[Nicole Garnett (guest-blogging), February 15, 2007 at 2:41pm] Trackbacks
Precondemnation Negotiations

Most academic discussions of eminent domain also overlook the fact that the compensation that a property owner receives almost always results from a bargain between the owner and a Taker, rather than a judicial determination of the property's fair market value. State and federal laws require Takers, in most instances, to seek to purchase property on the market before resorting to eminent domain. Even if pre-condemnation bargaining were not required, the government would have important incentives to negotiate to avoid the high "due process costs" associated with a formal eminent domain proceeding.

Anecdotal accounts accusing the government of "low balling" property owners during pre-condemnation negotiations are common. It is difficult to evaluate these claims. Certainly, the negotiations that precede a condemnation differ in material respects from arms-length negotiations between private individuals. Pre-condemnation negotiations really do occur in "in the shadow of the law." Eminent domain is the classic example of liability-rule protection of an entitlement: both parties understand that an objecting property owner cannot ultimately say no. Owners have little incentive to ask for more than market value if they realize that they will not get it. Of course, if a property owner believes that the government is understating the value of her property, she could exercise her legal right to challenge the amount of compensation offered in court. But, a rational property owner will not force the government to condemn her land unless the expected value of the proceeding—that is, the award minus litigation costs—exceeds the government's offer.

That said, Takers operate under significant incentives to reach a mutually advantageous agreement. For example, many states penalize the government for failed negotiations by awarding the property owner attorney fees and costs if the final judgment in an eminent domain proceeding exceeds the government's final offer. These fee-shifting statutes penalize the government for unreasonably refusing to settle prior to trial. As a California appellate court recently observed, "one would expect a prudent condemnor to offer its best estimate of fair market value plus some reflection of its own savings from avoiding trial, with a further upward adjustment for elimination of potential liability for the condemnee's litigation expenses." Building the H2 Plant: A Bargaining Case Study

Because the negotiations between property owners and Takers are opaque and decentralized, it is difficult to gain information about how the bargaining process works. The remainder of this Post therefore outlines a case study that I conducted of an economic-development project near my home in South Bend, Indiana. This project required the assembly of fifty-two parcels in order to construct a manufacturing facility that promised to generate significant economic benefits to a relatively depressed economic area. This case study is not generalizable, but it does yield insights into the kinds of factors influencing Takers' negotiations with property owners.

AM General has manufactured "Humvees" in northern Indiana since 1984. In 1992, AM General began to use this plant to manufacture ultra-luxury sports utility vehicles (known as the "Hummer" or "H1") for civilian use. In 1999, GM acquired exclusive rights to the Hummer trademark, but agreed that AM General would manufacture a smaller, more affordable, "H2," for GM. This agreement was conditioned upon AM General acquiring the property for a new 630,000-square-foot manufacturing facility quite quickly. AM General and GM decided to build the new plant directly adjacent to the existing Humvee facility. The property needed for these purposes consisted of fifty-two separate lots in a low-density, blue-collar, residential neighborhood.

AM General itself acquired the seven parcels directly adjacent to its property; these property owners received, on average, 141% of the appraised value of their homes. St. Joseph County, Indiana agreed to acquire the remainder of the needed land, by eminent domain if necessary. The County began to take steps to pave the way for condemnations. These initial legal moves upset residents, causing the the County to allow more time for private negotiations. Between March and June of 2000, the County purchased the remaining parcels voluntarily. The County now leases the property back to AM General.

In preparation for negotiations with property owners, county officials consulted with several private companies that had assembled land for large projects in the area. These experts indicated that assembling property that is not currently on the market usually requires prices that exceed market value by 20 to 25 percent. Apparently in response to this advice, county officials decided to comply with the federal relocation assistance guidelines. While the County did not believe that it was bound by these rules, generous relocation assistance was seen as a way to expedite the bargaining process. Before approaching a landowner, the County acquired two appraisals of the targeted properties. The County also presented the property owners with an estimate of the relocation assistance that they would receive, in an effort to demonstrate that the fair market value award was only part of the compensation that they would receive. Finally, AM General independently offered to pay every property owner a $5000 bonus for meeting the voluntarily negotiated time schedule, half of which was paid at the closing and the other half when the owner vacated the property.

I collected data on the appraisals, sales prices, and relocation assistance for each of the parcels purchased by the County. This data reveals several very interesting things about the bargains between the County and the targeted property owners. First, property owners received, on average, 157% of the average appraised value of their property. Second, a significant part of the total compensation that owners received came in the form of relocation assistance. As a result, the total compensation received by owners displaced by the County actually exceeded the compensation received by the seven owners who negotiated directly with AM General. Third, the high compensation levels were almost universally attributable to replacement-value payments. With one exception (an unoccupied house), the county paid some form of replacement subsidy. The average replacement value stipend received by homeowners was $40,529.10 (nearly twice the statutory maximum); the payments ranged from a low of $441.74 to a high of $85,500. On average, owners received a replacement-value stipend equal to 44.81% of their sale price. Some stipends exceeded the sale price: One owner received $56,000 for his house and $85,500 to secure a replacement dwelling; another received a $74,300 replacement subsidy for his $69,000 house.

This case study is not intended to demonstrate how the pre-condemnation bargaining process works in every case. Pre-condemnation bargaining is context specific and undoubtedly is influenced by local legal, political and economic circumstances. But to understand eminent domain, we need to learn more about the ubiquitous -- but almost universally disregarded -- practice of precondemnation negotiations.

Tom Holsinger (mail):
Yes, eminent domain proceedings are generally the tail end of a much longer bargaining process.
2.15.2007 4:18pm
logicnazi (mail) (www):
I would very much like to see data from a larger sample. It seems clear that in this case property owners got a fair shake but I have no way of determining if this is representative. In particular one might expect the PR issues and potential for outrage particularly present when taking property to make a factory to increase the payouts.

Your points are fairly compelling as far as the educated, well off property owner is concerned (though I still worry about how many states have the rule you cite). However, I am worried that many less educated or poor property owners will not be able to take the risk of hiring an expensive lawyer to contest the condemnation award in court or even know about the state's responsibility to pay for their attorney fees in certain circumstances.

In short even if the system is in principle fair for a property owner with many resources this doesn't show that the psychological effect of the government knocking on your door and telling you "We will give you X for your house otherwise we will take you to court and condemn your property" isn't to make the property owner accept a below market price for their home.

Also troubling is that precondemnation negotiations give the government a strong incentive to make it's initial offer well below market value and what it is ultimately willing to pay (as well as working to conceal what prices it has already paid). The net effect of this seems likely to be that resource poor/uneducated home owners would receive below market value while those who knew how to negotiate would receive above market value.
2.15.2007 5:00pm
Byomtov (mail):
An additional factor that ought to motivate the Taker to make generous offers is speed. Presumably, whatever the project being built, but especially in the case of a commercial facility, getting it done sooner has substantial value.

I wonder if stock market takeovers provide some sort of model for reasonable compensation in these cases. Takeovers normally involve a premium, often a hefty one, over the market price - a very clear measure of FMV - of the shares. Obviously, this is because not all holders are willing to sell at the market price.

There are certainly some big differences, but the underlying idea is the same - someone wants to accumulate a large block of property from a number of holders and is willing to pay some premium to do it.
2.15.2007 5:11pm
Tom Holsinger (mail):

The bargainng process prior to filing of an emninent domain action is sometimes lengthy. The action itself tends to be quick, but it generally occurs at the very end of the overall process.
2.15.2007 5:39pm
Byomtov (mail):
Tom H.,

Yes. I understand that, but it's not clear to me if you are disagreeing with something in my comment. Are you suggesting that Takers are not in fact very concerned about speed?
2.15.2007 5:47pm
It is patently unfair for the government to pay 100% of the appraised value of the property. Owners have significant costs in moving, aside from just sentimental attachment to their property. Closing costs, mortgage origination costs, moving costs, inspection costs (for the new property) are all significant. The only thing these folks don't have to pay is realtor costs. There is also the cost of lost work time to pack and move, possibly enroll kids in a new school, and a plethora of more minor costs. Getting paid 100% of appraised value could saddle the property owner with significant costs.
2.15.2007 5:49pm
jallgor (mail):
I think the reasons for pre-condemnation negotiation are obvious. For a big commercial development speed and momentum are important factors. Negotiating and cutting deals with a significant number of landowners sends a message to politicians needed to support the project, people who live in the area, etc. that this is something that will inevitably happen. All these kinds of developments need heavy political backing and politicians will push developers to step up and negotiate to avoid negative publicity.
The question of whether 150% or 200% or 300% percent of appraisal value is "fair" is another thing entirely. I got a price for my home under these conditions that I was very happy with but that didn't mean that I couldn't have gotten more if the developer didn't have eminent domain in his back pocket. It all comes down to the purpose of the project. Is it really a public good like a public school or hospital or is just rent seeking by some developer with connections? If it's rent seeking, the question of "fair" compensation should be what is the land worth to the developer. I should be able to get exactly as much as he's willing to pay not some artificial appraisal value. And in order for that to happen eminent domain can't be involved. If it's truly a public project then "fair" compensation might be appraisal value and relocation expenses but that coercive type of power should be used very sparingly. The problem is that cases like Kelo have given the thumbs up to use eminent domain in obvious cases of rent seeking.
So I think the only analysis worth engaging in on this topic is an analysis of what is truly a publuic taking and what is a private taking masquerading as a public one.
2.15.2007 6:31pm
DG wrote:
It is patently unfair for the government to pay 100% of the appraised value of the property. Owners have significant costs in moving, aside from just sentimental attachment to their property. ... Getting paid 100% of appraised value could saddle the property owner with significant costs.
Yep. It's enough to make you wonder about constitutional interpretations. Since the 5th Amendment's "public purpose" is interpreted so broadly it includes giving the property to politicians' pals private developers, then why isn't "just compensation" interpreted at least broadly enough to fully recompense an owner for all the costs resulting from the taking?

Ambrose Bierce answered the question long ago:
Deliberation, n.: The act of examining one's bread to determine which side it is buttered on.
2.15.2007 6:48pm
Nicole: Bravo on your research. Too often, it seems, legal scholars seem to prefer to engage in intellectual history or a brand of philosophy while avoiding messier - and more time-consuming - empirical research.

That being said, I have a few questions for you regarding your case study. First, can you elaborate on your note that the owners received 157% of average assessed property value? Some states have laws restricting the rate of assessment growth, for instance, and other states restrict assessments to certain periods of time. In most states, I would hazard, property assessments are typically behind fair market value. Therefore I am not sure whether or how the assessed value in South Bend reflected actual market value. Furthermore, I would think that the median (rather than average) "over" payment would be useful for evaluating fairness - after all, by relying on "averages", one could posit that one subset of (presumably well-connected or well-educated) property owners received massive overcompensation while the residue of (unconnected or uneducated) owners received far less. Third, what was the relationship between sale price and replacement subsidy? That is to say, did owners with high sale prices typically receive lower replacement subsidies, and vice versa, or is there some other relationship that you can ascertain? How do you account for the apparently wide variability of sale prices and replacement subsidies? Is there some economic variable that can explain the variances, or might this fall to the owners' subjective qualities (race, education, political connections, etc)? After all, at least some of the distrust of condemnation relates to its essentially political character, which at its extremes could be characterized as a local form of "nationalization" or even as a corrupt transfer of private assets into the hands of the politically favored. I applaud your efforts to analyze the issue empirically, though, and I would hope that you could include some review of the owners' "subjective" variables when analyzing condemnation (and pre-condemnation) proceedings.
2.15.2007 6:49pm
The compensation paid for each unit of an aggregate of properties selected for some project should reflect that unit's contribution to the value of the anticipated public benefit to be gained. A more suitable and and also practical valuation method could be based on the expected increase in tax revenue amortized over some arbitrary time period (say 30 years?).

Also, another problem with appraisals (this time on the overvalued side), is that they can be systematically overvalued in recently sold homes, because appraisals are conducted after sale price negotiations, and appraisers who kill deals with accurate valuations lower than the sale price do not get repeat work.
2.15.2007 7:51pm
Tom Holsinger (mail):

The incentives for speed are not constant within a given taking, let alone constant for different takings. As an example, a recent case I had involved the location of a powerline easement taking for the Modesto Irrigation District. MID performed surveys of several different routes, and its eventual choice combined elements of two of those based on environmental and financial factors. The latter entailed a distinct preference to avoid displacing private residences as those entailed far more compensation expense than farm land and dairy grazing land.

The environmental tradeoffs evaluated, OTHOH, entailed a clear preference to avoid potential environmental challenges and ensuing litigation delays.

These considerations considerably lengthened the pre-condemnation process. There was an environmental challenge anyway, by some farmers whose real motive was to have MID instead take some private residences. MID's arguments on farmers' EIR petition challenge included an explanation of how time was of the essence due to major projected increases in power demands from the rapid population growth in this area.

So here there was a lengthy pre-condemnation process, followed by a swift attempted taking and then a 5-6 month delay due to environmental litigation.

Eminent domain does not entail a single tempo. It varies wildly. And not all takings are the same.

As another example where speed of takings is not at all an issue, consider that the cost of takings of for construction projects is only a tiny fraction of the actual construction cost of the projects.

The California Department of Transportation has a long list of future projects where the speed of taking land is entirely dependent on funding of the construction. They and the landowners know that Cal-Trans WILL take the land in question eventually, but just when is up to the California legislature, not Cal-Trans.
2.15.2007 8:07pm
Tom Holsinger (mail):

The word of art here is "severance damages". California condemnation law allows for those, and probably so does the law of most states.
2.15.2007 8:10pm
Andy Freeman (mail):
> Getting paid 100% of appraised value could saddle the property owner with significant costs.

Under CA's Prop 13, the taxable value of a property can increase no faster than 2%/year except when said property changes hands.

If we take the house of the proverbial little old lady and she buys an "identical" house for the amount that she received from the takings, her property taxes are likely to increase by several times.
2.15.2007 8:45pm
logicnazi (mail) (www):
Andy Freeman,

Yah but that just goes to show you that prop 13 is an idiotic law. People who have jobs that require them to move around a lot have things shitty enough already they don't deserve to be screwed over on taxes nor is staying in one place a moral good that deserves to be rewarded.

Also prop 13 plays the anvil to the hammer of Californian voters constant demands for more government services with the state budget in the middle. Frankly, it is just stupid to cap taxes like this without also capping spending, especially when the state can squeeze out extra money by reducing payments to municipalities.

Finally and most importantly prop 13 undermines the fairness of the tax system. Property tax is designed to be a tax on accumulated wealth by mandating that the assessed values of houses not match their actual value you undermine the fairness of the whole system. At the very least we should stop lying about it and admit these aren't valuations at all.

I understand the concerns about not having people with fixed incomes get pushed out of their houses but these are best dealt with by other laws (rules about taxes for people over 65 and the like).
2.16.2007 1:00am
Whadonna More:
Um, does "replacement subsidy" in the last paragraph mean "relocation subsidy" or something else? If it's something else, how did the gov't determine the figures - mere horsetrading?

Also - what "appraisal" value was used - tax appraisal (a complete fiction in many jurisdictions) or a real FMV appraisal based on timely sales comparables?
2.16.2007 11:27am
Andy Freeman (mail):
> it is just stupid to cap taxes like this without also capping spending

CA nominally has a "balanced budget" requirement, so a tax cap is a spending cap.

> rules about taxes for people over 65 and the like

Taxing her out of her house at 55 or 60 is so much better....

The little old lady didn't ask other people to highly value her house. She just wants to live in it.
2.16.2007 11:31am
Stacy (mail) (www):
I've studied this issue a bit, and I think two things:

1) The inclusion of economic development in the definition of "public use" is wrongheaded in the extreme. A road or bridge is one thing, a shopping mall or office building is clearly something else

2) You can't know the fair market value of a property until it's sold. The best you can do is to compare it to similar nearby properties that have been sold recently, and that comparison may or may not be valid. Tax assessments have the are at least consistent across the municipality, though as other commenters point out, the assessment is almost certainly less than market value. It isn't practical for the developer to publicly announce their intention to buy a certain set of properties, because the property owners will have incentive to gouge the developer.

The best approach is probably a stealthy one, where agents of the developer initially buy some of the properties incognito to establish a baseline valuation, thereafter negotiating with the remaining owners based on that number, with eminent domain being used (if at all) only to deal with extreme holdouts.
2.16.2007 1:46pm