In a previous post background, options, and general pricing of mitigation areas for watershed services was examined for forest landowners. However, the pricing issue is a tough one, with little basis and being dependent on site-specific variables and markets. Therefore, it deserves a closer look. Here are some potential pricing scenarios and valuations for landowners who may be entering watershed ecosystem markets.
As stated, the fair pricing of mitigation areas provide many challenges beyond that of other exchangeable goods. There are no standard prices or pricing mechanisms to aid in the determination of market value and therefore most reported values demonstrate a wide range and are often determined on a project basis. Three methods are generally used in pricing mitigation areas and are the same as the standard methods for real property appraisal. These methods are cost-less-depreciation, comparable sales, and income capitalization. While each method has particular applications in which it is given preference to best reflect an accurate price, often it is a combination of methods that are used to provide a more complete estimate. It should be stated that any value provided is a good faith effort on the part of the appraiser and based on the best and most accurate data available; however, it is truly an estimate and may or may not be accepted as a market price.
Below, a series of hypothetical price estimates are provided, using the standard valuation methods, for mitigation areas in the southern Appalachians. A range of values is determined and then reconciled to provide a best estimate of market price. Though this price is only an estimate, it may help provide some level basis to allow a more open discussion to begin between landowners and permittees.
The cost-less-depreciation method for determining value is carried out by identifying and quantifying all costs associated with improvements or assets that are being appraised. This method is not the most applicable when valuing forest or natural capital assets since they generally have no depreciation. Yet determining the cost components of known market prices can allow an approximation to be made for each of those components – similar to incremental costs analysis. In this exercise, the land acquisition cost is the variable of interest. Determined price estimates using this method were described in a previous post, and ranged from $20-30 per linear foot, equating to $4356-7623 per acre. These values essentially represent the land acquisition costs deducted from regional ILF programs as they were used for the cost basis. These approximations match the stated range of administrative and land acquisition costs (3-10 percent) as part of the total mitigation costs as determined in 2007 by the Environmental Law Institute and in 2004 by Bonham and Stephenson. Additionally, one resource notes that The Nature Conservancy (TNC), as the steward of the Virginia In-Lieu Fee (ILF) program, receives a three percent administration fee on ILF payments. At the current ILF price of $400 per linear foot, this fee equates to $2613.60 per acre. While it is thought that administrative costs under the current proposal would not be at the level of the ILF program, this number does provide another reference as to the portion of fees required for administration. The values of $4356-7623 per acre therefore provide a good estimate, compared with additional sources, as covering administration and land acquisition costs.
The comparable sales (or Transactions evidence) method is the preferred method for determining prices and market values for exchangeable goods. Under this method, known prices for transactions of like assets that have occurred are compared and adjusted to provide an estimated value for the targeted asset. This method has limited application in the case of mitigation areas however, in that no comparable sales data are available. While transactions are taking place, there is no requirement to report prices, and furthermore no organization is tasked with tracking these prices. One of the best current assets for total market tracking is currently SpeciesBanking.com; however no per unit prices are given. This is likely due to factors that make pricing of mitigation areas especially challenging such as site-specificities and temporal and regional demand.
One comparable listing with The Bay Bank, a reputable marketplace organization, similar in scope as a mitigation area, was noted in Maryland for $4000/ac. Other listings for habitat and forest conservation in Maryland were shown to be within the $2600-2800.
Though these values provide some order of reference, none are within the southern Appalachians, and therefore pricing may be subject to or influenced by other states’ laws and regulations. It is also important to note that these are asking prices and not sale prices. While generally at least three comparable sales are preferred and within as close as possible proximity and recent occurrence, these few listings are all that was observed through a search of public records.
The income capitalization approach is a common method for estimating values of timberlands or other natural capital assets. Under this method a discounted potential cash flow criteria is used to estimate the value of each component, land and timber in this example, for future income to the present using compound interest to account for the time value of projected costs and revenue. In this case, the income capitalization method is used to make a comparison of future values with and without restrictions in present, or real, dollars. Generally, this method is used in determining potential timberland values, by estimating the value of bare land for use in timber production calculated into perpetuity, but here the values were determined and discounted for the term of a proposed example agreement of 30 years.
In order to find an applicable price with the income capitalization method for this example, future values of the land and timber, with and without any restrictive covenants, were discounted to the present using a five percent discount rate. The future value of the land and timber with restrictions was then subtracted from the future value of the land and timber without restrictions. Future conditions and values were projected to reflect a timber growth rate of four percent and an increase of timber prices of 1.5 percent. (Current conditions and prices are approximated to be $300/ac for land, approximately 3000 bf/ac, and timber prices of $165/MBF of all product combined. These prices however are likely too low given improving markets and recent timberland transactions.) For this example, additional assumptions of a 30 percent reduction in land value and a 70 percent reduction in harvestable timber was made with the restrictive covenants to represent the diminished rights of the landowner under a compensatory mitigation agreement. All values used for land and timber were estimated and should only be considered approximations.
The total value of the restrictions, and therefore the price of the mitigation areas, is estimated to be approximately $834.32 per acre using the income capitalization approach. This price should be considered the minimum payment required in order for the landowner to not lose real value as a result of any restrictive covenants.
Liquidation Value as Opportunity Costs
One final value, the liquidation value, should also be examined in providing price estimates for mitigation areas. This is used as a proxy for the opportunity costs of maintaining or liquidating all assets (land and timber) and using those revenues for alternative investments. In this example, the current liquidation value of the land is estimated to be $795 per acre (current price of land and timber). If this amount were placed in an alternative investment with a three percent interest rate for the 30-year period of the considered agreements, its value would be $1929.67.
A comparison of the various valuation methods shows a range in values from $834.32 to $7623.00 per acre. The least of these values, as obtained through the income capitalization method, should be considered the lowest acceptable price preventing the loss of real assets value resulting from allowed mitigation actions. The upper values of this range are based on estimates made in the cost basis method with “optimistic” or the highest likely prices to be paid. In order to calculate a market price based on the various methods and accounting for the estimated values, a weighted average was determined giving higher weight to preferred valuation methods. This weighted average price was concluded to be $3136.24.
In order to reconcile the prices across such a large range preference was given to the income capitalization and liquidation prices. These numbers represent the low end of what the landowner should be willing to accept, therefore should have a larger influence on any values used in decision-making. Next, preference was given to the comparable sales prices. This is the preferred method when comparable transactions are known and taking place. Lastly, preference was given to the costs basis, as these numbers are speculative and highly variable depending on several factors including sites, conditions, and operating costs and therefore considered to not be as a reliable indicator of value.
In consideration of the determined values and comparable prices of other projects, it is concluded that a fair market price for mitigation areas should be in the range of approximately $1000-7000 with a weighted average and proposed value of $3136.24. While this price may not actualize in the market, based on current conditions, it provides an example of what may be considered a fair-market price.