When Recognizing a Separate Economic Unit Lowers Compensation

Charles B. McFarland. Attorney & Principal, McFarland PLLC, Houston, Texas

The relevant parcel determination is required in every appraisal. A relevant parcel may be defined as the tract or tracts of land that possess a unity of ownership and have the same—or an integrated—highest and best use. This determination is inseparable from the highest and best use determination because it is an exercise necessarily stemming from the principle that just compensation be based on the highest and best use of the property taken.

Courts have repeatedly emphasized that just compensation is measured by the market value of the property at the time of the taking. Market value is to be arrived at upon just consideration of all the uses for which it is suitable, including the highest and most profitable use for which the property is adaptable and needed or likely to be needed in the reasonably near future to the full extent that the prospect of demand for such use affects the market value while the property is privately held. Under the market value standard, the owner is entitled to receive what a willing buyer would pay in cash to a willing seller at the time of the taking.

The relevant parcel determination is informed and necessitated by this definition of market value. To properly determine market value, it is necessary to identify the parcel that would be sold by a willing seller to a willing buyer for the property’s highest and best use. In other words, when the portion of the land taken cannot be considered an independent economic unit reflecting the highest and best use of the property and would thus deprive the landowner of adequate compensation for the part taken if considered solely as severed land, market value must necessarily be determined by considering some portion or all of the remainder to construct an economic unit.

The part taken can usually be considered its own economic unit or relevant parcel whenever government takes the entire contiguous ownership of the defendant. These situations are referred to as total acquisitions, whole takings, or total takings. When government takes a narrow strip of land, the part taken usually cannot be considered its own relevant parcel. In these situations, appraisers typically look next to the whole contiguous ownership of the landowner. This default follows the direction of the courts to consider the three unities of physical contiguity, unity of ownership, and unity of use.

Landowners may rebut this default relevant parcel, arguing instead that the acquisition should be considered its own economic unit. The normal procedure for awarding compensation for an easement is to determine the highest and best use of the entire acreage within the property lines of the parent tract and then to calculate the difference between the market value of the tract before and after the taking. Appraisers frequently fail to analyze whether the parent tract (another term for relevant parcel) might comprise some alternative carveout within the property lines. Instead, they look at the three unities and determined that the whole physically contiguous property owned by the defendant defined the relevant parcel.

The possibility of an alternative relevant parcel to the default contiguous ownership typically arises where the landowner asserts that only a smaller economic unit would adequately recognize the highest and best use of the property taken. This is almost always the context of such an argument, which is appropriate because the relevant highest and best use is the highest and best use of the property being taken. Sometimes, however, the government’s appraiser will attempt to carve out a relevant parcel that prioritizes the highest and best use of a different portion of the property, separately considered, that would render the part taken less valuable than it would be as part of the whole. This is a constitutional error.

Both the relevant parcel and the highest and best use determinations must center on the property to be acquired. It is improper, therefore, to consider whether a portion of the whole property would sell for more if it did not include the property to be acquired. Governmental appraisers can make this mistake when analyzing property containing lowlands or areas within the floodplain or floodway. Frequently, the lowland areas are targeted for acquisition in drainage projects, and it is easy to say these portions of the overall tract are less valuable than the upland portion of the property, even though the uplands are not separated from the part taken by any of the three unities—physical contiguity, unity of ownership, or unity of use.

This approach will lead the appraiser to conclude that in contrast to the upland portion of the property, which may be viewed as developable land, the highest and best use of the lowland portion is passive recreational or some other low-intensive use. The logic behind this conclusions is that the upland and floodplain portions cannot be reasonably integrated and so the lowland portion must be its own relevant parcel.  But this was a foregone conclusion—a conclusion that forecloses essentially all economic use of the property taken, let alone its highest and best use.

This foundational error leads to the selection of a relevant parcel that violates constitutional guarantees in several apparent ways. First, the appraiser has selected a parcel that no willing seller would part with. No willing seller would carve out the most flood-prone portion of his property for separate sale, let alone do so in a way that deprives the floodplain land of any reasonable access or utilities. A reasonably knowledgeable seller would keep the entire property together if the whole would sell for more than the sum of the parts.

It is self-evident that the relevant highest and best use and relevant parcel determinations are the highest and best use of the property being taken and the relevant parcel that supports that use. The appraiser must not lose sight of this underlying premise in determining highest and best use and relevant parcel.

The recognition that the present value of property may reflect its development potential is nothing more than an acknowledgement of the realities of the marketplace. Those realities suggest that we acknowledge an economic fact: that contiguous property held in common ownership but devoted to separate uses may nonetheless be valued by the market for an integrated use. The appraiser should never ask what the highest and best use of the portion of the property not being acquired is, considered separately. The only relevant question is the highest and best use of the part taken, together with however much of the property not being acquired is necessary to achieve that highest use.

Failing to recognize when the part taken must be valued as a separate economic unit (or part of a separate economic unit) to achieve its highest value will result in an improper averaging of its market value with less valuable land. Less obviously, failing to recognize when the part taken must be valued as part of the overall property to achieve its highest value improperly deprives the property owner of the market value of the part taken as a proportionate part of the whole. To avoid this mistake, the appraiser’s highest and best use determination must always center on the part taken.

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