Quarry land value methodology is one of the most contentious issues in quarry valuation.
Having been involved in several litigation matters that centered around the issue of quarry land value, it seems that the simplicity of this issue tends to become lost in a quagmire of unnecessary complication by otherwise rationally thinking people.
From my experience, it appears to me that the source of these unnecessary complications and the errors that inevitably results, stem from either the failure to understand or the refusal to recognize the basic fact that quarry land, in and of itself, is the source of its own value.
Let me explain.
Before I get too deep into the woods on this topic, let's start with understanding that the classical and universally accepted definition of the term "real estate" is the tangible aspect of land. While the specific definition varies slightly depending on its source, this is the definition we'll use here.
It's important to distinguish between the tangible aspect of "real estate" which is the land, and the term, "real property," which refers to the intangible rights associated with the various interests to the use and ownership of the tangible real estate.
Let's also clearly understand that the purpose of an appraisal is NOT an appraisal of the tangible real estate, but an appraisal of the specifically identified real property rights associated with the identified parcel of real estate as referenced in USPAP Standards-Rule 1-2(e)(ii).
TAKE NOTE The remaining information in this article is based on the premise that the land being valued is a properly permitted quarry site in a viable market for commercial construction materials. It's also based on the premise that the land may or may not be owned by the same person who owns and operates the quarry business operating on that land. The final premise of this theoretical valuation is that its purpose is to form an opinion of the fair market value of the fee simple real property rights associated with the quarry land.
Moving on to the actual valuation process of forming a professionally competent opinion of quarry land value, we first have to recognize the fact that the land itself will be extracted from its earthbound state. Once extracted it becomes a product that will be sold for commercial use.
Based on this fact, as well as what we know from experience, people who own quarry land form their opinion of the value of that land according to its ability to produce net income. Thus, quarry landowners consider land used for quarry mining to be an investment property.
Consequently, according to the American Society of Appraisers' College of Fellows, property "which is bought for the primary, if not sole purpose of generating income for its owner" is known as an "Investment Property."
The College of Fellows goes on to say, "Investment Property can only be valued by the Investment Analysis method." In some circles, the Investment Analysis method is known as the "Income Capitalization Approach."
Now that we know the Investment Analysis method is the appropriate appraisal methodology to form a credible opinion of the value of quarry land, we now have to identify the source of the income from which our value will derived.
The single most important fact that must be understood is that there is a difference between the income that's generated for the owner of the real estate, which is from rent, and the income that's generated for the owner of the quarry mining business, which is from product sales.
When appraising quarry land, it's critically important that the difference between land rental income and business income from sales be identified and segregated even if the land owner and the business owner are the same person.
Now that we know rental income to the land is the appropriate income to be used in developing our quarry land value, we now have to obtain the appropriate rental income information for use in our valuation. The rental income (called "royalty") should be developed from analyzing and comparing actual quarry land leases to our quarry.
Relevant considerings for comparing and "adjusting" these royalty rates to our quarry include; the length of the contract, the type of material being extracted, the amount of material remaining in the land at the time of the lease, the difficulty of the extraction, and the market into which the material is being sold. Other considerations may be made depending on the information and its source.
Now that we have our royalty rate (e.g. $1.00/ton of material sold), and assuming that we already know the estimated amount/volume of reserves remaining in our parcel of land, we can:
IMPORTANT NOTE: Virtually all land lease contracts for quarry land are "absolute net" lease contracts. This means the tenant is responsible for the payment of all costs and expenses to the land (e.g. real property taxes, mining permits, environmental permits, maintenance, insurance, etc.). Therefore, the rental income to the land owner has no required expenses for the land owner.
Because the appraisal of investment property requires the appraiser to account for both the "return on" the invested capital (as an annual interest rate) as well as the "return of" the invested capital (getting back the amount of the initial investment) at the end of the investment period (usually upon the sale of the investment), the final step in forming a credible opinion of quarry land (as well as any other type of real estate investment property) is to form an opinion of the value of the real estate at the end of the selected holding period.
PLEASE NOTE: The estimated value of the real estate at the end of the investment holding period is called the "reversion value" or simply, "the reversion." It's called the reversion because it's at this point when the rights of use and occupancy that the land owner has temporarily transferred to the tenant via the lease now revert back to the owner at the end of the lease.
After formulating our opinion of the reversion value, we will select and apply an appropriate risk rate at which to discount, or transform that future value estimate to it's present value.
Finally, to find the overall value of our quarry land, the final step in this entire procedure will be to add together the net present value of each year's net cash flow and add to that the net present value of the reversion value. The sum of all of these items is the estimated value of the fee simple real property rights of our quarry land. Or, in layman's terms, it's the value of the "real estate."
Why Not Use Comparable Sales?
First, the sales comparison valuation method only contrasts and compares the physical attributes of one parcel of real estate to another; it does not consider income. Additionally, the sales prices of income producing real estate reflect nothing other than the capitalized amount of the net income without separately considering the physical attributes of the real estate (which are actually accounted for and reflected in the income generated by a property).
Consequently, unless you know the exact itemized expenses for a sold income property and can properly analyze those expenses to make a reasonable comparison with your subject property (which is virtually impossible), the sales comparison method cannot possibly provide a credible opinion of the value of an income producing property, including quarry land.
In the end, because the value of income producing property, including quarry land, is based on the net cash flow from that specific property and not on any physical comparison, the application of the sales comparison approach cannot possibly provide a professionally competent indication of the value of quarry land.
I hope you've enjoyed this article and learned something you didn't know or didn't understand.
I look forward to any thoughts or comments you may have. Please contact me if you wish to discuss this or any other valuation issue.