value that the public places upon various goods and services. Laboratory experiments isolate subjects in artificial environments and cause them to bid for various environmental goods such as unobstructed views. These experiments tend to be similar to contingent valuation studies. Finally, medical costs resulting from hazards provide yet another indication of the costs imposed by environmental problems.

VII. PRECEDENTS FOR INTRODUCTION OF HEDONIC ANALYSES

Courts in five states had accepted hedonic damages, and lawyers have introduced hedonic damages in 26 other states. In Sherrod v. Berry a jury awarded hedonic damages nearly three times the size of typical economic losses. The Association of Trial Lawyers of America has endorsed the technique.

Government agencies also establish values for life and property through hedonic methods in cost benefit analyses of regulations and spending. The Occupational Health and Safety Administration uses a value of $3.5 million for life, while the Environmental Protection Agency assigns price tags between $400,000 and $8.5 million.

VIII. CONCLUSION

In conclusion, hedonic valuation techniques and statistical analyses are the most systematic means available to measure values of real estate disamenities. Information from selected sales can also prove useful. Failure to utilize these techniques could expose litigants, buyers, and sellers to significant monetary losses.

REFERENCES

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Brookshire, David S., Thayer, Mark A., Tschirhart, John, Schulze, William D. (1985); "A Test of the Expected Utility Model: Evidence from Earthquake Risks", Journal of Political Economy, Vol. 85, No. 2, pp. 369-389

Cobb, Steven (1984), "The Impact of Site Characteristics on Housing Cost Estimates", Journal of Urban Economics, Volume 15, pp. 26-45

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Elliot-Jones, Michael (1994) "Commercial Property Values & Toxic Sites" unpublished

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