It is largely conceded that the law of eminent domain has more than its share of absurdities, and of these, few are as absurd as the so-called ”undivided fee rule.” It requires that when property is taken and just compensation is determined, the appraisers are required to ignore the actual state of title and to pretend that the entire subject property is owned by one person, even when it isn’t. If it produces an income, they are told they must ignore it. Such a contradiction of reality is particularly absurd when the property being valued is a rented-out commercial property, because the preferred and soundest way of valuing it is to capitalize the cash flow produced by the rentals, because that is what people pay for when they buy income property in the free market, and therefore that is what determines its market value.
But even though courts say that “just compensation” is to be deemed fair market value, in eminent domain, as we just explained, you have to assume that irrespective of what the market does, the lease does not exist, and further that one person owns all property interests in the subject property. But if you assume that, what do you capitalize? Good question. The courts that follow this absurd rule say that the appraiser must posit reasonable rents, capitalize those and — voila! — thus come up with an opinion of value. Why reality (the actual lease) should be disregarded in favor of fiction no one has to the best of our knowledge explained.
Then, after value is determined in that fictitious fashion, the trial court apportiones the resulting lump sum among the owners of the various property rights in the property — landlords, tenants, easement holders, etc. If you say that quickly, it may make sense to slow-witted or morally insensitive folks, but if you think about it you have to face this question: if you assume that the actual lease does not exist and produces no cash stream to be capitalized, then what do you capitalize? The appraisers have to come up with something to capitalize. But by permitting appraisers to do that, you open the door to abuses — you then allow them to skew their opinions of value to suit their and their clients’ interests, by letting them capitalize fictitious rents, thus more or less assuming the answer to the question they are called upon to answer.
The problem is that if the appraiser capitalizes a lower-rent cash flow than what the subject property actually produces, the value will come out low, and there won’t be enough money in the court’s lump-sum award to cover the values due all owners of all property interests in the subject property.
As the Utah Supreme Court pointedly noted in a recent case, Utah D.O.T. v. FPA West Point, ___ P.3d ___, 2012 WL 5857334 (Utah), that puts the court in the ”place of the head of the household who must superintend the carving up and distribution of a chicken which is really not big enough to go around.” Quoting Orgel On Valuation Under Eminent Domain, at p. 482. Nicely put. California’s late, lamented Justice Otto M. Kaus, was less gentle when, in one of his opinions, he called such a result an “absurdity.”*
Which brings us back to the Utah Supreme Court and its FPA West Point decision. Here, the taking was of an access easement to a parcel owned by FPA (owner) and K-Mart (tenant), each of which wanted a separate valuation of its interest: FPA asked for a bench trial, and K-Mart wanted a jury trial. This forced the court to consider whether this could be done (each property interest would have to be valued separately, and these awards would then have to be added up (or aggregated) to produce the total award that the condemnor must pay. That is the ”aggregate of interest” approach, which is the opposite of the “undivided fee” rule, under which the whole shebang is tried as one ownership, with the resulting lump sum apportioned between FPA and K-Mart. The court chose the former approach, and in the process of doing so relied on a Utah statute (sec. 78B-6-511(1)), requiring that “the fact finder shall determine and assess the value of the property sought to be condemned . . . [and] each estate and interest therein.” Bottom line:
Under the aggregate of interests approach, “the condemnor pays each of the several owners the fair market value of his, her, or its property interest even [if] the total amount paid exceeds the fair market value of the property as if owned by a single owner. This approach ensures that all individual interests are accounted for and that each individual interest holder ‘is made whole by placing him in the position he would have occupied but for the taking.’ “
Or as Justice Holmes put it in rejecting the “undivided fee” rule on behalf of the Supreme Court (in this precise legal context, as it happens): “The Constitution deals with people, not with tracts of land.” Particularly so when what is in issue is the interpretation of a provision of the Bill of Rights which protects the people from the government, not the other way around.
Full disclosure: We dealt with his issue in our wet-behind-the-ears stage as a practicing lawyer, with very satisfactory results. See People v. Lynbar, Inc., 253 Cal.App.2d 870 (1967). For round two of that fight, see And Now, for a Word from the Sponsor: People v. Lynbar, Inc. Revisited, 5 Univ. San Francisco L. Rev. 39 (1970).
* Said the court: ”If real property worth $100,000 is subject to a lease at the economic rent, the lease — by definition — is neither a burden on the lessee, nor does it have any bonus value. The owner of the property would therefore receive the entire award, $ 100,000. If, however, the lease has a bonus value of $ 25,000 then . . . the condemner will only suffer a judgment of $ 75,000. This however, means that the court will be $ 25,000 short when, after the condemner is discharged, it attempts to award both the lessor and the lessee just compensation for their respective interests.” Kaus, J. in Clayton v. County of Los Angeles, 26 Cal.App.3d 390, 394, n. 6 (1972).