Quarry Land Value Methodology

by Kenneth J. Jones

Tags

Appraisals, Land, Land Value, Market Value, Methodology, Quarry

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(Originally Published in 2017 by Kenneth J. Jones)

Quarries, in their physical state, are made up of a variety of components. Generally speaking, they consist of land in which there is a commercially viable mineral deposit, machinery and equipment that's used to extract and process that deposit, and, in many cases, building structures used to shelter and repair the machinery and equipment, as well as housing on-site personnel.

quarry

From a valuation perspective, the value of a quarry as a business going-concern, is the combination of the undefined contributing values of the value of the mineral deposit (which includes the value of the real property rights), machinery and equipment, buildings, management, and good will.

However, there are certain situations that require the value of the real estate to be isolated from the business going-concern value. These situations commonly include eminent domain and condemnation valuations where the law states that only the real estate is legally compensable.

Other situations that require the value of the quarry's real estate to be isolated from its business going-concern value include real property tax assessing and real property tax assessment appeals, when financing requires the isolated value of the quarry's tangible assets, and other similar situations.

Consequently, when being approached to appraise a quarry, one of the most important issues to be determined before one can even provide a client with a proposal is to know the client's need for the appraisal.

For example, if the client's need is for condemnation or real property tax assessment litigation, the appraiser will (or should) know that they will be required to isolate and appraise only the value of the real property rights.

This article explains the most reliable valuation method for valuing the real property rights associated with a quarry.


Quarry land value methodology is one of the most contentious issues in quarry valuation.

Having been involved in several litigation matters centered around the issue of the value of the real property rights associated with a parcel of land used as a quarry, it seems that the basics of this issue tends to either become lost in a quagmire of unnecessary complication. or is grossly over-simplified. And both of these situations provide significantly unreliable valuation conclusions.

quarry

From my experience, it has become painfully obvious that the source of these unnecessary complications and over-simplifications along with the errors these strategies inevitably cause, stem from the lack of understanding the basic fact that quarry land itself, which contains the commercially viable mineral deposit is the sole source of its value.

To compound this failure of understanding that the land is the sole source of its value is the additional issue of attributing separate and additional values to temporary site and building improvements that only exist in support of the mining operation and will either be razed or abandoned at the end of the quarry's commercial life.

Before I get too deep in the woods on this topic, let's start by acknowledging the classical and universally accepted definition of the term "real estate" which is "the tangible aspect of land."

While this definition varies slightly, depending upon its source, this is the definition we'll use here.

It's also of critical importance to distinguish between the tangible aspect of "real estate" (being the land) and the term, "real property" which is the term used to refer to the intangible man-made rights associated with various interests in the ownership of real estate.

Let's also clearly understand, that when appraising real estate, the purpose of such an appraisal is NOT to appraise the tangible real estate itself, but to appraise the defined value of the identified real property rights associated with the identified parcel of real estate. (See USPAP Standards Rule 1-2(e)(ii) 

Please note, that the remaining information in this article is based on the premise that the land being valued is a legally permitted quarry site in a commercially viable market.

Moving on to the actual valuation process of forming a professionally competent opinion of quarry land value, we have to first recognize the fact, that the land, itself, will be extracted from its Earthbound state and transformed into a product that will be sold.

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 based on its ability to produce net income.

quarry

Thus, according to the College of Fellows of the American Society of Appraisers (ASA), a property "which is bought for the primary, if not sole purpose of generating income for its owner" is known as an "Investment Property."

Continuing to quote from the ASA College of Fellows, "Investment Property can only be valued by the Investment Analysis method." This method is also known as, the Income Capitalization Approach.

Assuming the type of real estate in which this business operates is commonly leased or rented by local property owners, the value of that real estate is based on the net rental income that's generated by a tenant.

Even if the real estate is owned by the retail business, the value of the real estate in which it operate will be based on the rental income that a prospective tenant would reasonably be expected to pay.

Consequently, the value of that real estate would not be based on the retail sales income generated by that business.


Since we now know that the investment analysis appraisal methodology (sometimes called the Income Approach) is the most appropriate method for forming an opinion of quarry land value, our next step is to identify the income source that's most appropriate to use in our valuation methodology.

First and most important, is to recognize the fact, that there's a world of difference between income that's generated for the owner of the real estate, which is rental income, and income that's generated for the owner of the quarry mining business which is generated from retail sales.

Regardless of whether they are the same entity that owns both the real estate and the business operation, the fact remains, that the income and expense structure to a business is completely different from rent generated for the owner of the real estate; the reasoning for this distinction is rather simple.

In order to better understand this difference, let's consider the example of a retail business that occupies retail store within which that business operates.

When the type of real estate in which this business operates is commonly leased or rented by local property owners, such as a retail store in a downtown retail area, the value of that retail real estate is based on the net rental income that's generated by a tenant.

Even if the real estate is owned by the retail business, the value of the real estate in which it operate will be based on the rental income that a prospective tenant would reasonably be expected to pay.

Consequently, the value of that real estate would not be based on the retail sales income generated by that business.

Moving on and understanding that the appropriate income source to use to develop our quarry land value is rental income, we can now go to the market and obtain rental income information that would be appropriate to use in developing our quarry's land value.

From there, and based on the estimated remaining amount of reserves in our real estate parcel, we can:

  • Select a period of years over which our market research indicates a business operator/tenant might reasonably anticipate generating sales.
  • Forecast an estimated annual sales volume from which the royalty (rent) will be derived.
  • Select an appropriate risk/discount rate, and
  • Apply that risk/discount rate to each annual estimated net cash-flow..

As an aside, the rental income in quarry land valuation is called a "royalty." This label is derived from the tradition of the business operator paying the land owner a fixed dollar amount per unit of material extracted and sold (e.g. $1.00 per ton).

 In some markets, the amount of the royalty is based on a percentage of the retail value of the material sold, although this is a less common practice than the payment of a fixed dollar amount per unit/

Finally, and because the method of valuing an investment property requires accounting for the "return on" the invested capital (such as an annual interest rate), AND the "return of" the invested capital at the end of the investment holding period, the final step in forming a professionally competent opinion of quarry land value is to form an opinion of the value of real estate at the end of the selected holding period.

Please note, that the estimated value of the real estate at the end of the investment's holding period is called, the "reversion value," or simply, "the reversion."

 For example, if we anticipate our productive holding period to be 20 years, the reversion value is the estimated value of the real estate at the end of those 20 years that will be realized in year 21.

When the reversion value is established, we then select and apply an appropriate risk discount rate to transform or "discount" that estimated future value to its present value.

Finally, the net present value of each annual cash-flow, plus the net present value of the reversion value are added together; the sum is the value of the real property rights associated with quarry's parcel of land.


Why Not Use Comparable Sales to Estimate Quarry Land Value?

The value of income producing real estate is equal to the capitalized amount of net income generated for its owner and is the basis of sale prices of investment/income-producing real estate.

The sales comparison valuation method merely contrasts and compares the physical attributes of one property to another and is most appropriate method for appraising real estate that is not typically bought for the purpose of generating income for its owner. Rather, the sales comparison valuation method is used to appraise real estate typically intended for the sole utility of its owner, such as a single-family residential dwelling used as the primary residence of its owner.

Consequently, the sale price stated on a deed from the sale of an income producing property, like a parcel of quarry land, reflects the investment parameters applied to the specific net cash- flow from that property as analyzed by the specific buyer of that particular income producing property.

However, without having complete knowledge of the income(s). the terms of the income sources, and the expenses from that property, as well as all other factors that may have influenced the development of the net income, such as the holding period, and the risk/discount rate arrived at by that specific buyer, and all of the other investment criteria that was considered by that buyer, there's absolutely no way to understand how to make a reasonable comparison of that sale to have it provide a reasonable indication of the value of the property being appraised.

In the end, because the value of income producing property, including quarry land value, is based upon the investment analysis from that specific property and is not based upon a comparison of its physical attributes, the application of the sales comparison approach cannot possibly provide a professionally competent indication of quarry land value.

 Therefore, the proper development of the royalty income valuation method is the most reliable method for forming a credible professional opinion of the value of the real property rights associated with a parcel of land used as a quarry.

I hope you've enjoyed this article and learned something you didn't know before.

I look forward to your thoughts and comments.

If you have any questions, or if you'd just like to discuss this topic, please don't hesitate to contact me.

I don't believe there's any such thing as a "stupid" question. So, ask away, and I'll do my best to answer you as quickly as possible.

Kenneth J. Jones, ASA, SCGREA
President, Broker of Record


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