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Case Study: The Project Influence Rule

| Apr 6, 2015 | Blog |

Project influence in a condemnation case refers to a positive or negative change in the market value of property as a result of the same public project for which all or a part of the property is being taken. When project influence is present, the market typically reacts to it in advance of the government’s acquisition of a particular property. Thus, by the time the acquisition actually occurs, market transactions will reflect the market’s view of the public project and its influence on market value. The majority rule in such instance is that any increase or decrease in market value directly attributable to the project should not be considered in determining market value. This rule is commonly referred to as the project influence rule.

The rationale underlying the project influence rule is straight-forward. Once property is slated for acquisition for a public improvement, it can no longer realize any benefits or suffer any damaging effects that the project may bring. Where the project enhances market value, excluding any value directly attributable to the project negates the impact of the project as to both the condemnor and condemnee, so that the government does not pay an enhancement attributable to its project and not normal market forces. Likewise, where the project negatively influences market value, these influences are excluded so that the property owner does not receive less than he would have but for the project. In simplest terms, the goal is to determine a property’s value as of the “date of taking” assuming that it had traded in the marketplace on that date between a willing buyer and seller, neither being under compulsion to buy or sell, disregarding any special impact the project may have on the property’s market value.

The project influence rule is a product of the indemnity principle that underlies our country’s notion of “just compensation.” Under this formulation, the just compensation clause works not only for the benefit of the property owner, but also for the condemnor. As the Supreme Court stated early on, “the theory of ‘just compensation’ under the Fifth Amendment is that such compensation is to be ‘just’ both to the owner of the property and to the public which pays the bill.” The government should not have to pay more for the property than would a private purchaser simply because the government is exercising its condemnation power in the public’s behalf. Instead, the government is to be equated to a private purchaser buying the property in question for its highest and best non-governmental use in the open market.

In calculating the compensation owed a property owner in a condemnation action, neither the government nor the property owner should be allowed to gather so-called “market value” facts from a market that has been influenced by the specific project for which the government seeks to condemn the owner’s property. Likewise, the government should not be permitted to artificially influence a market by various value-depressing acts so that the property it must acquire in that market will come at a cheaper price. An owner whose property is the type traded in the marketplace is entitled to compensation in a condemnation case based on free market transactions uninfluenced by such governmental activity. Equally as true, the government should not have to pay any more than is indicated in the free market for the property it needs, uninfluenced by its specific project. These concepts have become known as the “project influence” or “scope of the project” rule.

In Texas, the fact finder may not consider any specific damages or benefits to the value of one’s property that results from the public improvement to be constructed on the property in determining market value. Recently, the State has attempted to assert a new, more aggressive formulation of the project influence rule, a formulation that would turn the indemnity principle underlying Texas’s just compensation framework on its head. The law on project influence has not changed since 1974. The rule has been applied to numerous projects such as airports, schools, and sports arenas, all public improvements that would be expected to foster economic development and, thus, to enhance market value. A classic example of such a project influence was presented in downtown Houston when the Houston Sports Authority acquired property for the construction of a new stadium for the Houston Astros’ baseball club. The Sports Authority selected a somewhat depressed area of downtown Houston for the stadium’s location. Upon announcement of the new stadium’s location, the market value of property in this area increased sharply. This increase was a direct result of the planned construction of the new stadium and could not be considered in determining the market value of properties needed for the stadium’s construction.

In sharp contrast to these types of projects, the exclusion of evidence under the project influence rule has never been applied to a highway widening of an existing highway. For reasons that should be obvious, the rule has little or no application when the influence asserted is the result of the expansion of an existing highway project, like the widening of an existing highway. In each case in which the rule has been applied, it was undisputed that the new facility enhanced the market value of the land to be acquired. It was under these circumstances that the Supreme Court recognized that a property owner’s compensation “should under some circumstances or at some time cease to include enhancement due to the project which is itself the purpose of condemnation.”

The State now seeks to invoke this exclusion in highway widening cases. The widening of an existing highway, however, is a very different circumstance from the introduction of a new airport or other new facility to an area where none existed before. First, the benefit of a widened highway to an abutting commercial property is less clear. The commercial development along the highway is often the product of the strong residential areas surrounding the highway and, in part, exposure to the volume of traffic on the pre-existing highway.

The State fails to recognize that all of these factors existed before its widening project and are completely unrelated to its widening project. Government does not build infrastructure to attract people; government builds infrastructure to address the needs of the people. The State did not decide to widen the freeway to attract more traffic to this highway. Instead, the State’s decision to widen the freeway was to address the excess in traffic that already existed in the corridor. In fact, if the State were to look at its project honestly, it would have to recognize an obvious negative impact of the project on the commercial development along the existing freeway.

The purpose of most freeway widening projects is to facilitate the flow of traffic from Point A to Point B. A widening project is typically a huge benefit to Point B. Increasing the flow of traffic from Point A to Point B does not benefit those commercial properties along the freeway. Instead, for these properties the expanded freeway will tend to function as a bypass, which can only have a negative influence on market value.

Nevertheless, the State has asserted that the project influence rule required the wholesale exclusion of relevant market data along the pre-existing freeway corridor. The sole basis for this exclusion is the striking increase in market values that has transpired in the market area in the years since its project was announced. A proper analysis of project influence looks to the nature of the public project and determines whether it has impacted market value. In contrast, the State has perceived an increase in market value and seeks to attribute this increase to its project.

The problem with the State’s analysis is that there is no facet of its project that would explain or result in an increase in market values. Initially, the State argued that it was the new highway facility itself that was attracting the new development to the corridor. This was nonsense. First, it is the traffic on the roadway, and not the quality of the roadway, that interests commercial endeavors. Additionally, if this proposition were true, which is dubious, this impact would not manifest itself until the facility was completed, usually years later. In the meantime, the inconvenience from the State’s construction is the only discernible impact of the State’s project, and it is a decidedly negative one. Ultimately, this argument was rejected by the State’s own appraisers and has been abandoned.

Influenced by these same appraisers, the State replaced this argument with a more complicated, if equally unconvincing, argument: the State’s taking of commercial land and conversion of this land from a commercial to a governmental (highway) use reduced the supply of commercial land along the market area, thus increasing the price of property. The appeal of the argument is two-fold. Appraisal is a subfield of economics, and the laws of supply and demand are in full effect. Additionally, the State’s premise seems incontrovertible: If the State takes 200 acres of commercial land along the freeway and devotes this land to highway use, there must be 200 fewer acres of commercial land.

The State’s analysis is overly simplistic. The argument that by taking commercial land and devoting it to highway use you have decreased the supply of commercial land fails to take into consideration the impact of partial takings on improved properties. It is true that the State acquired a lot of vacant land. It also acquired a lot of land from improved tracts, and in several instances along a freeway project, the State’s taking of a portion of an improved property will result in the demolition of the improvements located on that property. Once this consideration is factored into the vacant land analysis, it turns out that the State’s project may actually increase the acreage of vacant land.

To date, the State’s project influence arguments have focused on the sales prices of comparable land sales along the freeway corridor. The argument the State has not yet made is that its project resulted in increased rents of commercial properties along the freeway. Under the facts, this argument would strain all credibility. The evidence is exceedingly clear that the only impact evidenced to date is a negative one. Construction of the State’s project results in rent concessions, increased vacancy, increased defaults, and increased relocations of businesses away from this market area. Any benefit or enhancement to rents could not be measured or even perceived until construction is completed, which is often years later.

Like the State’s argument regarding land sales, any asserted enhancement of rentals is not likely to be supported by the market data. One facet of the State’s project is that, because many older improved properties are impacted and, ultimately, demolished as a result of the State’s project, there is a renewal of improvements along the freeway after the taking. In other words, not only did the State’s project increase the supply of vacant land along the freeway, but when these vacant tracts are improved, they replace outmoded or outdated uses of land with additional retail commercial properties, resulting in a net increase in retail space available for rent. In other words, the exact opposite of the State’s premise is true: its project results in an increased supply of both vacant land and, as a result thereof, an increased supply of retail space available for lease.

There are additionally problems with the State’s broad supply and demand formulation of the project influence rule. The alleged impact, if true, would not be limited to the subject freeway commercial corridor. The decrease in the supply of land, if true, should have an incremental effect on the price of land everywhere. An investor in income-producing, commercial real estate does not have a vested interest in a particular location or market area. The decrease in supply of land in one market area, therefore, should affect all land with the same highest and best use. Because every transaction is impacted by every other transaction, the State’s posited formulation of project influence, at its logical conclusion, would mean that all sales that follow the project’s announcement are project influenced and could not be considered, regardless of location.

In its focus on lowering the compensation to be paid to property owners, the State failed to recognize that other market areas, removed from the project freeway corridor, experienced similar levels of appreciation in market value over the same time periods. Before you could reasonably conclude that the increase in values along the project freeway was the undefined product of the State’s widening project, you would have to explain why properties in this market area would not be subject to the comparable appreciation in values experienced by other market areas in the city. There is no explanation available.

An increase in values is not enough to trigger the project influence rule. For the exclusion of market data on which a property owner can rely to establish its compensation claim to apply, the project must be shown to influence the sales price of the particular transaction. This evidence has eluded the State because it does not exist.

The project influence rule is concerned with the evidence that a property owner is going to be able to rely on to prove its compensation claim. The policy served by the project influence rule is the principle of indemnification and its guarantee not only that the property owner will be made whole but also that the government will only have to pay for what it is acquiring and not any enhancements that its own project has generated. The State’s formulations of the project influence rule violate this policy. While purporting to object to transactions under the project influence rule, the State’s arguments for exclusion do not require that the price for the identified transactions be enhanced by the widened highway facility itself, as required by every judicial formulation of the project influence rule. Instead, the State’s version of the project influence rule would require exclusion of the evidence whether or not there was any influence from the project itself. This formulation of the project influence rule, if encountered, must be rejected.