Three Rules for Forensic Real Estate Damage Valuation: Deductive, Adductive, or Reductive Rule?

Article excerpt

FORENSIC VALUATION: WHAT IS IT?

Forensic real estate valuation is the application of economic principles and methodologies to answer questions of fact as to whether real estate values have suffered a permanent damage. Forensic real estate valuation contrasts with the prevailing valuation theory in the real estate industry that often fails to distinguish permanent loss from the following:

SITUATIONS WHERE DAMAGES ARE IMPERMANENT OR NON-RECOVERABLE

* Where the market has already provided "implicit compensation" for a pre-existing "foreseeable" condition (i.e., the "foreseeability damage test").

* Where the purported loss reflects the real estate market cycle.

* Where the loss was insured and thus recoverable.

* Where the loss is a brief, temporary loss of marketability.

* Where the loss was mitigatable or avoidable.

* Where the loss is speculative or stems from a self-interested claim of "stigma."

* Where any diminution in value reflects a changed highest use of the property rather than full economic loss.

* Where the loss is due to non-compensable regulatory changes.

* Where there is an interim use, or "next-best use," of a property that serves as a prophylaxis against total loss.

* Where "project influence" from a public project results in an increase or decrease in property value that is legally not to be considered in an eminent domain property appraisal. "Project stigma" is a self-contradictory term because it is legally disallowed in public agency real estate appraisals.

* Where any diminution in property value was possibly due to some extraneous condition or event other than that purported.

* Where there was no discernible damage at all.

Alleged damages might be the result of a physical invasion; proximity to a nuisance; overreaching land use regulations; indirect benefit or burden transfers; some fickle and transitory notion of stigma; or irrational phobic reaction to some uncertain environmental substance or condition. From this starting point the forensic valuation consultant gathers evidence to determine if permanent damages have occurred. Like forensic engineering, forensic real estate valuation is similar to failure analysis and root cause analysis with respect to the methodologies and logic employed. [1]

The term "forensic" is used here to connote the investigation of whether property values have been permanently damaged in the context of a trial of fact, pre-trial settlement, arbitration, or as a matter of public policy. Forensic valuation is like conventional real estate appraisal in that appraisers are held to a standard to not fudge the numbers, to avoid unacceptable valuation methods, and to shun undisclosed assumptions to back up a desired result. But the distinguishing characteristic of forensic valuation is its focus on the measurement of permanent property losses, its insistence on the use of consistent, logical, and legally appropriate valuation methods to the situation at hand, and its adherence to the scientific method that requires the reporting of unwanted results and disconfirming market data.

RE-DEFINING THE THREE CONVENTIONAL APPROACHES FOR DAMAGE VALUATION

Neither law nor real estate appraisal has thoroughly clarified the different damage valuation methodologies that are applicable under tort law, condemnation law, regulatory takings law, and inverse condemnation law in various political jurisdictions. Real estate appraisal generally relies on three cardinal valuation methods: the Cost, Sales Comparison, and Income Approaches. This article shows that there are three methods of damage valuation that generally comport with the three conventional methods of valuation.

The three conventional valuation methodologies have been incorporated into damage law under different terminology and computation formats. Two rules predominate and have mostly been applied to damage situations involving use of eminent domain powers by public entities:

Existing Nomenclature for Damage Valuation Rules:

* The Federal Rule or Before and After Rule (Comparison Approach)

* The State Rule or Value of the Take Plus Damages Rule (Cost Approach)

The Federal Rule tries to solve the damage measurement problem by using "deductive logic"; the value after the damage is "deducted" from the value before the damage to arrive at an estimate of damage compensation. …