1. Valuation of
contaminated
properties:
a
Canadian
perspective
Overview to become a concern for appraisers in Canada as outlined in the
Issues related to the contamination of real estate in Canada con- Toxic Mold Alert1 prepared by Marsh Canada Ltd., which states
tinue to evolve and society is becoming more aware of these envi- that “toxic mold losses grow into a billion dollar problem.”
ronmental challenges. The political and regulatory framework as it It is apparent that contamination can affect the market value
pertains to the environment are constantly evolving, as evidenced by of property due to potential environmental liability, which may
the adoption of the Kyoto Protocol and ongoing changes to federal be incurred by past, present and future owners. This, in turn, will
and provincial environmental legislation. Contamination can be a have an obvious impact on obtaining financing and, ultimately, the
result of manmade or naturally occurring elements within the envi- marketability of the property.
ronment or a combination of both. Radon and mold are examples As such, contamination of real estate raises an interesting
of naturally occurring contaminants, whereas manmade sources challenge for the real estate appraiser. The purpose of this article
may include lead, PCBs, asbestos, UFFI, electromagnetic radiation is threefold. First, it is to provide the appraiser with some insight
(EMF), hydrocarbons from leaking underground storage tanks, waste on real estate contamination and ideas on how to deal with these
sites (landfills), noise and odours. challenges from a valuation perspective. Second, it is to intro-
Contamination could affect the duce terminology adopted by our American counterparts for the
quality of soils, groundwater, sur- valuation of contaminated real estate and
face water, air, building materials recommend that real
and any combination thereof. It is
worth noting that mold is starting
B Y G O R D O N E . M A C N A I R , A A C I , P. A P P , S R / W A
2. estate appraisers in Canada adopt this but remediation is not required for the cur- the present utilization can be significant
terminology. Third, to provide information rent use since there are no off-site issues for the owner, especially for an operating
on additional valuation techniques that (regulations permit the existing use since facility that is in legal compliance. While
can be used for appraising contaminated the contamination is contained on site). primarily an issue relating to industrial
property. The estimated impaired value 3 based on properties, value in use considerations can
the current use is $1,000,000. However, come into effect for many different kinds of
Appraisal principles based on the highest and best use analy- property.
Before moving on to some of the valuation sis, the site could be rezoned to residen- This difference is explained in the Con-
issues involving contaminated real estate, tial and realize an estimated unimpaired taminated Property Valuation Guideline7
it is important that we review some of the value4 of $1,600,000. However, since the prepared by the Arizona Department of
basic concepts of real estate. The rights remediation costs for residential use are Revenue which states: “Value in Exchange
of ownership are often referred to as the $750,000, the value would be reduced to is the price that would tend to occur as
Bundle of Rights Theory 2 and contamina- $850,000 (assuming there is no envi- a result of the interaction of the market
tion can affect the right to use, lease and ronmental stigma). Based on this simple forces of supply and demand. Value in Use
sell, which is an inherent part of this theory. analysis, the highest and best use of the takes valuation to an added step by saying
The highest and best use of a property subject site is limited to the continuation that, if a property fulfills a utility, it has
can also be affected by contamination, of the existing industrial use. value despite the traditional theory of the
since it could have a potential impact on Another important principle to con- market being the indicator of value. Value
the land use. The purpose of the highest sider with contaminated properties is the in Use suggests that a property which is
and best use analysis is to provide a basis Principle of Substitution5. The underly- still in use, or which can be used in the
for evaluating real property, which takes ing premise with this principle is that the near future, has a value to the owner.
into account factors such as physically purchaser has choices as recognized in In the case of contaminated properties,
possible, legally permissible, financially the Tridan6 case. The trial judge, Justice the concept of Value in Use is important
feasible and maximally productive. Since Binks, is quoted as follows: “Given two because it challenges the claim that a
contamination could have an affect on uncontaminated properties, one of which property has no value if the cost of reme-
potential uses now or in the future, the had previously experienced a spill and had diation exceeds its market value. If the
value of the real estate could suffer as a been cleaned, an informed and willing cost of remediation exceeds the replace-
consequence. The following example will buyer would prefer the property that had ment cost (unimpaired value), the Value in
demonstrate this point: never been contaminated. This certainly Use concept can be applied. Value in Use
A one-hectare site is improved with an would devalue the fair market price of the states that value lies in utility.”
older industrial building and the site is con- once contaminated property relative to This concept was demonstrated in the
taminated with hydrocarbons as a result of one that had never experienced a spill.” Montague 8 decision. The case involved
a leaking underground storage tank. The Other appraisal considerations are a division of assets between spouses.
cost to remediate the site is $750,000, Value in Exchange vs. Value in Use, as One of the assets was an operating gas
they are two distinct terms. For many station with an estimated market value
contaminated properties, it is of $175,000 and the remediation costs
critical for the appraiser for removing the contaminated soil and
to distinguish between groundwater were estimated to exceed
these two terms. $200,000. The trial judge held that, since
While there the land was polluted and the cost of
may be little cleanup exceeded the value of the land,
demand in the land was worth nothing, even though
the mar- the husband continued to operate the
ketplace for business from this location. Therefore, the
a contami- Value in Exchange in this case was ruled
nated site, if to be zero with respect to the distribu-
contamination tion of the matrimonial assets. However,
is not severe, it the husband ends up with a Value in Use,
is quite possible since there is still utility and he is able to
that the present use continue operating the business from this
can continue safely and property, which would obviously have a
legally. The contribution for value to that particular user.
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5. market’s perception of increased envi- post-remediation, the stigma lessens even decision, the Courts have ruled that an
ronmental risk due to contamination. The more since there is little to no uncer- innocent neighbour whose property is
theory for stigma is that remediation costs tainty. These three stages have also been contaminated is entitled to the entire cost
do not fully account for the loss in value to referred to as before, during and after of remediating its property to a pristine
the property owner. remediation16. condition, noting it was not enough to
For valuation purposes, the matter It is important to note that not every clean the site to MOE guidelines. Prior
of environmental stigma is addressed in contaminated site will result in environ- to the Tridan decision, it was common
CUSPAP under Environmental Impacts, mental stigma and any adjustment for this to rely on guidance from the Guideline
which states, “The value of an interest in feature must come from the marketplace. and remediation would typically occur to
impacted or contaminated real estate may For instance, the City of Ottawa has been generic contaminant levels. Clearly, the
not be measurable simply by deducting the dealing with a contaminated site (a closed Tridan18 decision has made the standard
remediation or compliance cost estimate municipal landfill) for the past three years, more onerous for remediating contami-
from the opinion of value as unaffected. where there is off-site contamination. nated sites.
Other factors may influence value, includ- Studies have been completed which have It should also be noted that the nature
ing any positive or negative impact on confirmed that there is no environmental and extent of contamination will vary
marketability (stigma) and the possibility of stigma in this instance to the impacted and is site specific. As well, remediation
change in highest and best use.” surrounding properties. There are a methods and costs will vary depending on
The Tridan15 case dealt with the matter number of reasons for this outcome. First each situation. As an example, the City
of environmental stigma. At the trial judge and foremost, the City has been front and of Ottawa is currently looking at reme-
level, the ruling stated that there was centre with this project and has kept the diating a site with hydrocarbons in the
stigma (17% to 18%) of the unimpaired public informed throughout this process. soil and groundwater. Our environmental
value. However, the decision also ruled As well, a human health risk assessment consultant has advised us that we have
that Tridan was responsible for clean- was completed which confirmed that there six available remediation options based on
ing up the site to pristine standards. The was no potential risk to the residents in the existing use. The options range in cost
Ontario Court of Appeal (OCA) dismissed the area. Finally, the City has undertaken from $240,000 for a one-time capital cost
stigma since it was of the opinion that remediation at the source of contamina- with ongoing monitoring costs estimated
there would be no stigma if the site were tion within the closed landfill to decrease at $60,000 per annum for basically a
to be cleaned up in a pristine fashion. The potential long-term migration of contami- containment option, to $6,500,000, which
Supreme Court of Canada declined to hear nation leaving the site. involves tunneling underneath the build-
the appeal of the OCA decision, which in ing. The recommended option will involve
essence agreed with the OCA decision. What is clean? a one-time capital cost of $525,000 for
The theory behind environmental It is important to understand that reme- an angled extraction system with annual
stigma is that, typically, stigma is consid- diation is rarely a synonym for absolute operating costs of $110,000 for approxi-
ered to be at its highest during the first cleanup. Remediation is the activity mately seven years.
stage of the remediation cycle, when the designed to reduce the level of con- There is also the challenge of chang-
contamination has been first discovered tamination to meet criteria set forth in ing standards. With improving technology
and uncertainty is at its greatest. With the Guideline for Use at Contaminated for remediating contaminated real estate,
the next stage, the remediation stage, the Sites in Ontario (Guideline) criteria. Typi- the expectations for remediation could
stigma starts to lessen because the prob- cally, cleanup implies that the site will be become more rigorous. The bottom line
lem becomes more understood. During the cleaned to pristine conditions. Pristine is that we do not really know when clean
last stage, conditions denote that there are no traces is clean or whether a remediation that is
of contamination whatsoever within acceptable today will be acceptable some
the site that exceed the back- time in the future.
ground criteria under the From a valuation perspective, it is
Guideline which permits important for the appraiser to understand
certain levels of contami- that the estimate of remediation and
nants. compliance cost estimation is beyond
The Tridan17 deci- the expertise of most appraisers and, as
sion has created some such, environmental consultants typically
interesting problems provide these estimates. This is captured
in this area. With this in CUSPAP, Lines 6360 to 6369.
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C A N A D I E N
6. CUSPAP considerations Failure to address known contamina- to, or proximate to the property. Conceptu-
for appraising an impaired tion in an appraisal could result in a mis- ally, this could be considered the ‘as-is’
property leading report (lines 6357 – 6358). value of a contaminated property. USPAP
Ethics Standards An example of an Extraordinary 2003, Advisory Opinion 9 (AO-9)
It is unethical for a member to act in a Assumption is the absence of contamina- 4
Unimpaired Value – The market value
manner that is misleading or fraudulent tion where such contamination is probable of a contaminated property developed
(lines 110 – 115). It is unethical for a (lines 6499 – 6502). under the hypothetical condition that the
member to develop, use or permit others property is not contaminated. USPAP
to use, for any purpose, any report which Conclusion 2003, Advisory Opinion 9 (AO-9)
the member knows, or ought to know, is Appraising contaminated real estate 5
Principle of Substitution, Basics
misleading (lines 426- 428). Competence creates interesting challenges for the of Real Estate Appraising, 3rd Edition,
provision (lines 644 – 654): The appraiser real estate appraiser. With this type of Appraisal Institute of Canada, pg. 88, “The
must have the competence to perform this appraisal, it is important for the appraiser principle of substitution states that when
type of assignment or disclose otherwise. to remember the basic appraisal principles several similar or commensurate com-
in determining how the bundle of rights modities, goods or services are available,
Appraisal Standard – Rules can be affected by contamination. the one with the lowest price attracts the
In the report, the appraiser must identify From a valuation perspective, the three greatest demand and widest distribution.”
all assumptions and limiting conditions approaches to value can be used in this 6
Tridan Developments Ltd. v. Shell
(line 1029) and any hypothetical condi- type of assignment, but there is a new Canada Products Ltd. (2000), 35 R.P.R.
tions (line 1031) generation of valuation options that should (3d), 141 (Ont. S.C.J.) revd 57 O.R. (3d)
be considered in this type of valuation. 503, 154 O.A.C. 1 (C.A.)
Appraisal Standard – Comments The valuation of contaminated real estate 7
Contaminated Property Valuation
Characteristics of the Property – consid- also creates its own terminology and it is Guideline, Arizona Department of Revenue,
eration of known environmental impacts/ recommended that Canadian appraisers revised September 1, 1998
hazardous substances must be analyzed adopt the terminology (to be modified to 8
Montague v. Montague (1996), 92
(line 1480). reflect Canadian content), as demon- O.A.C.202, 23 R.F.L. (4th) 62(C.A.)
Assumptions and Limiting Conditions, strated in this article, to create consis- 9
Rylands v. Fletcher (1868),
Extraordinary Assumption, Extraordinary tency to approaches and expression. L.R.3H.L.330, affg (1866), L.R.1
Limiting Condition and Hypothetical Condi-
10
Environmental Protection Act, R.S.O.,
tions (lines 1491 – 1544). End Notes c. E.19, Amended 2002
1
Toxic Mold Alert – Toxic Mold Losses 11
Ontario Water Resources Act,
Practice Notes Grow into Billion Dollar Problem, prepared R.S.O.1990,c.O.40, Amended 2002
Environmental impacts, recognition of by Marsh Canada Limited, November 10
Fisheries Act, R.S.C. 1985 c. R-14
contamination, remediation and compli- 2003 13
Valuing Contaminated Properties, An
ance cost estimation and Value Opinions
2
Bundle of Rights, Basics of Real Appraisal Institute Anthology, Richard J.
of Interests in Impacted Real Estate (lines Estate Appraising, Appraisal Institute of Roddewig, MAI, CRE, Editor, 2002
6335 – 6381). Canada, 3rd Edition, pg. 23, “The theory 14
Methods and Techniques for Con-
affirms that ownership of property involves taminated Property Valuation, Thomas
a bundle of legal privileges. Like a O. Jackson, PhD, MAI, Appraisal Journal,
bundle of sticks, each one repre- October 2003, pg 311
sents a distinct and separate 15
Tridan, ibid
right or interest that can 16
Jackson, T., Environmental Risk
be dealt with separately Perceptions of Commercial and Indus-
or together as the case trial Real Estate Lenders, Journal of Real
might be.” Estate Research, 2001, Vol. 22, No. 3,
3
Impaired Value pgs. 271-88.
– The market value 17
Tridan, ibid
of the property being 18
Tridan, ibid
appraised with full con-
sideration of the effects of Gordon MacNair, AACI, P. App is
its environmental condition Manager, Appraisals, Environmental
Remediation and Special Projects,
and the presence of environ-
City of Ottawa.
mental contamination on, adjacent
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