Applying Fair Market Value Concepts to Water Rights

Article excerpt

Market acquisitions of water rights are increasingly common in regions where existing water supplies are fully appropriated and development of new supplies is costly. Both market acquisition and development encourage new water users to bid water away from current right holders. Urban growth, environmental disputes and Native American claims to water all create incentives for acquisition of water supplies. While water right acquisitions often are essential to real estate development, they also are the subject of controversy in state and federal courts, legislatures and administrative agencies.

Water use and transfer is carefully scrutinized and highly regulated in most western states. Within this conflictual environment, water rights valuation has become an important task. Such appraisals provide essential information for potential buyers, many of whom are real estate developers and city governments seeking supplies for growing populations. Appraisers may assess fair market value for the courts to award compensation for damages or takings of water rights; for public agencies who supply water to farms, cities and business; and for conservation organizations who acquire water for wildlife refuges, wetlands and streams.

This article reviews several markets for water rights in the western U.S. and discusses the application of fair market value to water rights and how this differs from other real property in several critical ways.

BACKGROUND ON WATER MARKETS IN THE WESTERN UNITED STATES

The markets where water rights are traded vary by region, water source and types of buyers and sellers. Traditionally, a market is defined as a set of arrangements where buyers and sellers are brought together by the price mechanism. For water rights appraisal, it is the interaction of individuals who exchange water rights, water supplies associated with land and water-related infrastructure for other assets, such as money.(1)

A transaction that involves both land (and improvements) and water may still be considered a water transaction if the acquisition was motivated primarily by the desire to obtain water supplies. These transactions are common in Arizona where water transactions often include land acquisitions, due to specific provisions in state law. In Colorado, New Mexico, Utah and Nevada, water rights can be (and frequently are) bought and sold separately from land.

Information on major water sources and uses, transactions and prices for five water market regions are briefly described in this article. Figure 1 identifies the five market areas which are located in Nevada, Utah, Colorado, Arizona and New Mexico. (Figure 1 omitted) Price observations have been made as comparable as possible allowing for time and market areas. Prices have been adjusted, using the Gross National Product (GNP) price deflator, to 1986 dollar values. In addition, several conventions have been adopted to compare different water rights in terms of common units of measure. Water rights may be transferred in perpetuity (sold) or temporarily (leased). Unless otherwise noted, transactions described in this study are for sales rather than leases.

WATER HAS RIGHTS, TOO

In quantifying water rights, it is important to distinguish between diversion rights and the consumptive use portion. Diversion rights refer to the maximum quantity of water which may be withdrawn per unit of time from a water source. Consumptive use refers to the portion of that diversion right which may be removed permanently from the hydrologic system through evaporation, transpiration or other means. The difference between diversion and consumptive use is the "return flow," or the portion of the diverted water which returns to the system and is available for appropriation and use by others. In many areas, transfers of water rights are limited to the consumptive use portion of the water right. This limitation is enforced to protect other water users from having their own water rights adversely impacted as a result of the transfer. …