But is it market value? Separating market appraisal from the liability
model
The Appraisal Journal; Chicago; Oct 1999; Wayne C Lusvardi;

Volume:
67
Issue:
4
Start Page:
382-397
ISSN:
00037087
Subject Terms:
Real estate appraisal
Environmental liability
Environmental regulations
Models
Studies
Real estate appraisal
Environmental liability
Environmental regulations
Models
Studies
Classification Codes:
9190: US
8360: Real estate industry
1540: Pollution control
4310: Regulation
9130: Experimental/theoretical treatment
Geographic Names:
US
US

Abstract:
How can an appraiser resolve the dilemma between irrational risk
response and rational conceptions of market
value? This article explores how the market response to real estate
environmental risks reflects an irrational
vicious circle. For the appraisal industry's consideration, nine
propositions are offered, asserting that properties
with undesirable environmental conditions do not result in value
diminution to surrounding properties as the
remediation/stigma concepts of appraisal imply. Rather, environmental
regulation contributes to price supports for
nearby properties at the expense of the tainted property.

Full Text:
Copyright Appraisal Institute Oct 1999

[Headnote]
How can an appraiser resolve the dilemma between irrational risk
response and rational conceptions of market value? This article explores
how
the market response to real estate environmental risks reflects an
"irrational vicious circle." For the appraisal industry's consideration,
nine
propositions are offered, asserting that properties with undesirable
environmental conditions do not result in value diminution to
surrounding
properties as the remediation/stigma concepts of appraisal imply.
Rather, environmental regulation contributes to price supports for
nearby
properties at the expense of the tainted property.

A consensus of recent impartial scientific literature concludes that
highly regulated common environmental substances and
emissions associated with real estate are what risk analysts call
"phantom risks." In other words, those substances that do not
present real risk in human health terms.1 Concurrent with these findings
recent case law under Daubert v. Merrell Dow
Pharmaceuticals2 excludes evidence that does not meet the tests of the
scientific method (the Daubert test) from court cases
where the reliability of the claim rests on scientific information.
Reaffirming the Daubert decision, General Electrio Co. v. Joiner3
excludes testimony in toxic tort cases that amounts to only "subjective
belief or unsupported speculation."

The lack of scientific evidence that substances and emissions associated
with real estate pose a threat to human health and the
growing lack of legal foundation for honoring complaints without such
evidence place appraisers in a bind between regulatory
law and case law, legal definitions of rational market value and
irrational environmental policies, media, and public perception.
The following propositions are offered for consideration by the
appraisal industry to resolve the dilemma between irrational risk
response and rational conceptions of market value.

Proposition 1: Misperception

A consensus of the literature on environmental risk indicates that
people tend to overestimate small, but highly regulated
environmental risks associated with real estate. Conversely, there is a
tendency to underestimate larger risks. Therefore,
individual risk perceptions are often irrational and in error. For
example, individuals overestimate the infinitesimally small risks
posed by asbestos, lead, radon, electromagnetic fields, and waste sites.
In contrast, they underestimate risks of much greater
magnitude associated with real estate such as home accidents, building
fires, or drowning.

Infinitesimally small risks, such as those in the proposition above are
overestimated by the public while the most prevalent
environmental conditions associated with real estate are underestimated
as to risk by the public (see table 1).

This "small risk: overestimation/large risk: underestimation" pattern
lends support to the notion that the public is uninformed
about environmental risks.4 The following statements summarize the
irrational nature of risk perception as reflected in the
environmental risk literature:5

1. People simplify their perceptions.

2. Once a person's mind is made up, it is difficult to change it.

3. People remember what they see.

4. People cannot detect omissions in the risk information they receive.

5. People disagree more about what risk is than about its magnitude.

6. People have difficulty in detecting inconsistencies in disputes about
risk.

TABLE 1

7. People have difficulty evaluating expertise.

Despite the irrationality of public reaction to environmental risks, the
evidence suggests that there is a more accurate perception
of risk when it has a direct impact on an individual's financial
condition or property value and the regulatory costs cannot be
shifted to society at large.6 Research also reveals that people can
learn more rational responses to risk when unbiased
information is imparted separately from the distorted effects of media,
regulations, or biased research.7 In regard to real estate
appraisal, one could expect that property owners, managers, buyers, and
sellers would have more accurate perceptions of
environmental risks on property values than noninvestors in real estate
markets.

Proposition 2: Overregulation

Mirroring the "vicious environmental risk circle," government agencies
base environmental regulation and remediation on
seemingly irrational factors. In other words, government regulation and
remediation standards at face value cannot be relied on
by real estate appraisers to reflect the true risks of environmental
conditions. For example, about 95% of waste-site remediation
costs do not result in benefits to human health or the physical
environment but are mainly incurred for public perception
purposes.

A consensus of the reviewed scientific literature indicates that
regulation of toxic substances is based on a flawed zero dose
threshold methodology where excessive precaution is the basis of
regulation.8 Unknown to much of the public, environmental
protection standards do not even adhere to commonly accepted statistical
significance tests (95% confidence interval) or
relative risk ratios (>1.0) and are not scientifically provable.9 Noted
professor of law and economics at Harvard Law School
and editor of Journal of Risk and Uncertainty, W. Kip Viscusi has
stated:

When confronting government risk statistics, there is a tendency to take
this information at face value. Presumably, government
officials should be a source of accurate risk information.
Unfortunately, the practice of risk assessment in the federal
government of the United States is not concerned with providing best
estimates of the risk of measures of central tendency.
Rather, the policy emphasis is on conservative risk assessments, so that
risk management and risk analysis become blurred.10

In dealing with the issue of the impact of toxic substances on real
estate, the appraisal industry needs to be guided by the
preponderance of the impartial scientific literature-the dosage, not
mere exposure or proximity, makes the poison.11 The dosage
from such environmental substances and emissions as radon gas,
lead-based paint, intact asbestos insulation, weak
electromagnetic fields, or carcinogens associated with so-called
hazardous waste sites is so negligible and the route of exposure
such a remote probability that they represent benign conditions not
requiring the excessive regulation of real estate.12 The failure
to consider the magnitude of the dosage of environmental substances or
emissions and the size of the population exposed is
called the "scope effects bias."13

Irrational environmental remediation measures are the mirror image of
irrational environmental risk analysis. Strikingly, the first
99.5% of all potentially hazardous substances from toxic waste sites are
eliminated by the first 5% of remediation
expenditures.-14 Ninety five percent of all cleanup costs are only for
public perception purposes and achieve nothing in health
reduction. Figure 1 summarizes the research findings relating to
irrational environmental protection and site remediation policies
for toxic waste sites.

Proposition 3: Exaggerated Publicity

Publicity generated through media sources or liability lawsuits tends to
overexaggerate minute environmental risks. Therefore,
appraisers cannot rely on media reports of environmental risk events as
reflections of true risk because substantial publicity
tends to overdramatize the risk and lead to the public overestimation of
risk. Take, for example, the Love Canal case, which led
to public hysteria.

Peter M. Sandman, professor of environmental and community medicine at
Rutgers University, has conducted research that
shows how the news media often unrealistically increases public anxiety
about an environmental issue even when the intention is
unbiased reporting. Sandman has summarized his findings in the following
principles:15

1. Surveys suggest that the amount of media coverage accorded
environmental risk topics is not related to its seriousness in
health terms.

2. Most media coverage is not about real risk or hazard but about blame,
fear, anger, and other nontechnical issues.

3. When technical information is provided in news stories, it has
little, if any, effect on the audience.

4. Alarming content about risk is more common than reassuring content.

5. The media audience tends to respond to negative information and some
may remain unconvinced once the alarm is sounded.

6. Reporters rely most on official sources (EPA) than industry sources
on the "safe" side or environmental activists on the
"risky" side.

7. Journalistic competition tends to focus on alarm to the advantage of
inept journalists and less on reassurance at the expense
of skillful journalists.

Hazard perception field studies indicate that prior to media exposure,
the public generally fails to recognize many potentially
hazardous environments while minimizing potential harm even from
significant risks.16 Risk perception generally conforms to
what is called the "availability effect."17 People tend to overestimate
risks that have been the focus of recent experience.
Similarly, the EPA is reported to set more stringent cleanup standards
when there is substantial media coverage of the site. The
media plays a role in risk perception by dramatically focusing attention
on current environmental conditions, many of which are
no threat to human health or the environment.

The classic example of the effects of media on environmental issues is
the 1978 case of Love Canal near Niagara Falls, New
York. Love Canal was a former toxic waste dump that has become
synonymous with the term chemical tragedy. However,
Love Canal was not even the worst waste dumpsite of which the press was
aware at the time. The case prompted evacuations,
relocation, mass purchase of more than 100 homes, research, site
remediation, and litigation costing about $300 million in
response to the presence of toxic substances in the ground, all of which
were uncalled for.18 No serious or chronic illness has
been attributed to chemicals at Love Canal by peer-supported scientific
studies. The cause of the hysteric reaction by the
residents of Love Canal was not adverse health effects but the use of
science for political and special interests, media
exaggeration of risk, and perceived loss of property value as a
consequence.

Proposition 4: The Irrational Environmental Risk Spiral

The bad chemistry of exaggerated media coverage, uninformed
misperception, and overregulation of environmental risks
combine to form a self-fulfilling "vicious circle" of risk. Thus,
appraisals of properties with identified environmental conditions
tend to mistake the irrational risk spiral for true risk. For example,
most of the appraisal literature focuses on exotic, but
miniscule risks, not significant environmental risks.

The combined effects of the first three propositions form a circular
pattern of what U.S. Supreme Court Justice Stephen Breyer
calls the irrational vicious circle of environmental risk policy.19 This
cycle typically includes exaggerated media response to an
environmental incident that threatens property values, public
misperception, public political pressure, lack of public education,
overregulation, government institutionalization of overly conservative
science, and a feedback loop that starts the cycle all over
again (see figure 2).20

Repeated studies show that the expert's evaluation of environmental
risks consistently differs from that of the public. Socalled
toxic waste sites appear near the bottom of most expert lists and at the
top of the public's list of concerns. The gap between
public and expert perception of risk has itself been misinterpreted as
reflecting that the public views toxic waste sites as a
significant health risk. But what remains unexplained is why the public
does not move away from such purported hazards, and
instead prefers to reside close by. An explanation of this mystery is
offered in proposition 6.

Mirroring the irrational environmental risk spiral, the professional
appraisal literature is almost silent as to environmental
conditions with the greatest magnitude of risk and mainly has focused on
miniscule, speculative, and exotic risks (e.g., waste
sites, asbestos, electromagnetic fields, crime scenes, and synthetic
building materials).

Proposition 5: Rational Market Value

Given the first four propositions, the question is whether real estate
appraisers are measuring the rational reactions of informed
market participants of undeveloped land or the reactions of nearby
owners of residential properties resulting from irrational
media and regulation of environmental risks. Appraisers should keep in
mind that market reaction to environmental risks that is
irrational or reactive to irrational media and regulation does not
reflect the rationality tests of legally defined market value. For
example, remediation costs do not reflect the market value between
willing buyers and sellers, but are compulsory costs
imposed by government regulation or courts.

With regard to environmental risks, the role of science is to answer the
question, Is it true? The counterpart role of the appraisal
profession is to answer the question, Is it market value? The irrational
risk cycle does not meet the rationality tests of legally
defined market value (i.e., informed parties, prudent behavior, and
responsible management with each party cross-checking the
other by self-interest).

Most important, law and science have decreed that objective scientific
values and verifiable evidence shall trump subjective and
speculative evidence in matters relating to determining the market value
of real property. Physicist H. W. Lewis in his
award-winning science book, Technological Risk, states that the
irrational magnification of small and insignificant environmental
risks reflects phobia, not stigma.21 Because phobic reactions to
environmental risks are irrational, they are inconsistent with the
rationality tests contained in the definition of market value.

Environmental remediation costs do not reflect a value derived from a
transaction between willing buyers and sellers, but the
compulsory costs imposed by government or courts on property owners
and/or responsible parties for real or perceived
environmental risks. Also, environmental stigma is not derived from
knowledgeable parties but often mirrors the irrational
environmental risk perception cycle. Moreover, when it is in the
public's best interest to accept the risks associated with public
projects such as power plants or freeways, an opportunistic individual
may be tempted to overstate his or her aversion to smoke
or noise. In so doing, he may hope to be bought off by the community at
a "holdout price," reflecting the huge collective benefit
at stake. If a market does not cross-check the interest of each party,
there can only be one-sided valuation of environmental
risks.

FIGURE 2

Many appraisers claim that what may be irrational risk or phantom risk
to one buyer may be perceived as real and
contaminationrelated to another.22 This line of argument does not
distinguish between a subjective and an irrational reaction to
risk. By definition, market value includes subjective perception, but
excludes irrationality. The concept of market value
presumes a legitimate perceptual bias in favor of faraway investors over
fearful neighborhood parents in evaluating
environmental risks affecting real estate. Even if there is an absence
of information on toxic risk, and the market participant is
thus overly protective, the situation reflects buyer motivation based on
ignorance and overly risk-aversive market behavior that is
not consistent with the legal definition of market value.

The knowledgeable buyer test contained in the definition of market value
cuts both ways, however. Where market participants
overestimate environmental risk, it is incumbent on real estate
appraisers to consider the small magnitude of such risks in their
valuations. However, where market participants underestimate risk, it is
incumbent on appraisers to consider the larger
magnitude of such risks in their valuations. But where a greater
magnitude of risk is encountered, appraisers must also consider
the typically offsetting mechanisms to mitigate such risks (namely,
health and safety ordinances, landuse controls, environmental
risk insurance, liability indemnification, hazard abatement districts,
and government assistance programs).

Proposition 6: Environmental Regulation as Price Protection

Paradoxically, the irrational risk policy cycle serves to equalize and
protect surrounding property values at the expense of
environmentally regulated parcels. Contrary to the prevailing appraisal
concepts, negative environmental spillovers (externalities)
do not necessarily lead to stigma on surrounding property values.
Rather, environmental regulation serves to preserve
surrounding property values. For example, empirical economic studies
conclude that due to government flood protection
programs, a general discount for floodplain location does not exist.23

In the "mixed economy" of the United States many economic activities are
undertaken by the private sector, while government
undertakes others.24 The public looks to the government to provide
protection from unexpected or sudden negative social
changes such as unemployment, disability, impoverishment, or retirement.
Assistance comes in the form of unemployment and
disability insurance, family cash assistance programs, and Medicare. The
growth of government-assistance programs has
extended to both planned and unplanned economic changes such as student
loans, agricultural price supports and subsidies,
disaster loans, and economic inflation controls (e.g., federal discount
rate). Zoning is a form of land-use regulation for health
and welfare to prevent the creation of value-diminishing nuisances.
Government-assistance programs more recently have
extended to fairness and distribution issues purportedly resulting from
market failures.25

In the past 30 years, the government has taken an increased role in
ensuring the quality of the environment, even the perceived
quality of the environment. The cost resulting to the public from the
side effects of industry such as pollution, contamination, or
the alleged extinction of plant or animal species, is what is called a
"negative externality" or spillover.26 The role of government
has expanded in recent years to eliminate negative externalities by the
use of environmental regulations, fines, mitigation fees,
toxic tort lawsuits, subsidization of private remediation measures,
and/or by trying to create proxy markets for trading
environmental credits (such as pollution credits, transfer development
rights, and mitigation credits, etc.).

Prior to the government's protection from negative environmental
externalities ("detrimental conditions"), the belief was that the
enormous benefits of an industrial society offset the costs of any side
effects. As economist Joseph E. Stiglitz has stated:

Consider, for instance, a steel mill that pollutes the neighboring air.
Those who live nearby are clearly worse off as a result of the
pollution. But if the steel mill existed before they purchased their
houses, the price they paid for their house would have reflected
the fact that the air was polluted; they paid less for their house than
they otherwise would have. The person who suffered was
the owner of the house at the time that the steel mill was constructed.
In most cases, it would have been impossible to find that
individual. Alternatively, suppose that the house was not constructed
until after the mill was. In that case, the person who might
have been hurt was the owner of the land. But it may be that the gain in
value to his land from its proximity to the mill exceeded
the loss from pollution. When the value of an asset (like land)
increases or decreases to reflect the surrounding amenities (the
cleanliness of the air, the proximity to jobs), we say that the value of
these amenities is capitalized.27

Under the rational expectations theory in economics, the effect of
proximity to real or perceived negative environmental
conditions is reflected in natural price differences (i.e., location
adjustment). In contrast, under externality theory, it is believed
the workings of the market impose an unfair burden on ignorant property
owners who live near public or private facilities that
contain or emit real or perceived negative environmental conditions.
These negative environmental conditions are what are
sometimes called "proximity damages" in the field of eminent domain, and
are typically noncompensable when property is
physically taken for a public purpose. Under externality theory, all
price differences due to location are caused by negative
externalities and must be reimbursed by excise taxes, fines, court
awards, surcharges, and mitigation fees. In other words, it is
the function of environmental regulations to offset the natural workings
of the private real estate market with respect to
environmental location.

Government remedies for negative environmental conditions that pose only
small or negligible risks to human health and the
physical environment mainly function to support or equalize the value of
properties affected by the irrational risk cycle. As
economist William A. Fischel states in his book Regulatory Takings,
environmental "regulations do transfer wealth from one
class of people, owners of undeveloped land, to another class of people,
owners of already existing homes."28 Political
scientist Stephen Holmes and law professor Cass R. Sunstein state in
their book The Cost of Rights that the preservation of
property rights and values in the United States is sustained by a
"mutually beneficial taxation-for-protection exchange between
owners and government."29

Under such a "safety net," residential property rights are considered a
government-delivered service and property value a form
of entitlement derived therefrom. Small or nonexistent environmental
risks are highly regulated to protect affected property
owners from the impacts that may result from a negative perception of
their property values (e.g., proximity to landfills). The
cost of such regulation is passed through to all taxpayers or citizens
in the form of taxes or lawsuit awards. Paradoxically, this is
why appraisers often cannot find any real value diminution in
residential properties near socalled detrimental environmental
conditions. This also explains why these "toxic properties" not
surrounded by residential districts often do not reflect any
diminution in price. However, usually there is no cost/benefit analysis
to determine if the amount of "preserved" values of
nearby residential properties equals or exceeds the amount of
environmental excise taxes imposed and the diminution in value to
the regulated parcel.

In a price-support system, the government maintains a higher-than-normal
price. Economists cite four options for price
supports: (1) regulatory force; (2) economic incentives to reduce
supply; (3) subsidizing the sale of good to consumers; and (4)
buying up and storing, giving away, and destroying the good .30
Environmental protection policies utilize regulation to compel
compliance, require cleanup of sites so they can be reused, and remove
(remediate) annoying substances, resulting in a de facto
subsidy to surrounding affected property owners.

The missing rational component in the seemingly "irrational
environmental risk cycle" is the desire of the public to have
government "routinely lay hold of public resources and expend them to
salvage, or boost the value of, private (property)
rights."31 This includes insulation from sudden and unexpected value
shocks resulting from highly visible environmental
incidents concerning substances or emissions that pose only negligible
risks (the not-in-my-backyard-syndrome, also known as
"NIMBY").32 Peter W. Huber, a Supreme Court law clerk and MITtrained
engineer, has aptly summed up the NIMBY
syndrome origin of the irrational risk response as follows:

By endlessly inflating the individual's right to sue, the courts
multiplied opportunities for the exercise of one of the most natural
and powerful of human instincts, the NIMBY syndrome. Everybody will
concede that some chemical factory, highway system,
hydroelectric dam, or waste dump, somewhere or other, is probably
necessary. But everyone adds the caveat, "not in my
backyard"-or anywhere nearby... In case after case, the courts have
promoted the individual's right to sue over the community's
right to act. Increasingly, the private suit is directed against the
community itself-as represented by the municipality, the state, or
the federal government. The community needs jails, AIDS clinics, and
waste dumps, of some description, somewhere or other.
But the individual enjoys an ever-expanding right not to be exposed in
any way to the incidental-perhaps statistically minute but
always unavoidable-public hazards. In the end, the shrinkage of all
other rights in the face of an ever-expanding right to sue was
a simple and unavoidable matter of bookkeeping."33

The NIMBY syndrome, the expansion of the tort-liability system, and
environmental regulations are not only at the core of
overestimated manmade environmental risks, but influences policies
designed to protect property owners from significant
natural hazards such as flood losses. Keith Smith, professor emeritus of
environmental science at the University of Stirling, and
Roy Ward, professor emeritus of geography at the University of Hull,
both of the United Kingdom, relate that flood protection
policy in the United States reflects the same underestimated risk
pattern and irrational regulatory policies of such manmade
environmental conditions as fires or home accidents.' Subsidized flood
insurance programs are said to follow a "living with
floods" policy that rationally protects the view and recreational
amenities of private properties proximate to oceans, rivers, and
lakes, but irrationally leads to the transfer of national wealth to
affected property owners 35 A U.S. Army Corps of Engineers
review study of prior flood plain valuations concluded that: "A general
discount for floodplain location... does not exist."36 Put
bluntly, environmental protection policies are about wealth transfers,
not health transfers.

The protection of residential property values, rather than the
protection of endangered species, is at the root of plant and animal
habitat preservation/mitigation policies as well. The public wants to
preserve open space and view amenities near their own
properties due to the enhanced value it generates,"but typically wants
to shift the cost onto the larger community as a common
benefit. This is why the policy of the Environmental Protection Act is
to require "on-site / in-kind" mitigation of habitat losses
wherever possible. The available data is not consistent with the
assertion that there is widespread deforestation or extinction of
species requiring such massive preservation." As William Cooper of the
Biology Department of Michigan State University has
stated, environmental preservation policy ignores tradeoffs or benefit
shifts where sport fishing is valued more than commercial
fishing, eco-tourism more than off-road motor biking, rural estates
protected by agricultural preserves more than urban sprawl,
and a view amenity for incumbent housing more than affordable housing
for future homeowners.39

A recent example of similar irrational environmental habitat mitigation
policy is the one required for the construction of a
massive water reservoir project in Riverside County, California. A
regional water agency selected a 10,000-acre agricultural
valley for the reservoir site because it had the least amount of
environmental impacts. Due to the historical agricultural use of the
valley, there were only a few, low-quality environmental resources
present prior to the public project. Nonetheless, about an
equal amount of acreage, but with high-quality and highdensity habitats,
was acquired as mitigation land. Ironically, Riverside
County had over 75% of its land area already designated as public open
space. After construction, the reservoir would create
water resources for "urban vegetation and forests" as well as a manmade
lake for wildlife. The apparent overwhelming positive
tradeoff between the few natural resources destroyed and those created
by the reservoir project were not factored into the
mitigation equation. Apparently, under the rules for "environmental
accounting," the loss of a small natural wildlife habitat is
counted and much larger environmental benefits from manmade "urban
forests" or lakes are discounted.

Ironically, the "bad chemistry" of NIMBY, government regulation and
liability law, combined with the distortions of media, have
created the so-called "stigmatized" market conditions from which the
public seeks protection. Although externality theory places
blame for the irrational environmental risk cycle on "market failure,"
it is just as plausible that governmental landuse zoning and
expanded liability creates such unwanted conditions (legal and
regulatory failure, not market failure).

Real estate appraisers who mistakenly dwell on remediation and stigma
concepts for the valuation of environmental risks fail to
understand that environmental regulation is not necessarily in place to
protect public health or the environment, but to protect
property rights and even subsidize property values at times.
Contributing to the overly protective response of the market to any
threat to property values are government policies that give favorable
tax treatment to home ownership. Many homeowners view
an investment in real estate in a highly protective manner because it
often serves as a "forced retirement savings account." The
seemingly irrational response to the regulation of small environmental
risks becomes more understandable and rational when the
threat to the financial nest egg of nearby properties is factored into
the risk-cycle equation.

Proposition 7: Disclosure of Noneconomic Analyses

Use of the remediation/stigma concepts that prevail in the appraisal
industry reflects a noneconomic analysis of environmental
conditions and risks. Professional standards should require appraisers
to disclose the type of environmental risk analysis
performed: an "economic analysis" or a "noneconomic" analysis. For
example, the remediation/stigma concepts employ only
single-entry accounting of negative ledger items without taking into
consideration environmental offsets (benefits, mitigations,
etc.).

Appraisers must currently disclose whether they are rendering an oral,
limited, or complete appraisal of property and the
accompanying limiting conditions and assumptions on which it is based.
Similarly, appraisers should be required to disclose
whether they are undertaking an economic or noneco-- nomic analysis of
the environmental risks associated with an appraised
property.

A cardinal principal of economics is that "people face tradeoffs."40
Significant environmental risks are typically undertaken
because of much larger rewards. For example, those who accept the risk
of living in a floodplain are often willing to trade it for
the amenity of an ocean or riverfront view amenity, or the availability
of cheap water for farming, fishing, and other activities.
The risk of a flood is often mitigated by government floodplain mapping,
subsidized flood insurance, and long cycles between
peak flood events. The availability of flood insurance provides a
guarantee of reimbursement, enhances affected property
values, and removes the risk of catastrophic financial failure. Without
addressing both benefits and detriments from
environmental conditions, along with any mitigation measures, it is
impossible to undertake any economic analysis or an
appraisal.

The prevailing single-entry format for accounting environmental risks
addresses remediation costs and any accompanying
stigma without considering associated benefits or mitigations. This
methodology reflects the debit-only bookkeeping system of
tort liability law, but is a noneconomic analysis of environmental risks
(i.e., no tradeoffs). Appraisers should be guided by the
principle of balance in valuing properties with environmental risk
issues.

Because the costs that impact real estate from such environmental
regulation do not produce significant health benefits to
society, and reflect unbalanced accounting methods, it would be more
accurate to call such "negative ledger" values for what
they really are: deadweight environmental excise taxes, or "the excess
of the total harm done by a tax over the actual revenue
raised. 1141 These taxes may come in the specific form of fines,
mitigation fees, emission charges, hazard abatement district tax
levees, remediation costs, or toxic tort lawsuit awards. Likewise, it
would be more truthful if appraisers called any analysis that
considers only environmental costs as an environmental taxation analysis
rather than the current misleading analysis of
detrimental conditions, contamination, remediation, and stigma.

The valuation of many environmental conditions is a variation of
insurance appraisal. The "cost to cure plus stigma" method
violates the following economic valuation formula specified in the
insurance codes of most state jurisdictions in the United
States, as shown in this typical codified insurance loss valuation
formula:

Diminution in value (i.e., value before - value after = diminution) or
cost to cure, whichever is the lesser. Therefore, loss = < Vd
or < Cc.

Appraisers simplistically using the cost to cure plus stigma (or
remediation costs and stigma) method of valuing losses prevalent
in tort law must also disclose one of the following indispensable
assumptions.

When market value is reported, that:

1. No market study was conducted to determine if a discount for the same
loss item is embedded (capitalized) in the market
prices of similar properties.

2. Given the limited availability of market data, it is statistically or
analytically impossible to isolate the price discount for the loss
item in question. Thus, the cost to cure plus stigma method relies on
purely subjective judgment and cannot be externally
validated from the market one way or another.

When a non-market value is reported, that:

3. No market study was conducted to determine if such discounts are
embedded (capitalized) into market prices.

4. The loss reported does not reflect market value, but a liability
payment or tax. It is often said that a real estate appraisal is no
better than the assumptions on which it is based. Without disclosing the
above assumptions, the client may be misled that the
loss estimated by the cost plus stigma formula reflects the true price
the market is willing to pay to eliminate the environmental
condition rather than the cost estimated by an appraiser.

Proposition 8: Truth in Appraising Real estate disclosure laws focus on
the presence or absence of environmental substances or
emissions associated with risk (subjective risk), not with the magnitude
of risk (objective risk). Therefore, appraisers should
render informed opinions of real estate value that disclose the
magnitude of risk by rational and informed parties. For example, it
is common sense that intact asbestos insulation is not likely to present
a significant risk to human health, but may reflect a risk of
a liability lawsuit, given the government's irrational "zero dose"
protection standard.

Real estate appraisers should be held to a higher standard of disclosure
than real estate brokers. Brokers must disclose the
presence or absence of an environmental substance, emission, or
condition. Appraisers, however, should adhere to a "truth in
appraising" standard that reports the true magnitude of environmental
risks not just the presence or absence of an environmental
substance or emission.42

Real estate sales disclosure laws are onesided and do not go far enough
to distinguish between real and phantom environmental
risks, stigma and phobia, and rational and irrational responses to risk.
Uninformed market participants retain real estate
appraisers to inform them of the true risks posed by environmental
conditions. The "knowledgeability test" contained in the
definition of market value presumes that appraisers will value
properties without merely reverberating the irrational fears of the
public, the exaggerations of media, the excessive precaution in
regulations, or the positions of litigants. To do otherwise would
result in the loss of professional status for appraisers.

This does not mean that appraisers need to be psychologists, media
experts, or scientists. It does mean that they would have to
use the same sound reasoning, impartiality, and judgment expected of a
properly informed professional. The use of professional
judgment about environmental risks includes the ability to take into
account the objective magnitude of risk.

Appraisers using common sense, sound judgment, and an undergraduate
collegelevel understanding of science, should be able
to ascertain large risks from small risks, such as those shown in table
1. Appraisers should also have an understanding of the
elementary rule of toxicology: "The dosage makes the poison." This means
that everything is a potential poison, depending on
its dosage. The fundamental principle of the scientific method that "you
can't prove a negative" should be understood by
appraisers. For example, science cannot ever categorically prove that a
substance cannot cause cancer.43 In addition,
appraisers should also have a grasp of the rudiments of epidemiology.
Some examples are that correlation is not causation,
disease clusters are almost always random, confounding factors often
distort health studies, etc.' Appraisers should be
sufficiently computer literate to access Internet web sites that provide
impartial information on environmental issues, such as the
excellent "Toxicology Tutor" site by the National Library of Science.45
Appraisers also should know what type of specialist to
consult. For example, toxicologists are the right experts in regard to
chemicals. Last but not least, appraisers need to be able to
find impartial source materials on environmental risks that resist the
rival claims of industry, environmentalists, legal advocates,
or the government. (A suggested list of such materials is included in
the "References" section.)

More specific examples of simple sound judgment, observation, and common
sense should also be exercised. Appraisers
should be able to recognize that undisturbed asbestos insulation in
buildings does not represent a health hazard although it may
be the basis for a liability lawsuit, given the government's irrational
"zero dosage" protection standard. Other specific examples
involve recognizing that naturally occurring electrical fields in the
human body "can be millions of times greater than those
resulting from power lines."46 Before the awareness of the "sick
building syndrome," radon gas buildup in homes, or
occupational asbestos fibers in ambient air, it was well known that you
could not enclose people in airtight rooms without
making them ill.47 Similar examples abound in the scientific literature
on environmental risks that are accessible to the informed
layperson.48

According to risk economist W. Kip Viscusi, "information by its very
nature tends to be a public good," and everyone within a
market and the larger society should have "an incentive to convey
information honestly and truthfully."49 To convey information
essential to the market accurately, valuation analyses should not
emulate an irrational risk perception not consonant with actual
market behavior. Failure to do so could resuit in pessimistic valuations
of properties surrounding regulated environmental
conditions. If the valuations of surrounding properties are too low,
more realistic buyers will find bargains and bid up prices to
an appropriate level. Poaching on poor appraisals of properties
proximate to undesirable, but non-dangerous environmental
conditions is a possibility under the remediation/ stigma concepts.

In addition, the use of such technicalsounding terms as remediation,
cost to cure, or stigma can mislead the public into thinking
that the source of any negative impacts on property values derives from
environmental conditions rather than from overreaching
regulations. The use of such nomenclature also implies professional
competence in making this distinction.50

Proposition 9: Unbalanced Appraisal Methodologies

Environmentally regulated properties present unrecognized and unresolved
methodological problems for appraisers. Therefore,
appraisers should adhere to the appraisal principle of balance in
analyzing risk to both the undesirable parcel or surrounding
properties. For example, the cost to cure plus stigma formula of tort
law ignores the possibility of embedded (capitalized)
discounts in sales prices for an environmental condition and is thus an
improper form of double compensation.

Many abandoned waste sites represent a potential monetary liability to
those who are considered "principal responsible parties"
in the chain of toxic liability. However, any toxic cleanup liability
only impacts property values when the underlying real estate is
the asset of last resort to cover the remediation costs. If a
well-capitalized business or industry is the principal responsible party

and is acting responsibly to comply with environmental regulations,
there typically is no diminution to the value of the real estate.
The author is aware of a large condemnation case of a contaminated
property owned by a Fortune 500 company, where
reportedly the cleanup costs on the property represented a deficiency
that exceeded market value. The condemning agency's
appraiser failed to consider whether the owner could indemnify any user
or buyer of the property against toxic liability.
Moreover, the owner had insured other users and buyers of nearby similar
lands (e.g., insurance comparables). The inability of
appraisers to identify and analyze any measures that could mitigate
environmental risks can lead to unbalanced, misleading, and
perhaps incompetent appraisals. The principle of balance assumes an
economic tradeoff analysis and holds that "real property
value is created and sustained when contrasting, opposing, or
interacting elements are in a state of equilibrium."51 This principle
should be incorporated into professional standards for the valuation of
environmental conditions affecting real property by
requiring analyses of mitigations and benefits as well unless only a
"noneconomic" analysis is to be performed and disclosed to
the client.

Another methodological problem in appraising properties in urban areas
with identified environmental risks such as waste sites is
that the surrounding properties represent an economic complement. An
economic complement is a tangible good that is used in
conjunction with another good (for example, eggs and cereal).52 An
economic substitute is a good that can be used in place of
another (such as butter or margarine). Real estate appraisal is
typically concerned with economic substitution, not
complementarity The problem with appraising abandoned waste sites for
example, is that they are regulated to protect
surrounding property values to the detriment of regulated parcels. The
regulation of waste sites creates a de facto economic
complement of contaminated land and surrounding protected property
values. Whether both sets of complementary properties
should be appraised together in a mass appraisal is an unrecognized and
unresolved methodological valuation problem. This
problem is likely to be encountered more frequently given the recent
trend of local governments to permit the establishment of
hazard abatement districts (HADs) which comprises both affected and
unaffected properties in a given impacted area.53

Another flagrant methodological error in appraising properties with
perceived negative environmental conditions is the problem
of double compensation. For example, in Southern California, the real
estate market already reflects an embedded (capitalized)
price discount of $15,000 for a fire-retardant (but not fireproof) wood
shake roof in a new hillside single-family residential estate
home in a high fire hazard zone. A class action lawsuit is successful
against the builder for use of defective building materials,
resulting in an award of $10,000 cost to cure plus a $5,000 stigma
damage per home. The damage is proven directly from the
market by both matched-paired sales data and higher capitalization
rates. In so doing, the property owner has received double
compensation for imputed loss already proven to be embedded into market
prices.54 The purpose of damage appraisals should
not be to prove a preexisting market discount for alleged stigma, but
that compensation may be indicated where no such prior
discount is made by the market (a null valuation hypothesis).

The tort liability system singularly focuses on payment of damages for
defects in products, warnings, and performance. Tort
law is predicated on the assumption that if compensation for defects is
costly, the people responsible will eliminate them. But
the hunt for defects by lawyers and appraisers is nonsensical and
endless. If payment for defects is extended to the use of
anything less than the highest-quality building materials, the outcome
is nothing more than another income redistribution program
masquerading as damage law. The freedom of choice expressed in markets
and the entire legal definition of market value would
be negated, and the market appraisal process would be rendered
meaningless. Any valuation adjustments made for
environmental location or quality of construction would be considered a
damage for which a property owner would require
compensation. An after-transaction lawsuit and appraisal to recover what
the market deprived would follow every property sales
transaction. In other words, "if you can't afford a silk purse, but only
one made out of a sow's ear, tort law would at least
guarantee a silk sow."

SEPARATING MARKET APPRAISAL FROM THE LIABILITY MODEL

By inheriting terms from toxic tort law such as remediation costs and
stigma, the appraisal profession has been compelled to
accept the irrational risk policy cycle at face value. By tacit adoption
of the debit-only bookkeeping system of tort liability law,
the appraisal industry has subtly succumbed to noneconomic valuation
models. These trends do not solely come from the
appraisal industry, but stem from the valuation formats imposed by the
tort law system and environmental regulation.

This situation has come about incrementally without much critical
professional discussion as to whether any of these concepts
and methods are consistent with the rational paradigm of market value,
accepted appraisal principles, and professional appraisal
standards. The uncritical acceptance of concepts and methods associated
with the irrational risk cycle has brought about a
frequently encountered situation known as "pluralistic ignorance," in
which everyone is wrong, as described by environmental
engineer and sociologist Allan Mazur in his book, A Hazardous Inquiry:
The Rashomon Effect at Love Canal.55 In response to
the one-sided damage calculus of toxic tort law and environmental
regulations, the profession is moving incrementally from
market appraisal toward a liability model of valuation. This follows a
larger societal trend of moving from a market economy to
a legal economy. However, mounting scientific evidence, recent changes
in federal case law, the glaring inconsistency of
environmental valuation concepts and methods with accepted appraisal
principles, and a burgeoning property rights movement
all add up to a situation to which the appraisal industry can no longer
cast a blind eye.

To remedy this dilemma, the appraisal profession needs to create a
bright line between a market model and a liability model of
appraising. Appraisers can legitimately disagree about opinions of
value. However, they must always uphold professional
appraisal standards and must not fail or neglect to perform the
following: (a) identify the consequential differences between
cost-to-cure plus stigma and market value, (b) disclose whether the
appraisal methodology employed was economic or
noneconomic, (c) ensure that they do not employ methods that result in
double compensation, (d) treat economic complements
and economic substitutes differently, and (e) omit any slanted
assumptions on which an appraisal could be based. This article
does not delve into a detailed systematic procedure for properly
appraising property with an identified environmental risk or an
adjudicated nuisance under tort law. However, an outline is suggested
for further professional scrutiny (see figure 3).

FIGURE 3

[Sidebar]
FIGURE 1 Major Findings in Waste Site Regulation and Remediation Policy
1. It is not the health risk posed by chemicals, but the perceived
synthetic or natural character of chemicals that results in irrational
fear of
waste sites., All-natural items in the typical daily diet contain a
greater amount of natural carcinogens than unlikely waste site
exposures.b
2. The EPA adheres to a "no-dose" or "zero threshold" methodology in
calculating risk from waste sites whereby any trace amount of chemical
substance is deemed hazardous.c
3. The EPA does not take into account the extent of population at risk
in its cleanup decisions.d 4. The EPA assumes that a waste site will
change in intensity of land use and that someone in the future will
drink over 2 quarts of contaminated water per day for 30 years.e
5. There are thousands of inactive waste sites where chemicals have
migrated into the surrounding environment, including underground
aquifers!
6. There is no peer-supported scientific evidence of inactive waste
sites having caused chronic illnesses such as cancer in surrounding
communities.a
7, There is no occupational-study evidence of serious illness stemming
from chemical exposure levels as low as those associated with waste
sites.h
8. The first 5% of waste site cleanup expenditures eliminate about 99.5%
of all potentially hazardous substances. Cost is not a consideration
in site cleanup.1
9. Political factors such as voting rates are influential in determining
cleanup policies. Political factors have the greatest incluence when the

risks posed by a site are small and there are no or few exposed people.1

10. The irrational reaction by affected property owners to publicized
environmental conditions Is often due to a perceived threat to property
values, not public health. a sense of "relative deprivation" pervades
property owners affected by the perceived threat of diminished property
values caused by environmental conditions created for the common good
but affecting a few (e.g., landfills, utility lines, etc.).k Sources:
a Viscusi 1998, 88.
b Ibid., 84-85.
c Ibid., 84,
d Ibid., 96. eScott R. Baker, 'Regulating and Managing Risk: Impact of
Subjectivity and Objectivity," in C. Richard Cothern, Handbook for
Environmental Risk Decision-Making (New York, New York: Lewis
Publishers, 1996), 84.
f WIavsky, 183,
g Ibid.
h Ibid.
i Viscusi 1998, 100.
J Ibid., 96.
k Mazur. 210.

[Footnote]
Author's Note: The opinions expressed in this article are the author's.

[Footnote]
1. Aaron Wildavsky, But Is It True? A Citizen's Guide to Environmental
Health and Safety Issues (Cambridge, Massachusetts: Harvard
University Press, 1995); Kenneth R. Foster, David E. Bernstein, and
Peter W. Huber, Phantom Risk: Scientific Inference and the Law
(Cambridge, Massachusetts: Massachusetts Institute of Technology Press,
1993); H. W. Lewis, Technological Risk (New York, New York: W.
W. Norton and Co., 1990); Ronald E. Gots, Toxic Risks: Science,
Regulation, and Perception (Ann Arbor, Michigan: Lewis Publishers,
1993); and
Cassandra Chrones Moore, Haunted Housing: How Toxic Scare Stories Are
Spooking the Public Out of House and Home (Washington, D.C.:
Cato Institute, 1997).

[Footnote]
2. Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579, 597
(1993).
3. General Electric Co., et al. v. Robert K. Joinder et. ux,, S. Ct.,
1997 WL 76-44563 (U.S.).

[Footnote]
4. W. Kip Viscusi, Rational Risk Policy (Oxford, England: Clarendon
Press, 1998): 8.
5. Susan L. Cutter, Living with Risk (New York, New York: Edward Arnold,
1993), 24.

[Footnote]
6. W. Kip Viscusi, Fatal Tradeoffs: Public and Private Responsibilities
for Risk (Oxford, England: Oxford University Press, 1992):106107.

[Footnote]
7. Viscusi 1992,108; M. Alice Ottoboni, The Dose Makes the Poison: A
Plain Language Guide to Toxicology (New York, New York: Van
Nostrand, 1997): 186-187; and Gots, 258.
8. Roger Bate, ed., What Risk? Science, Politics and Public Health
(Oxford, England: Butterworth-Heinemann, 1997).
9. Stephen J. Milloy, Science Without Sense: The Risky Business of
Public Health Research (Washington, D.C.: Cato Institute, 1995), chapter

3.

[Footnote]
10. Viscusi 1998,88.
11. Ottoboni, 30-31.
12. Wildavsky, 1-282.
13. Viscusi 1998, 127.
14. Ibid., 100.

[Footnote]
15. Peter M. Sandman, "Mass Media and Environmental Risk: Seven
Principles," in What Risk? Science, Politics and Public Health, 225-284.

[Footnote]
16. Cutter, 15.
17. Viscusi 1998, 96.
18. Allan Mazur, A Hazardous Inquiry: The Rashomon Effect at Love Canal
(Cambridge, Massachusetts: Harvard University Press, 1998):
142-161.

[Footnote]
19. Stephen M. Breyer, Breaking the Vicious Circle: Toward Effective
Risk Regulation (Cambridge, Massachusetts: Harvard University Press,
1993): 50-51.
20. Viscusi 1998, 96-97.

[Footnote]
21. Lewis, 21-22.

[Footnote]
22. Baker, 83-92.
23. Philip T. Chow, James L. Floyd, and William Holliday, Empirical
Studies to the Effect of Flood Risk on Housing Prices-Are Prices of
Floodplain
Properties Discounted for Primary Flood Damages?, Review draft,
Washington, D.C.: Institute for Water Resources, U.S. Army Corps of
Engineers, report no. 96-PS-2, March 1997.

[Footnote]
24. Joseph E. Stiglitz, The Economics of the Public Sector, 2d ed. (New
York, New York: W. W. Norton and Co., 1988): 2.
25. Ibid., 75.
26. Externality is defined as the impact of one person's actions on the
well-being of a bystander. See N. Gregory Mankiw, Principles of
Economics (New York, New York: Dryden Press, 1998): 778.

[Footnote]
27. Stiglitz. 232-233.
28. William A. Fischel, Regulatory Taking: Law, Economics, and Politics
(Cambridge, Massachusetts: Harvard University Press, 1995), 251.
29. Stephen Holmes and Cass R. Sunstein, The Cost of Rights: Why Liberty
Depends on Taxes (New York: W.W. Norton and Co., 1999): 195.

[Footnote]
29. Stephen Holmes and Cass R Sunstein, The Cost of Rights: Why Liberty
Depends on Taxes (New York, New York: W. W. Norton and Co.,
1999): 195.

[Footnote]
30. David C. Collander, Microeconomics, 3d ed. (Irwin-McGraw Hill,
1998): 332.
31. Holmes and Sunstein, 14.
32. Charles Piller, The Fail-Safe Society: Community Defiance and the
End of American Technological Optimism (Berkeley, California: University

of California Press, 1991).

[Footnote]
33. Peter W. Huber, Liability: The Legal Revolution and Its Consequences
(New York, New York: Basic Books, 1990): 183-184.
34. Keith Smith and Roy Ward, Floods: Physical Processes and Human
Impacts (New York, New York: John Wiley and Sons, 1998): 293-336.
35. J. D. Shilling, C.F. Sirmans, and J. D. Benjamin, "Flood Insurance,
Wealth Distribution, and Urban Property Values," Journal of Urban
Economics (1989): 26, 43-43.

[Footnote]
36. Chow et al.
37. James R. Rinehart and Jeffrey J. Pompe, "Estimating the Effect of a
View on Undeveloped Property Values," The Appraisal Journal (January
1999): 57-61

[Footnote]
38. Julian L. Simon, "Disappearing Species, Deforestation and Data," in
Jay H. Lehr, ed., Rational Readings on Environmental Concerns (New
York, New York: Van Nostrand-Reinhold, 1992), 741-749. For evidence
provided by the Carbon Modeling Consortium (CMC) at Princeton
University that a greenhouse gas (carbon dioxide) sponge is soaking up
carbon discharged by fossil fuels and stimulating forest growth, see
Jocelyn Kaiser, "Possibly Vast Greenhouse Gas Sponge Ignites
Controversy," Science (October 16, 1998): 282, 386-387.

[Footnote]
39. William Cooper, "Values and Value Judgments in Ecological Health
Assessments," in Rational Readings on Environmental Concerns, 3-10.

[Footnote]
40. Manikiw, 4.
41. See John Black, A Dictionary of Economic (New York, New York: Oxford
Univeristy Press, 1997), 109, for the difinition of "deadweight tax."

[Footnote]
42. Victor Cohn, "Telling the Public the Facts--Or the Probable
Facts-About Risks," in C. Richard Cothem, ed., Handbook for
Environmental Risk
Decision Making (New York, New York: Lewis Publishers, 1996): 103-113.
43. Gots, 95-96.

[Footnote]
44. Michael Fumento, Science Under Siege (New York, New York: Quill
Books, 1993), chapter 3.
45. Toxicology Tutor, http://sis.nlm.nih.gov/toxtutrl/map.htm.
46. William R. Bennett, Jr., "Power Lines Are Homely, Not Hazardous,"
Wall Street Journal (August 10, 1993): A-10; Health and LowFrequency
Electromagnetic Fields (New Haven, Connecticut: Yale University Press,
1994).

[Footnote]
47. Ottoboni, 161.
48. Wildavsku, 1-448; Lewis, 3-338; Ottoboni, 1-204; Gots, 1-262; and
Moore, 1-274.
49. Viscusi 1992, 155.
50. Deirdere N. McCloskey, The Rhetoric of Economics, 2d ed. (Madison,
Illonois: Univeristy of Wisconsin Press, 1998): 168-186.
51. Appraisal Institure, The Appraisal of Real Estate, 11th ed.
(Chicago, Illinois: Appraisal Institute, 1996): 44.
52. Collander, G-1.

[Footnote]
53. Mayrav Saar, "Landslide Victims Aim to Undermine Project," Orange
County Register (December 31,1998): Metro sec. 1, page 5.
54. For an example of this "doubling-up" error, see: J. A. Kilpatrick,
D. C. Brown, and R. C. Rogers, "The Performance of Exterior Insulation
Finish Systems and Property Value," The Appraisal Journal (January
1999): 83-88.
55. Mazur, 6.

[Reference]
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[Reference]
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[Author note]
Wayne C. Lusvardi is a senior real estate representative with The
Metropolitan Water District of Southern California. He received a BA in
demography from Aurora Univerity, Aurora, Illinois. Contact: (213)
2177661. Fax 217-7650. wlusvardi@mwd.dst.ca.us.

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