1. The Valuation of Contaminated Property Presented by: Thomas O. Jackson, Ph.D. Real Property Analytics, Inc. www.real-analytics.com Includes copyrighted material, all rights reserved.

2. Stigma Concept  Stigma reflects risk and uncertainty  All real estate investments have risk  Risk is inherent in homeownership  Stigma is risk related to additional uncertainties ƒEnvironmental condition of property ƒPotential future liabilities ƒUnknown hazards ƒUndisclosed or hidden costs ƒFear of the unknown  Stigma damages v. remediation costs ƒDoes one "cure" the other? ƒTemporary v. permanent condition

3. Risk Factors  Nature and extent of contamination  Existence of approved remediation plan  Degree of reliance placed on regulatory authority  Indemnifications by responsible party  Potential for third party (toxic tort) liabilities ƒAdjacent property owners ƒEmployees and tenants  Cost and timing of remediation effort ƒRisk based remediation standards

4. Risk Factors (continued)  Effects of remedial activities on use economic use of property  Residual land use restrictions subsequent to closure (deed restrictions and their impact on highest and best use)  Environmental insurance ƒRemediation cost cap most common  Market conditions ƒStrong market demand has mitigating effect ƒWeak market conditions exacerbate einvironmental risk ƒCondiitons specific to location and use

5. Remediation Lifecycle  Degree of perceived risk (stigma effects) changes over remediation lifecycle  Before cleanup stage ƒLittle knowledge or certainty about nature and extent of contamination ƒPerceived risks and adverse property impacts at a maximum  During cleanup - risk decreases, value increases  After cleanup ƒNo further action, regulatory closure ƒRisk declines to market levels ƒValue increases –Unimpaired levels –Higher levels - sales research

6. Market Risk Perceptions  Perceptions of risk by market underlie property value impacts and damages  Understanding perceptions is key to understanding the effects of contamination on value  Stigma is a perception issue  Results from scientific national study of lenders and investors conducted in Fall 1999 (funded by NSF)  Representative sample, results allow for inference  Property referred to is source site income producing with groundwater contamination  For lenders, assume borrower is creditworthy  For investors, assume investment otherwise meets criteria

7.  Before cleanup: ƒwould make loan without adjustments: 1.3% ƒwould make loan with adjustments: 5.5% ƒwould not make loan: 93.2%  During cleanup: ƒwould make loan without adjustments: 6.4% ƒwould make loan with adjustments: 54.2% ƒwould not make loan: 39.4%  After cleanup: ƒwould make loan without adjustments: 65.3% ƒwould make loan with adjustments: 30.5% ƒwould not make loan: 4.2% Lender Risk Perceptions (Based on national sample of 236 investors, Fall 1999) Copyright Thomas O. Jackson, Ph.D.

8.  Before cleanup: ƒwould invest without adjustments: 5.6% ƒwould invest with adjustments: 35.2% ƒwould not invest: 59.2%  During cleanup: ƒwould invest without adjustments: 20.1% ƒwould invest with adjustments: 69.3% ƒwould not invest: 10.6%  After cleanup: ƒwould invest without adjustments: 62.4% ƒwould invest with adjustments: 37.1% ƒwould not invest: 0.6% Investor Risk Perceptions (Based on national sample of 179 investors, Fall 1999) Copyright Thomas O. Jackson, Ph.D.

9. Methods  Case Studies ƒ2 step process ƒMandatory elements –SNAP (Source, non-source, adjacent, proximate) –Property type –Permitted v. accidental discharge ƒOther elements –Remediation lifecycle (before/during/after) –Type of contaminant –Indemnifications and insurance

10. Methods (continued)  Multiple Regression Analysis (hedonic modeling) ƒVariables that effect price (size, age, etc.) ƒDoes environmental condition have an additional effect? ƒOld houses in poor neighborhoods ƒStatistical significance ƒUses/abuses of technique –Intervening factors –Spurious correlations

11. Methods (continued)  Income capitalization ƒOldest method for contaminated property valuation ƒBest support in appraisal literature ƒIncome / rate = value (IRV) ƒHigh rate for high risk, low rate for low risk ƒContamination increases risk and rate ƒIncrement of increase in rate is risk premium ƒHow does appraiser determine risk premium? –Lender and investor surveys –Extraction from sales data

12. Income Capitalization Analysis (Uncontaminated Properties) Unimpaired Value = $240,000 per year 10.00% = $2,400,000 Capitalization Rate Net Operating Income Note: Based on an analysis of 39 retail centers sold in the southern California area from 1997 to 1999. Copyright Thomas O. Jackson, Ph.D.

13. Income Capitalization Analysis (Contaminated Properties Sold Before Cleanup) Impaired Value = $240,000 per year 12.55% = $1,912,350 Capitalization Rate Net Operating Income Note: Represents property value diminution of $487,649, or 20.3% of value in unimpaired condition. Copyright Thomas O. Jackson, Ph.D.

14. Income Capitalization Analysis (Contaminated Properties Sold After Cleanup) "Cured" Value = $240,000 per year 9.76% = $2,459,016 Capitalization Rate Net Operating Income Note: Difference in value from uncontaminated properties 2.5% higher, but not statistically significant. Copyright Thomas O. Jackson, Ph.D.

15. Mechanics of Income Capitalization Analysis for Contaminated Property Valuation

16. $100,000 / Year$100,000 Value = = = $800,000 (0. 25 x 0.20) + (0.75 x 0.10) 0.125 Proportion Equity Equity Return Proportion Debt Cost of Debt Income Capitalization Analysis (Hypothetical Unimpaired Baseline)

17. $100,000 / Year$100,000 Value = = = $727,273 (0.25 x 0.25) + (0.75 x 0.10)0.1375 Proportion Equity Equity Return Proportion Mortgage Cost of Mortgage Income Capitalization Analysis (Still Mortgagable, Small Equity Risk Premium)

18. Income Capitalization Analysis (No Mortgage, Large Equity Risk Premium) $100,000 / Year$100,000 Value = = = $333,333 (1.0 x 0.30) + (0.0 x 0.10) 0.30 Proportion Equity Equity Return Proportion Mortgage Cost of Mortgage