Eminent Domain Report

Appraising a property being acquired through eminent domain involves a number of unique valuation rules, including highest and best use, larger parcel, date of value, and unique evidentiary restrictions on comparable sales and hypothetical conditions.  One of those rules is known as the “project influence rule”:  an appraiser must disregard any increase or decrease in the property’s value due to the project for which the property is being acquired.  A recent court of appeal decision, City of Pacifica v. Tong (2024 Cal. App. Unpub. LEXIS 7984*), highlights why this rule is not always easy to apply, and how it can get appraisers in trouble. 

Background

City of Pacifica v. Tong involves the City’s acquisition of a 1.7-acre property on a bluff overlooking the Pacific Ocean.  The property was originally developed with two 20-unit apartment buildings that the owner had previously purchased the property for $6 million.  The property had a history of bluff failure and erosion, and the City red-tagged the buildings due to wave action and erosion undermining the foundations of the apartment buildings.  After abatement warrants were issued, the City demolished the apartment buildings.

Shortly thereafter, the City offered to purchase the property under threat of eminent domain for shoreline protection purposes.  The City valued the property at $76,500 based on a land banking / speculation highest and best use.  The owners did not accept the City’s offer, and the City proceeded to file an eminent domain action. 

Trial Court Valuation Issues

Shortly before trial, the parties conducted an expert exchange.  The City relied on its original appraisal and valuation of $76,500.  The City’s appraiser concluded that development of the property was not reasonably probable given the high geologic risks.  The owner’s appraiser valued the property at $4.375 million, concluding that the highest and best use was an ability to transfer development rights (TDRs) under the City’s TDR ordinance which provided owners with “a mechanism to relocate potential development from areas where environmental or land use impacts could be severe to other areas more appropriate for development….”  The owner had never applied to transfer TDRs from the property, and the property was not in a “sending” area of the City’s TDR ordinance, but the City’s planning commission had discretion to approve any specific TDR application.

The City and the owner then exchanged final offers and final demands; the City stuck to its appraised value of $76,500, while the owner made a final demand of $2.2 million.

On the first day of trial, the court excluded any evidence of valuation of the property based on the existence of TDRs, and then continued the trial so the owner could submit an amended valuation statement.  The owner’s amended valuation concluded the highest and best use was for land banking, but that once the City completed its project, the property would be more valuable, either for development purposes or based on the property having the potential ability to transfer TDRs.  The owner’s new valuation concluded a land bank purchaser would be willing to pay $2 million based on these future development opportunities.

After both appraisers testified, the trial court issued a statement of decision concluding that the fair market value of the property was $2 million.  The court concluded that it was possible to engineer and design a development of the property, and the owner’s appraisal did not run afoul of the “project influence rule” since the City’s own project demonstrated the possibility that the owner could reinforce and stabilize the bluff from future erosion.  The court further concluded that the City failed to update its original appraisal (i.e., it had the wrong date of value), and the City’s appraisal did not rely on any comparable sales within the City, or with similar zoning, or along the coast.  The court also determined the owner was entitled to litigation expenses (including attorneys’ fees and expert fees) since the City’s final offer was unreasonable, and the owner’s final demand was reasonable.  The City appealed. 

Application of the Project Influence Rule

On appeal, the primary dispute involved whether the trial court’s valuation of the property violated the project influence rule (Code of Civil Procedure section 1263.330) because it considered increases in value flowing from the City’s project in determining the property’s fair market value.  The City claimed the trial court improperly adopted the owner’s argument that because a hypothetical land banker would have considered the City’s project, the property should be valued as if it had been, or imminently would be, stabilized by the project and thus would be suitable for residential development.  The owner countered that the case falls within an exception of the project influence rule, allowing for consideration of project-enhanced value up to the time the property was pin-pointed to be condemned for inclusion in the project. 

The Court of Appeal explained that under the project influence rule, any increase or decrease in the property's value caused by the project for which the property is condemned may not be considered. Thus, to the extent the fair market value of the property condemned increases or decreases because of the project for which it is condemned, such project-caused increases or decreases must be excluded from the just compensation calculus.  However, a property owner is allowed to share in the appreciation caused by proximity to a project up until the point it becomes “reasonably foreseeable that the land is likely to be condemned” for the public project.

The Court of Appeal held that in this case, it was known from inception of the City’s project that the owner’s property would be acquired, and the owner’s appraisal relying on the City’s project to stabilize the bluff and allow for development was therefore improper.  However, the Court of Appeal deferred to the trial court’s findings that the City’s appraiser’s valuation conclusions and comparable sales defied logic, while the owner’s appraiser’s comparable sales were more suitable (even though they needed to be substantially adjusted downward to account for the difficulties in developing the property).  Therefore, even though the trial court improperly allowed valuation testimony that violated the project influence rule, substantial evidence supported the trial court’s determination of just compensation.

Litigation Expenses Were Proper

Under California eminent domain law, 20 days before trial, the public agency and property owner are required to exchange a final offer of compensation and a final demand.  (See Code of Civil Procedure section 1250.410.)  If the court finds the public agency’s final offer was unreasonable and the property owner’s final demand was reasonable, the property owner is entitled to recover litigation expenses. 

Here, even though the owner’s final demand was $2.2 million and the ultimate award was $2 million, the Court concluded the final demand was reasonable at the time it was made, especially because at the time it was issued, the owner had an appraisal at over $4 million (which was later excluded and then reduced).

In contrast, the City’s final offer of $76,500, inclusive of interest and costs, was materially unreasonable.  It was the exact amount of the City’s valuation, and more than $1.9 million below the award.  The Court concluded that the City’s final offer was “absurdly low”, and the City’s stubborn refusal to accept that the property might have some value was unreasonable. 

The Court therefore upheld the trial court’s award of the property owner’s litigation expenses. 

Take-Aways

The case serves as an important reminder to consider and properly assess the application of the project influence rule when conducting an eminent domain appraisal.  Determining the date of the property’s probable inclusion in the project can have significant consequences on the ultimate valuation.  The case also serves as a reminder for public agencies that they cannot simply rely on their deposit appraisal for trial purposes; the date of value should be updated, and the appraiser should conduct a thorough appraisal with the best comparable data available.  Finally, public agencies cannot stick to their guns in issuing a final offer; an agency should consider the risk that a judge or jury may find some merit in the owner’s valuation.  Failure to do so is not in the spirit of the offer to compromise statute, and public agencies that fail to account for such risk expose themselves to paying the property owner’s attorneys’ fees and expert fees.