What Does Fair Market Value Mean in Determining Just Compensation?

This Article is written by Owners’ Counsel of America for general informational purposes only.  It is intended to assist landowners by providing them with some basic information about the concept of  “Fair Market Value” as it pertains to the determination of just compensation in an eminent domain case. This Article is not to be viewed as providing legal advice or to be considered as a substitute for consulting with an experienced eminent domain, takings or property rights lawyer on the matters covered herein. The definition of all hyper-linked terms can be found in the Dictionary of Key Terms on the OCA Website. 

Just Compensation

The Fifth Amendment of the United States Constitution provides that private property may not be taken for public use without payment of just compensation to the private owner of the property. A property owner should be fairly and fully indemnified for the loss of the property. As such, an owner has the right to recover the equivalent in financial compensation of the property condemned.

Through the payment of just compensation, a landowner is entitled to be restored to the financial position he or she would have been in had the property not been taken. Generally, the measure of compensation for property taken by eminent domain is its fair market value. Fair market value is a practical standard to aid the parties and courts in determining what constitutes just compensation. Fundamentally, this involves obtaining one or more appraisals of the property being condemned.

Fair Market Value

Almost every state ties the just compensation to be paid for the taking of property by eminent domain to its “fair” or “reasonable” market value. While there is no uniform definition of what this term means that applies to each and every state, a general definition can be properly characterized as follows:

The price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of the relevant facts.

This Article will examine the meaning of each of these key factors, i.e. purchase price, willingness of the parties to engage in the transaction, and knowledge of all relevant facts.

Purchase Price

Although property that is the subject of a condemnation action is not being purchased, but rather being taken from the owner without the owner’s consent, for eminent domain purposes the property is treated as though it were the subject of an ordinary purchase for the purpose of ascertaining market value. Thus, the market value formula is applied to determine what price the property would garner if placed on the open market and then transferred from seller to buyer.

Typically, market value is determined by the purchase prices of properties similar to the subject property that have recently been bought and sold on the open market around the same time period that the subject property is being evaluated. These are generally consummated transactions, meaning that the purchase price and all terms of the purchase have been agreed to between the respective buyer and seller, and the transaction has actually closed so that title has been transferred.

Because the definition of market value generally embraces an actual  “transfer” or “changing of hands” of the property’s ownership from buyer to seller, most states require that any sales relied on to determine market value must be completed transactions. This often means that offers to purchase, listing prices and other non-consummated real estate transactions cannot be considered for purposes of determining market value, although there may be exceptions to this general rule in unique circumstances.

Willingness

Despite the fact that oftentimes the property owner in an eminent domain proceeding is not conveying the property on a consensual or voluntary basis, the definition of market value contemplates that both the seller and buyer are “willing” participants to the transaction. Thus, actual real estate transactions and sales to which the subject property is being compared that are either deemed forced in nature, made under duress or coercion, or in some other manner not voluntary or not representative of market value are generally improper to be considered. Further, in many jurisdictions, sales made to a condemning authority are considered forced sales based on the assumption that the sale occurred under the threat of condemnation. In such an event, the sale is likely to be deemed inadmissible.

Knowledge of Relevant Facts

The market value formula is intended to duplicate what the purchase price of the subject property would be if it too were sold on the open market. Thus, the definition of market value embraces the concept of informed parties, meaning that both the seller and the buyer are presumed to be fully knowledgeable of all the relevant facts and information that they would typically be aware of in a true real estate transaction. This means that all details about both the subject property and the property or properties to which it is being compared— such as zoning, location, physical features, improvements, environmental condition, market interest rates, etc.—are proper to be considered and evaluated in arriving at market value.

It’s worth noting that typically market value does not include consideration of personal factors that may be associated with the loss of property, such as stress, pain and suffering, loss time or inconvenience, relocation expenses, sentimental attachment or emotional distress.

Severance or Residual Damages

Market value generally references how the value of the property being taken will be evaluated for purposes of determining just compensation. However, in many jurisdictions an additional compensation element comes  into play when only part of an owner’s property is taken, leaving remaining property which is sometimes called the remainder or residue. In such instances an owner may also be entitled to receive damages to the remainder that are caused by the project being constructed on the property being taken. The topic of damages is addressed in a separate OCA Featured Article.

Cost and Income Approaches

Finally, sometimes the market value of an owner’s property cannot be captured simply by comparing it to other properties that have recently been bought and sold on the open market. In such instances other valuation approaches may be applied. For instance, if the property is generating income, the income approach may be the best method for determining the property’s market value. This method determines present value based on projected future income. Alternatively, if the property is improved with buildings and other structures, the cost approach may be more suitable for determining value.

In some instances all three approaches may be deemed suitable for determining a property’s market value. The important thing to understand is that every situation and property is different and therefore must be evaluated to determine the best method or methods for ascertainging market value.