Money and Dirt: A blog on legal issues impacting California real estate investment, development, and secured lending

Valuation Of “Different” Property In Condemnation — Does a Developed Market Exist?

When real property interests are acquired by the power of eminent domain, the owner is entitled to receive “just compensation” in the form of fair market value for the property taken.

Often, fair market value is established by looking at comparable sales — recent free market sales of similar properties.  But when there is no developed market for the type of property at issue, value can be established “by any method of valuation that is just and equitable.”

A recent California Court of Appeal opinion — Central Valley Gas Storage LLC v. Southam — applies these valuation principles to property used for underground natural gas storage.

Facts: Condemnation of property for underground natural gas storage

Central Valley Gas Storage LLC (“Central Valley”) operated an underground natural gas storage project at a depleted gas field in Colusa County.  Central Valley injects natural gas into the underground reservoir where it is stored until later withdrawn for use.

The gas storage project encompassed 677 acres overall, 80 of which were owned by Fred Southam and his entity Southam & Son.  Central Valley negotiated leases for underground storage with almost all of the landowners who held property within the project zone.  But Southam refused to enter into a lease.

Central Valley invoked the power of eminent domain under Public Utilities Code section 625 to condemn the underground gas storage rights on Southam’s property.

Trial court proceedings

Southam did not contest Central Valley’s rights to invoke the power of eminent domain.  But Southam contended its property was far more valuable than what Central Valley offered due to the property’s vast underground storage volume.

Central Valley filed a motion to exclude evidence of any valuation method that depended on underground storage volume.  In support of the motion, Central Valley’s expert witness stated that a market for natural gas storage leases had developed in California over the past 20 years, and that such leases uniformly compensated owners based on the amount of surface acreage at issue, not underground volume.  Underground volume, the expert opined, was too uncertain and speculative to be used as a valuation metric.

The trial court granted Central Valley’s motion in part, and after Southam failed to produce any evidence of actual comparable leases based on underground volume, the trial court granted a further motion in limine excluding volume valuation testimony at trial.

With the evidence thus narrowed, the jury rendered a verdict that matched Central Valley’s evidence of value based on surface area.

Southam appealed, arguing the trial court should have allowed his volume-based valuation testimony.

Court of Appeal’s Opinion

The Court of Appeal affirmed the trial court’s judgment and rulings.

The court held that when a developed market exists for the type of property at issue, it would be error to admit evidence of a valuation methodology that ignores the developed market.

Here, Central Valley’s undisputed evidence showed that a developed market for natural gas storage leases had developed in California over the past two decades, that all leases in that market were based on the number of surface acres the landowners held within the gas storage and buffer zone boundaries, and that volume-based valuation would be too speculative to be useful.

Based on this developed market using surface area based lease valuations, the trial court correctly excluded Southam’s alternative valuation evidence based on storage volume.

Lesson

Even if property is “different,” that does not necessarily open the door to any type of creative valuation methodologies that an appraiser can conjure.  If there is a developed market for the property at issue, valuation methods may be constrained by the market’s practices.

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