Thank you to our colleague, economist William Wade, for sending along this piece, reacting to a recent decision by the Massachusetts Appeals Court.
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Financial inconsistency bedevils takings decisions
This blog recently reported on a Massachusetts Appellate Court takings case ruling (Smyth v. Conservation Comm’n of Falmouth, No. 17-P-1189 (Feb. 19, 2019)), that reversed a judgment for the plaintiff, in part, based on an erroneous economic impact evaluation under the famous Penn Central test.
Plaintiff inherited a parcel from her parents seemingly purchased in 1975 for $49,000. Plaintiff’s appraiser valued the land parcel at $700,000 with the intended development and $60,000 in its current status as an unbuildable lot. The trial court awarded damages of $640,000.
While other issues were at issue on appeal, the court ruled on the economic impact prong of Penn Central that the diminution in value, $700,000 to $60,000, was insufficient because the original purchase price (investment) was lower, $49,000, than $60,000. Such a deal! The land was worth $49,000 44 years ago and its $60,000 value at the time of the trial was more than the original purchase price. This was not a severe diminution in value! No taking.
I initially considered that the trial court had made one of the worst economic blunders of “apples and oranges” dollars since the Court of Federal Claims’ ruling in Walcek v. United States, 49 Fed. Cl. 248 (2001). In that case, in 1971, the Walceks invested in 14.5 acres of real property in Bethany Beach, Delaware, before passage of the 1972 Clean Water Act. Unfortunately, when the Walceks filed for Corps of Engineers’ permits in 1988 to fill and develop 77 lots, 13.2 acres were deemed wetlands. Ultimately, the Corps permitted a smaller uplands area for 28 units.
The economic impact, after much discussion at trial between appraisal experts, and further adjustments by the CFC, was measured as of 1996 as the difference between the $1,485,000, before value, and the $597,000 after value for the 28-lot development — a diminution in value of 59.8 percent.
The CFC also determined “that plaintiffs would derive an economic profit of at least $305,000” on the 28-lot development, which was nearly twice the Walceks’ tax basis in the property, $169,701. The court held that the denial of the permit amounted to a noncompensable diminution that allowed plaintiffs “to realize a not insignificant degree of their true reasonable investment-backed expectations.”
Both of these decisions ignore the time value of money — the identical economic failing. Who among the readers would be happy to accept the after dollar values as a reasonable return to investments ~20 or ~40 years prior?
Each economic impact legal analysis is fatally flawed by the first standard financial valuation step: establish the benchmark date for the evaluation. This is remarkably strange to this economist because appraisals universally identify the date of the valuation on the first page. Typically, in takings cases, this is the date of taking, which would be the date of denial of the permit. Expenditures prior that date are compounded forward to the date of taking; subsequent cash flows are discounted back to the same date. Discount rates are comprised of a nominal long bond rate plus appropriate risk premia. Bond rates include a measure of inflation. As a result, all monetary values in the analysis are expressed in “apple” denominated values, not “apples and oranges.”
In Walcek, the CFC dismissed the plaintiff appraiser’s apparent use of CPI’s to (somehow unexplained) adjust dollars to a common metric. The trial court in Smyth remarked that plaintiff counsel presented no “evidence at trial of the present value of the price [plaintiff’s] parents paid for the property in 1975.” Both the CFC and Smyth apparently believed there was no way the after values could provide a reasonable return to the investments if measured in dollar amounts of the same vintage.
These decisions reveal yet again that financial inconsistency continues to bedevil various courts over this century, years after Penn Central sought to establish Lingle’s “polestar” to guide other than Lucas takings. Financial and economic methods of estimating economic losses and evaluating severity of economic loss have remained the same since long before Penn Central. Defendant counsel and trial judges on the other hand have relied on an array mistaken economic methods to comply with the Penn Central test. See, for example, Wade, “Theory and Abuse of Just Compensation for Income Producing Property in Federal Courts: A View from above the Forest,” 46:2 Texas Environmental Law Review 140, 2016.