Approaches to Valuation of Real Estate in Eminent Domain Proceedings

Virginia Code § 25.1-230(A) requires payment of just compensation for all eminent domain takings. Typically, condemning authorities engage the services of licensed real estate appraisers for the determination of the value of just compensation owed to property owners for real property interest acquisitions effectuated through eminent domain.

Virginia appraisers generally utilize three approaches to determine fair market value of real property: the Market/Sales Comparison Approach, the Cost Approach, and the Income Approach.  

In eminent domain cases where only a portion of the property or specific property interests are acquired, in addition to a determination of fair market value of the property taken, appraisers must also analyze whether the portion not taken is damaged by the acquisition, and to what extent. Appraisers apply a before-and-after analysis to ascertain any damage to the residue. The sum of the fair market value of the property plus the damages figure represents just compensation for the taking.

1. The Market or Sales Comparison Approach

The Market Approach to valuation, also referred to as the Sale Comparison Approach, is the most commonly used valuation method by appraisers in eminent domain appraisals. It operates on the principle of substitution: a prudent buyer will not pay more for a similarly situated property. Appraisers identify recent sales of properties comparable to the subject property, which provide a strong empirical basis for the determination of the subject property’s fair market value.

When utilizing this approach, appraisers search for recent, arm’s-length sales of properties that are comparable to the subject property. Such comparable sales must be meticulously selected to ensure they are sufficiently similar to the subject property to allow for reliable results. Considerations such as the recency of the comparable property sale, and geographic proximity and physical similarities between the comparable property sale and the subject property must be evaluated to ensure sufficient similarities exist between them to warrant comparison.

When differences in the subject property and comparable property sales are observed, appraisers must make adjustments to the comparable property sale prices to conform with the attributes of the subject property. Examples of common adjustments employed by appraisers include adjustments for lot size, gross living area, number of rooms, and other physical characteristics of the property. Appraisers utilize quantitative processes, using specific dollar amounts and percentages derived from market data, to determine whether and how much a comparable property sale should be adjusted.

Once the adjustments are applied, appraisers calculate the adjusted sales prices for the comparable property sales and reconcile the data. Appraisers then perform a weighted analysis of the figures to reach their final opinion of the fair market value of the subject property.

2. The Cost Approach

The Cost Approach to real estate valuation is based on the principle that a buyer will not pay more for a property than the cost to acquire the land and construct a substitute property of equal utility. Put simply, the Cost Approach determines the value of real estate by determining the value of the land, plus the cost of the improvements or structures situated on the property, less depreciation. For vacant land, this equation collapses almost entirely to land value, which is why the Cost Approach is not recommended for land-only appraisals. This approach is typically used in eminent domain cases involving improved or special-use properties, or used indirectly to support land value through extraction from sales of improved properties.

To arrive at the value of the land, appraisers make their determination of value as if the land was vacant and available for its highest and best use. To value the land, appraisers typically use the Sales Comparison Approach on comparable vacant land, or a similar method utilizing comparable property sales.

To determine the cost of the improvements or structures situated on the property, appraisers utilize two measures of cost: Reproduction Cost and Replacement Cost. Reproduction Cost represents the exact replica, utilizing the same materials and design. Replacement Cost represents the modern equivalent of the structure with similar utility. Appraisers use the Marshall & Swift valuation model and other similar industry tools to determine appropriate cost figures.

Depreciation is the loss in value from new condition; it can be divided into three categories: Physical Deterioration, Functional Obsolescence, and External or Economic Obsolescence. Physical Deterioration relates to the physical wear and tear or deferred maintenance on the structure. Functional Obsolescence refers to design flaws, or over- or under-improvement; outdated designs are one example. External or Economic Obsolescence concerns market or environmental conditions, such as zoning changes, or nearby nuisances or infrastructure. Appraisers may not consider project influence in the consideration of External or Economic Obsolescence. Once the value of the land, cost of improvements, and depreciation are determined, appraisers are able to determine the fair market value of the property.

3. The Income Approach

The Income Approach is based on the idea that property is worth the present value of the future economic benefits it is capable of producing. Fair market value is calculated in this Approach by capitalizing the Net Operating Income using a market-derived capitalization rate.  It is most commonly used with multi-unit residential, commercial, and mixed-use buildings, as well as hotels, motels, senior housing, and rental homes in markets where capitalization data exists; it is not commonly used for owner-occupied properties like single family homes since they do not typically produce income. In eminent domain appraisals, this method is applied only when the land itself generates income or is commonly purchased for its income potential, such as through ground leases, parking operations, agricultural rent, or billboard site leases.

Appraisers utilizing the Income Approach first estimate market-based income attributable solely to the real estate. This entails isolating the portion of income a typical market participant would pay for use of the land itself, often measured as market ground rent or interim land rent derived from comparable leases, sales, or paired analyses. Contract rents are adjusted to market levels where necessary, and income streams tied to business operations, goodwill, or future development are excluded.

 Once the market-based income figure is determined, appraisers then deduct appropriate operating expenses that are properly chargeable to the land, such as management, insurance, maintenance, and vacancy, while excluding non-real-estate costs and expenses borne by tenants under typical market conditions, to determine the Net Operating Income. The resulting Net Operating Income is then capitalized into value using a capitalization rate derived from market evidence, including sales of comparable income-producing land, ground lease capitalization, or investor surveys, with adjustments to reflect risk, income stability, and the property’s highest and best use; the resulting figure represents the fair market value of the property. Throughout the analysis, appraisers must ensure that assumptions are market-supported, legally permissible, and, in eminent domain appraisals, free from project influence, including speculative development profits, business income, and any effects of the project.

The entire eminent domain process, including the valuation of real property, is technical, complicated, and nuanced. With decades of combined experience, the Eminent Domain Team at Sands Anderson is uniquely qualified to assist condemning authorities at all stages of the eminent domain process.

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