By

Wayne C. Lusvardi

Copyright © March 25, 2001 — All Rights Reserved

Both the Diminution Theory espoused by lawyers, and the Across-The-Fence Theory (ATF) espoused by corridors owners and appraisers, are self-interested, polarizing, and do not solve the valuation problem posed by granting partial interests in monopoly transportation, communications, and utility corridor properties. Alternatively, an Alternate Route Model that mimics "fair market value" and a Damage-Options Model are both offered here for consideration as solutions to the valuation problem of how to value partial rights in corridor properties. A number of bargaining algorithms (recipes) are suggested for fair division of the surplus productivity created by joint use of a property by an easement. Because nominal valuations for partial easements in corridor properties may result in the tragic overuse of corridors for negligible compensation ("the tragedy of the commons"), the "next-best" system of compensation may be for corridor owners to continue to erect economic barriers to entry by charging ATF value premiums.

Recently, a number of challenges have been registered in the professional literature by real estate attorneys against what is called the "Across-The-Fence" (ATF) Theory for corridor valuations. The objections to the use of ATF values for property rights within corridors are:

• No loss is sustained when there is no profitable use for the corridor
• No loss is sustained when the easement does not affect railway operations
• No loss is sustained unless there is actual demand by a third party
• No ATF value exists unless there is a demand by an abutting property owner
• No loss is sustained if the corridor was already burdened with an easement
• Use of ATF sales data is inappropriate when there is no possibility of

• ATF sales are inadmissible as public agency sales
• ATF values do not reflect the same legal use as the corridor
• ATF values reflect entitled and finished land values, corridors do not

The Nominal Valuation proponents even goes so far as to point out recent court decisions where nominal corridor valuations were extended to fee simple estate acquisitions not just easements. In sum, the legal relevance of the ATF corridor valuation theory, and its cousin the Reproduction Cost Method, is confined to only those situations where there is adequate proof of loss of some profitable use of the area of the corridor taken or encumbered. The Nominal Valuation theory may have the effect of pushing ATF valuation theory from the centerline to the fringe of accepted corridor valuation methods.

Proponents on ATF Theory mostly agree that use of the ATF valuation method for minor "transverse" easements across corridors is inappropriate and requires only a nominal valuation. But they take issue with any notion that longitudinal easements also reflect a nominal valuation rather than an "across the fence" value, value for corridor use, or a reproduction cost. Simply put, their position is based on the "premise that the corridor land should be worth as least as much as the land through which it passes."

The Across the Fence Method (ATF) proponents contend that ATF "has been extensively tested, peer-reviewed, and is widely accepted by the appraisal profession." They indicate that there is legal and professional recognition that corridor property often commands a premium or "enhancement factor" in the market. They state that even where the property owner no longer uses a transportation corridor for its original use, or there is no market demand for alternative uses, that it is unjust to appropriate an easement for practically nothing.

ATF proponents will have to justify the crux of their own argument that corridor valuation must conform to the highest and best use of the corridor. To wit, how do ATF values inhere to corridors when the corridor cannot be put to the same legal use as properties across-the-fence? Even where a case can be made for ATF values, how does raw and unentitled corridor land accrue the same unit value as fully improved and legally entitled land adjoining it? How does ATF value have any bearing on subordinate, relocatable easements within corridors that may have no discernible effect on the permanent market value of the underlying fee-simple estate?

Although the ATF proponents correctly believe that the "highest and best use" concept is central to the valuation issue, they fail to resolve the crux of the issue of whose highest use is to be considered; the buyer’s gain or the seller’s loss. Eminent domain law only recognizes a loss of a property owner’s rights as a basis of compensation; not the transfer value gained from avoiding payment for enormously more costly real estate across the fence from a corridor.

ATF value is the value of property external to the right of way. Who is assigned the property rights is the central valuation issue of what economists call "externalities." Externalities are defined as "a cost or benefit that is not included in the market price of a good."¹ One of the problems of valuing externalities is that they are intertwined and reciprocal. As legal scholar Richard A. Epstein has stated: "it is impossible to maintain…the distinction between ‘causing a harm’ (to the owner) on the one hand and ‘not conferring a benefit (to the buyer) on the other.’"² Does ATF reflect "market value" or "just compensation," or perhaps does it reflect the value of a positive externality? If so, where is the legal basis for just compensation for a positive externality accruing to a corridor user? Under the State Rule for estimation of just compensation in the State of California, eminent domain law only provides for consideration of benefits (i.e., positive externalities) as an offset against damages in a taking. There is no known legal precedence for considering an ATF premium when the situation is a giving instead of a taking.

The contention that the ATF Method has been peer-reviewed, tested, and accepted in the appraisal profession is perhaps overstated however. There is no critical or disinterested peer review of one valuation theory over another in the real estate appraisal profession as there is in science. Nor has ATF been officially adopted as a recommended valuation method by any professional organization.

Case law is the final arbiter of acceptable corridor valuation methods not professional acceptability. There are no endorsed methods, approved standard textbooks, or course materials that definitively prescribe acceptable corridor valuation methods in all situations involving corridor valuations. Professional education materials typically contain disclaimers "that the opinions and statements set forth therein do not necessarily reflect the viewpoint of the appraisal profession." In other words, there are no accepted or endorsed methods for corridor valuation, only well discussed methods. Even if the appraisal profession adopted a statement of acceptable corridor valuation methods, it would be legally toothless because we live under the "rule of law" not under the rule of professional acceptance.

ATF proponents often cite surveys or corridor owners showing that that ATF is the most commonly accepted method used for valuation of corridor real estate. But such surveys fail to mention that all of the owners polled in the survey were government, public utility, or semi-public utility entities that represent what economists call natural monopolies. No mention is made that monopolies can charge monopolistic prices. Thus, such studies are prone to the criticism that they are one-sided, report predictable results, and prove nothing because they are analogous to a survey conducted of sellers, not buyers. A survey of both buyers and sellers would be needed to meet the legal criteria of fair market value (e.g., a willing buyer and seller acting without compulsion, force, or monopolistic advantage).

The contention made by ATF proponents that it is difficult to predict the multiplicity of uses that new technologies and industries will make of transportation corridors in the future has merit, however. Use, or anticipation of a higher and better use, drives value. However, if there is no foreseeable use for a corridor the market often won’t reflect a higher value until such a use materializes. This writer’s translation of what ATF proponents are saying is that corridor owners hold on to such properties for their "reserve price" even though a corridor is currently underutilized.³ A "reserve price" is a market motivation, i.e, "buy and hold strategy," but fortunately or unfortunately is not compensable under eminent domain law. Furthermore, the legal standard in courts is "reasonable probability," not speculative possibility of some future use.

Appraisers working for railroad and electric transmission line owners often make the case that the unique connectivity that corridors provide between two points results in a market "enhancement factor" or "synergistic premium" over and above "across the fence" (ATF) values. However, no mention is ever made that such a premium may reflect a monopolistic price or hold out premium. And sometimes there is no imminent market demand, profitability, or market premium for a corridor. This was recently demonstrated in the proposed, but aborted, attempt to "dump" the unprofitable privately owned 91-Freeway Tollway Express Lanes in Orange County, California to a non-profit entity for a $274 million price without an appraisal.⁴

The ATF method certainly has been tested and sometimes accepted in the legal system, but rarely has been ratified at the appellate court level. The ATF Method oftentimes fails the legal acceptability tests when it can’t prove an economic loss, a third party market demand for the corridor, or interference with corridor use.

ATF proponents assert that ATF is a viable valuation theory even if it is like opening a bottle with a sledgehammer instead of a bottle opener. But ATF is so overused and the rationale for its use is so unconvincing that it evokes the response that "if all you have is a hammer, everything becomes a nail." The deficiencies of ATF theory noted above become even more apparent with the recent emergence of "relocatable easements" for fiber optic cable or pipelines within corridors that do not substantially affect the permanent market value of the underlying real estate at all.⁵ Novel, complex, and murky valuation issues are causing the ATF theory to unravel, such as fiber optic routes through railroad corridors, undersea fiber optic cables through marine sanctuaries, longitudinal and lateral pipeline easements underneath unbuildable flood control channels, and relocatable pipeline easements in electric transmission line corridors. A new paradigm is needed not only for corridor valuation, but also for just compensation law that may confiscate property for next to nothing.

Rights of ways are special use properties for which there is no open and competitive market. Thus, any transactions for use of rights of ways are dependent on appraisals. Although appraisals can be helpful, they are limited in valuing corridor real estate because of the tendency of appraisals to reflect highly polarized values: nominal values desired by buyers and monopolistic ATF values demanded by corridor owners. To reflect "willing-buyer/willing-seller" (WB/WS) market value conditions, we show here that neither a "nominal" nor an ATF value may be appropriate.

What is necessary to develop a "Willing-Buyer/Willing-Seller" paradigm for corridor valuations is a framework that mimics open and competitive market conditions. Ideally, the concept of market value presumes the availability of alternatives to all parties, lack of desperation, no force, somewhat equal bargaining power, and knowledgeable parties. However, for public utilities and cable companies there are few alternatives to use of a corridor for their facilities. Cognizant of the lack of alternatives available to users, the posture of corridor owners is usually "take it or leave it." If the buyer is a private entity they most often must cave in to such pressure to avoid delay for installation of their pipeline or fiber cable. However, should the buyer be a public entity, then they can consider condemnation as a method of canceling out the seller’s monopoly advantage. But if both parties to a corridor transaction drive "hard bargains," they face the uncertainty of litigation and the risk of being on the losing side of a "winner-takes-all" outcome. It is only by bargaining for an outcome between a nominal and an ATF value that uncertainty to both parties can be allayed and both parties can arrive at an agreed upon price for the use of the corridor. One of the ways to do this is to hypothetically assume viable alternate routes in public streets or other rights of ways for cable, pipeline, or other facilities to be located in the corridor. So to appraise fair market value an appraiser must simulate conditions whereby the buyer has other alternatives and has equal bargaining power.

The staked-out bargaining positions described above can be depicted in the following layer cake diagram:

Where the relative positions of the parties is reversed from that shown in the table above, and costs equal or exceed ATF, or there is no alternate route available, then the ATF price possibly reflect "just compensation" or a "monopoly price, but not pure "fair market value."

It is believed that the above-proposed Alternate Route Method for valuation of partial interests in transportation and utility corridors is based on accepted economic theory and is consistent with existing law. The Alternate Route Theory proposed above is based on the bargaining and externality valuation theory of Nobel Prize winning economist Ronald Coase.⁶ Moreover, the Alternate Route Theory "fair division" formula for valuation of partial interests in corridors is believed to be consistent with the provisions of both the Code of Civil Procedure and Evidence Code in the State of California for valuation of special purpose properties which states:

"The fair market value of property taken for which there is no relevant market

that is just and equitable." (see CCCP 1263.320(b) and Evidence Code 823).

Webster’s Dictionary defines the word "just" to mean "being what is merited or deserved, legally correct, or fair." Equitable means "dealing fairly and equally with all concerned."

Now that the bargaining range has been staked out the question arises how do we arrive at a fair outcome when neither side agrees on what "fair" means? The following is a humorous example of the problem of fair division excerpted from the fictional television situation comedy characters Ralph Kramden and Ed Norton in an episode of the Honeymooners (1955):

Excerpt From "The Honeymooners"

Both sides in a typical corridor valuation envision themselves in a life or death struggle to get a "fair share" of the leftover piece of cake. Neither side wants to give up a crumb. Bargaining algorithms are needed because neither side can agree, appraisals may merely reflect the polar positions of the parties, bureaucracies and corporations typically do not allow discretion to bargain for an outcome, and the "winner-takes-all" legal system serves as an incentive for a corridor owner to hold-out. So what is an algorithm? An algorithm is defined here as an instructed method, formula, routine, or protocol for arriving at a fair division within the agreed upon bargaining range. As mathematicians Jack Robertson and William Webb state: "In a sense an algorithm is somewhat like a recipe." ⁸

Mathematicians appropriately call methods for fair division "cake cutting algorithms." The purpose of fair division is to come up with what is called an "envy free algorithm." The opposite of an envy free algorithm is a "greedy algorithm."

The most well-known cake cutting algorithm is what is called the "Cut and Choose" method as shown below.

There is a host of cake cutting algorithms in mathematics, arbitration, law, and from markets for fair division of compensation, a partial list of which is shown below.

For a more complete list of bargaining algorithms see the references consulted at the end of this article.

One issue that is missing in the dialogue over corridor valuation methods is to what degree does an easement within a corridor encumber the property? Not all easements are equal. Some easements are what we may call "dominant" easements that permanently encumber the corridor for an exclusive use. Other easements are "subordinate" easements that are non-exclusive and sometimes even are relocatable inside or outside of the corridor at the sole cost of the holder of the easement.

Market value presumes not only property rights, but also freedom from unwanted liabilities (e.g., liability rights vs. property rights).⁹ If an easement is exclusive, or the property owner has the burden of relocating the holder of the easement, the future associated costs to eliminate the easement would likely be unpredictable and disproportionately large in comparison to the diminution in value of the corridor real estate. What corridor appraisers often fail to mention is that corridor owners often demand higher ATF values as a proxy for inestimable relocation costs, associated higher construction costs of their adjacent rail and utility facilities, higher ongoing maintenance costs, and future delays associated with working around other utilities co-located within a corridor. It is the future uncertainty of consequential damages associated with the encumbrance of an easement within a corridor that is often part of the real nub of the liability side of the valuation issue, not necessarily the value of the real estate for its corridor use, its ATF value, or its reproduction cost. It might be said the charge for the easement is only a proxy for future uncertainty. Compensation for rights to coexist within a corridor may be considered a sinking fund payment against inestimable future damages.

Thus, corridor valuation theories predicated on current value diminution, rather than future liabilities, are unlikely to resolve all the real compensation issues. It is true as Amspoker points out that many easements within corridors may be nominal in their effect on the value of the real estate asset. But this may omit the issue of future damages, no matter how speculative. The preponderance of the compensation for easements often is for severance damages, not the value of the taking. A corridor owner is not going to grant an easement willingly without either reducing the associated future downside risks or receiving compensation for such risks. The granting of easements in corridors can be like a delayed taking by eminent domain; the damages may not appear until far in the future, or not at all. Because the costs of any damages are speculative and inestimable, ATF values serve as surrogate insurance against future losses. From the liability side of the valuation equation, the proper recipe for corridor valuation is thus unknowable. The inescapable condition of markets, and life in general, is uncertainty. However, markets often require more return for more uncertainty (i.e., the risk/return principle).

The advocacy for ATF values and ATF premiums may be better understood by way of a stock market commodity options and hedging perspective than a real estate corridor valuation framework. The essence of an option is the right to buy something in the future at a set strike price but without the obligation to buy. Options are often used in the investment world to reduce risks and to obtain a fair value. By entering into an option contract, an optionor may lose much more than they possibly can gain. In commodities trading if the optionor wins at all, it will take until the option expires to realize the reward. If the optionor loses they may have to deliver the goods suddenly for the pre-set price even if the market price is higher. What would induce an optionor (or corridor owner) to enter into a deal with such apparently downside risks? The answer is: a premium. The premiums extracted by corridor owners for full or partial interests therein may be similarly understood as a mechanism for recovery for the risk of future upset. As economists Thomas E. Copeland and Phillip T. Keenan state:

To frame the issues involved with corridor valuation we must turn to economics not real estate appraisal. Basing appraised compensation on monopolistic ATF sales prices of corridors is prone to the criticism that such appraisals reflect circular and self-validating reasoning and fail to disclose that the concluded value reflects monopoly value, not pure fair market value. Monopolistic ATF sales prices for corridors often reflect a "house-of-cards" market whereby a prior sale is used to validate the price for a subsequent sale. The expertise of real estate appraisers is with open market properties, not limited market and monopolistic properties like transportation and utility corridors where the three conventional approaches to valuation may have little applicability. This is because transportation and utility corridors are special use properties for which there typically is only one buyer and one seller. This is called a "bilateral market" in economics. Corridors are not open market properties. They are monopoly properties. And they often reflect a monopoly price. However, this monopoly price may be justified given the tragic consequences that could result from overuse of corridors by "free riders."

Transportation and utility corridors are private property but used by the public rather than exclusively for the beneficial use of a private person. Corridors are often not perceived by the public as private property but as a "common pool asset" available for public use and value capture. Adjacent property owners sometimes want to use corridors for expansion. Public utilities want to avoid higher right of way costs by putting their lines in available rail and electric transmission line corridors. Nearby neighborhoods believe a corridor is a nuisance and often want it walled off. And the public often wants corridors converted to "green belts" to enhance adjacent view amenities or trails ("rails to trails"). Some even want high toll prices on bridge and tunnel corridors maintained because otherwise their bucolic neighborhoods would be flooded with sprawl and traffic. For example, many who live on Virginia’s eastern shore are battling a proposal to reduce the $10 one-way toll on the Chesapeake Bay Bridge-Tunnel that connects the eastern shore peninsula with residents on the mainland. By law, the bridge-tunnel will become a free road once its bonds are paid off. ¹¹ The attempt to capture value and overuse communal or corporate property is called the "tragedy of the commons" in economics. The tragedy of the commons is a "parable that illustrates why common resources get used more than is desirable from the standpoint of society as a whole" or from the standpoint of protecting property rights.¹² The tragedy of the commons concept is like an all-you-can eat restaurant, only for free!

Using our cake-cutting analogy, if we let one person cut the cake and also eat it, they exhaust the value of the resource. Letting corridor owners charge monopolistic prices is a lesser evil than letting corridors be plundered by exploiters. Perhaps there are sound economic reasons for corridor owners to derive premium prices for corridors to prevent exploitation of it as a common pool asset.¹³

In summary, valuation of transportation and utility corridor properties is not a piece of cake. Neither the Diminution Theory (i.e., nominal valuation) espoused by lawyers nor the ATF Theory (i.e., avoided land cost) advocated by appraisers is likely to resolve the complicated issues involved with valuation of corridor real estate. Corridors are not market properties, but monopoly properties. The prices paid for corridors for corridor use, or for partial rights to co-exist within a corridor, often reflect monopoly or holdout prices. Solutions to the problem of pricing monopolistic corridor property are to bargain on the basis of hypothetically avoided costs of an alternate route. Another solution would be to avoid future downside risks by paying an option premium or bargaining for relocatable easements that minimize or eliminate future consequential damages.

Notwithstanding the above, corridor owners may be justified in erecting economic barriers to entry by way of charging higher Across-the-Fence (ATF) prices for the granting of co-location rights within such properties to avoid the "tragedy of the commons" whereby "free-riders" exploit the resource for next to nothing.

Yoram Barzel, Economic Analysis of Property Rights (Cambridge University Press, 1997).