Eminent domain refers to the power of the government to take private property for public use. Under the Fifth Amendment, the government exercising this power must provide the property owner “just compensation,” which is generally the property’s fair market value (FMV). However, the valuation of the property may be influenced by the government’s plans for the acquisition, which can increase or decrease the FMV of the property. This is where the project influence rule comes into play.
“Project influence” refers to the positive and/or negative changes in the market value of property caused by a public project for which the property is being taken. The rule in such instance is that any impact on the value caused by project influence should not be considered when determining fair market value.
For example, if the government plans to build a sewage treatment plant in a residential neighborhood, this will likely have a negative impact on the value of homes surrounding the plant site. Conversely, if a new off-ramp is planned, the nearby land may increase in value.
The project influence rule is intended to protect both the property owner and the government from a market that has been influenced by the underlying project. In the examples above, the rule protects the condemned property owners by disregarding the effects of a sewage treatment plant as a factor in determining just compensation. For the land near the new off-ramp, the government is protected from having to potentially pay a premium attributable to its project. The goal of this rule is to determine a property’s value between a willing buyer and a willing seller as of the date immediately before a project begins to influence the value of the condemned property.
Although the rule may seem sensible on its face, it can create complications on the valuation process. In the sewage treatment plant example, an appraiser trying to determine just compensation for the owner of a home in the neighborhood generally would consider the recent sales prices of other homes in the area.
However, if plans for the plant had already been announced, the prices might be deflated based on the impending project. Likewise, the prices may be inflated if the project is seen as enhancing the area, such as the construction of the new off-ramp. In addition, if the government has already acquired several homes and razed them, the remaining homes may be less desirable.
Since the appraiser cannot consider the effects on the value of the property based on the project, the appraiser will need to determine just when the project influence rule was triggered (that is, when the impending project began to influence values). It is up to the appraiser to then make appropriate adjustments to the sales prices to reach FMV.
Note that the rule applies only to changes in value attributable to the project. The appraiser can and will consider changes due to other factors, including physical deterioration within the owner’s reasonable control.
For more information, contact Kenny Lau at 312.670.7444. Visit ORBA.com to learn more about our Real Estate Group.