THE UNIT RULE: MISUNDERSTOOD AND RIGHTLY SO

By: Kinnon W. Williams & Jake J. Stillwell

Introduction

The unit rule, states that when land in which various stakeholders have separate interests is condemned by the government in an eminent domain proceeding, the amount of compensation to be paid must be determined as if the property was owned in fee simple absolute by a single owner and without reference to the other attached interests.[1] Once the total amount of just compensation is determined, it is apportioned among the holders of various interests in the condemned property. This rule can create confusion in eminent domain proceedings because private property is often burdened by easements, covenants, reversionary interests, site specific zoning, and other interests besides outright ownership. This basic rule also does take into account that the condemning authority generally does not take any more of the property rights it needs for its intended purpose. This means that only very discrete property rights may be taken or that property may be taken subject to certain encumbrances. 

This paper and the accompanying presentation will explore these issues and attempt to shed light on what role covenants play in valuations, when easements should be considered, what are the effect of reversionary interests in valuation, the impact of leases, and how should site specific zoning be dealt with.  Finally, the appraisers’ role will be discussed[2].   

The Basics

As with any discussion, a review of the basic rule is called for.

Eaton explains the unit rule as follows:

The rule has two aspects:

First, the unit rule requires valuing property as a whole rather than by the sum of the values of the various interests into which in [sic] may have been carved, such as lessor and lessee, life tenant and remainderman, etc.  This is an application of the principle that it is the property, not the various titles, which is being taken. (n. 113. The term “in rem” is used to designate proceedings or actions instituted against the thing, in contradistinction to personal actions, which are said to be in personam. Many cases are illustrative of this principle.) Under this rule, the award for the whole is later apportioned among the claimants (lessor and lessee, life tenant and remainderman, etc.) as a second phase in the proceedings. . .

If there are several interests or estates in the property, the property should be appraised as a whole, embracing the rights, estates and interests of all who may claim, and as if in one ownership.  This is in keeping with the fact that it is the property itself – the thing – rather than the various titles to it which is being acquired. (n. 115. However, the appraiser may be required by the agency to furnish separate valuations of the separate estates or interests for negotiation purposes.)

. . . The second aspect of the unit rule is that different elements of a tract of land are not to be separately valued and added together.  For example, the value of timber is not added to a value for the house and those, in turn, added to a value for the remainder of the property.  The property is to be valued as a whole and its constituent parts considered only in the light of how they enhance or diminish the value of the whole, with care being exercised to avoid so-called “cumulative” appraisals.  This is a valid procedure because it is the entire unit which is being hypothetically sold, not the separate parts individually. [Citations omitted.]

The Washington State Department of Transportation Appraisal Report Guide states: “Basic ground rules of appraising property for WSDOT require the evaluation of all rights of fee ownership because WSDOT assumes the responsibility of clearing all interests presuming the market value or (sic) the fee to be equal to the sum of all partial interests.”

Real Estate Valuation in Litigation, J.D. Eaton, MAI, SRA, Appraisal Institute

            The Yellow Book describes the Unit Rule as follows:

            4.2.2    The Unit Rule.  The market value concept in federal acquisitions generally requires application of the so-called unit rule, a principle developed by the federal courts that dictates what is to be valued for just compensation purposes.  Under the unit rule, the property being appraised must be valued as a unitary whole and held in single ownership.  The value of the whole cannot be derived by adding together the separate values of various interests or components.  As a result, summation or cumulative appraisals are improper under federal law.  The unit rule relates to ownership interests (estates) in real estate – such as landlord and tenant, or mortgagor and mortgagee – and to various physical components of real estate – such as timber, mineral deposits, farmland, and buildings. As discussed in Section 4.6, the unit rule can raise particularly challenging valuation issues in appraisals for partial acquisitions, especially if easements are involved.

            4.2.2.1 Ownership Interests (the Undivided Fee). A property with multiple ownership interests or estates – such as lessor and lessee, life tenant and the holder of the remainder, or mortgagor and mortgagee – must be valued as a whole, embracing all of the rights, estates and interests of all who may claim, and as if in one ownership.  For example, in an acquisition of property in fee simple absolute, the property must be appraised as an undivided fee.  Similarly, in acquisitions of less-than-fee interests, the interests being appraised must be valued as if under single ownership.  The market value of the whole is later apportioned among “the respective interest holders . . . either by contract or judicial intervention.”  This is because just compensation is for the property itself, not the various ownership interests; thus, “the appraised value of the property represents the whole fee.”  This aspect of the unit rule ensures the public is not charged twice in federal acquisitions.

            4.2.2.2 Physical Components.  Buildings and improvements, timber, crops, sand, gravel, minerals, oil, and so forth, in or upon the property are to be considered to the extent they contribute to the market value of the property as a whole.  “[I]t is firmly settled that one does not value the land as one factor and then value the improvements as another factor and then add the two values to determine market value.”  Rather, the measure of just compensation is the market value of the entire property – not the total of the money values of the separate items.  As a result, in developing an opinion of value for federal acquisitions, the appraiser must consider all the elements that “contribute to make the property valuable, all . . . that detract from it, and finally, weighing all those elements, determine [the market value of] the single piece of property . . .” acquired (emphasis added).

Uniform Appraisal Standards for Federal Land Acquisitions 2016

            Finally, the model Eminent Domain Code suggests the following rule:

“The amount of compensation for the taking of property in which divided interests exist is based upon the fair market value of the property considered as a whole, giving appropriate consideration to the effect upon market value of the terms and circumstances under which the separate interests are held.”

Nichols on Eminent Domain, Section 12.05[3]1012, pg. 12-96.

             A brief review of this basic rule illuminates that the rule assumes that all estates and interests in the property will be acquired.[3] A particular issue for the appraiser then becomes apparent: How often does an agency acquire an entire fee?   While this may be true for the majority of strip takes for road ways and certain public works projects, this is not universally true. It is also contrary to a modern trend of agencies taking no more interest in property than is necessary. This is due in part in an effort to save public resources, but also the desire to allow property owners to retain as many property rights as reasonable.  

What if the agency must take subject to a particular interest? Say for example the Army Corps of Engineers holds an extensive easement over the parcel to which the agency cannot condemn, yet it is compelled to take the underlying fee, because if not taken the owner would be left with an uneconomic remnant?  Perhaps a School District desires to take land for a new elementary although the land has sewer and water easements over it that will serve the new school and which the School District has no authority to condemn?

            In the first example, the Army Corps easement generally has a negative economic impact on the property, whereas in the second example the water and sewer easements likely enhance the value of the property. How would strict implication of this rule impact just compensation to the property owner? Likely very little in the first example because the easement simply confirms what is generally apparent – the land area underlying the easement is encumbered by wetlands and has little economic utility. In the second example, however, just compensation to the property owner could be significantly impacted if the easements had to be cleared.  It would be an asset in the open market which a seller would not have to extinguish, but in a condemnation proceeding the owner would lose the value of the easements in the distribution phase.  

            Commentators however have suggested that much of the criticism of the undivided fee rule as has been applied by courts has been a consequence of “faulty appraisal techniques.” See Nichols on Eminent Domain, Section 12. 05 [4](1), pg 12-111.

            As stated in Nichols:

“Much of the inequity that may result from a rigid adherence to the undivided fee rule in cases where there is a negative leasehold may be eliminated by applying appraisal techniques which are consistent with market realities.”

Therefore, the very last question an appraiser should ask is – “Does this make sense?” 

Natural Resources

A nuanced problem of the unit rule is how to take into account profitable natural resources attached to the land without valuing those resources separate from and in addition to the property value itself – the dreaded cumulative or separate interest appraisal. Beyond semantics, this distinction has practical importance when it comes to awarding just compensation. For instance, in Meadows v. U.S., the government condemned property that was owned by Sara Meadows. Carlton Taylor owned timber rights to the trees on Meadow’s land. Meadows and Taylor moved the court to separate their eminent domain trials so that they could each be compensated according to their individual interests. The court denied separation, concluding that the relevant appraisal was the value of the land and timber together, rather than adding together the two separately-valued interests.

In U.S. v. 158.76 Acres of Land, 298 F.2d 559 (2^nd Cir. 1962) the value of the resources become entwined with the government’s dam project necessitating the condemnation. The land contained gravel deposits, which the landowner sold to the government contractors building the dam, thus creating an income stream. At trial, the property owner included the gravel sales in the appraisal, whereas the government argued that evidence of the gravel sales artificially enhanced the value of the property created by the government’s need for it - essentially a project influence which created a business opportunity. The court split the baby by excluding evidence of specific gravel sales to the contractors, but allowed a valuation that took into account the fact that the land had profitable gravel deposits, thus avoiding a cumulative appraisal.

These types of cases demonstrate how the courts maintain adherence to the unit rule while also taking into account value-adding natural resources that may be owned by a different party.

Convenant v. Contract Right

Covenants often burden land and make it nearly impossible to conduct an accurate appraisal without taking into consideration varying interests that fall “short” of outright ownership. In these cases, covenants may be compensable in eminent domain proceedings in favor of the beneficiary who loses some interest in the property.

U.S. Claims Court case, Childers v. United States, raised the issue of whether the appraisal should have reflected development restrictions imposed by a private deed.[4] The Claims Court concluded that the burdened property should be appraised without consideration of the deed restriction:

Defendant’s reliance on the deed restriction ignores both the unit rule and the County’s practice in rezoning. Under the unit rule, as mandated by the Yellow Book and other appraisal authorities, the appraiser must assume unified control and ownership without competing partial interests, such as a third party who might seek to enforce the [private deed] restriction … [In short] the unit rule required an appraiser to ignore the private deed restriction in valuing the property.

However, whether a property interest reflected in a covenant is compensable depends on whether the duty imposed is directly connected with the land. This is analysis that can create a great deal of confusion. A helpful example involves the interplay between two federal cases – U.S. v. 0.073 Acres of Land from the Fifth Circuit and Adaman Mutual Water Co. v. U.S. from the Ninth Circuit.

In Adaman, the company operated an irrigation and water distribution system in rural Arizona that serviced a series of small family farms.[5] Each homeowner was authorized to subscribe to the number of shares in Adaman equal to the number of acres they owned. Each share of stock entitled its holder to a portioned share of water. The area was so arid that any utility in the land was entirely dependent on access to the water distributed by Adaman. Due to the importance of the system, both the water rights and stock were made appurtenant to the land through real covenants. Proportionate assessments were made by Adaman on each homeowner to pay for capital investments in the irrigation facilities and for the operation and maintenance of the irrigation system. The government brought a condemnation action against approximatley eight percent of the land serviced by Adaman. The remaining land was subject to increased assessments because the operation and maintenance costs did not appreciably lessen by the condemnation. Adaman claimed it should be compensated for the lost assessments. The Ninth Circuit agreed, ruling that the duty to pay assessments was a compensable covenant running with the land. The benefit of this covenant, lower irrigation costs, was compensable because the government destroyed an intangible property right directly connected with the physical substance of the land.

The Fifth Circuit refined this rule in U.S. v. 0.073 Acres of Land.[6] There, the Marine’s Cove Townhome Association (MCTA) provided services such as trash collection and street maintenance to 58 townhomes at Mariners Cove. In exchange, the homeowners paid an assessment based on their 1/58 share. After Hurricane Katrina, the U.S. Army Corps of Engineers determined it needed 14 of the 58 townhomes for levy restoration projects. Citing Adaman, MCTA claimed it was entitled to just compensation for the loss of its right to collect assessments on the condemned properties. The Fifth Circuit disagreed and distinguished this case from Adaman by describing the covenant between MCTA and the homeowners as contractual, rather than a covenant running with the land. The difference was that the assessments collected in Adaman enabled the landowners to exercise their rights to the water under their land. While they had rights to the water under their land, only Adaman’s irrigation and distribution system allowed them to actually access and use this water. The utility and value of their land was directly tied to their ability to access water, which was facilitated by Adaman and financed by the assessments. Therefore, the assessments were critical to the functionality of the land itself. By contrast, the assessments collected by MCTA were more akin to a contract for services that were not necessary for the full enjoyment of ownership rights.

Further, although to some degree sounding to be in contract, noncompliance with restrictive covenants by a condemnor may be a compensable taking. In a memorandum opinion filed in King County Superior Court, Judge John P. Erlick stated that restrictive covenants are “important and valuable property rights” and denied the Washington State Department of Transportation (WSDOT) motion for summary judgment seeking a ruling that other property owners in the plat were not entitled to just compensation for a taking. Fisher v. Dep’t of Transp., No. 11-2-21568-7 SEA at *6, *10 (King County. Sup. Ct. Apr. 26, 2012). This opinion cleared the way for the other property owners in the plat to claim compensation for damages caused by loss or violation of the covenant. 

Accordingly, when WSDOT failed to comply with covenants restricting use of the property to residential uses, limiting boundary wall heights, building locations, and preventing construction lasting longer than 12 months, the other property owners in the plat were entitled to receive compensation. 

The key takeaway from these cases is that the infringement of covenants which run with the land taken are compensable in eminent domain proceedings when the covenants directly concern the use of the land acquired. Covenants that exist merely to provide contractual services not necessarily for the enjoyment of ownership rights are not compensable. Accordingly, covenants which limit height, use and size of structures fall under the purview of the unit rule.

These cases typify the difficulty in treating property as a single ownership unit during condemnation proceedings. Many types of legal instruments burden property – private deeds, assessments in real covenants, option to purchase leases. Yet, whether these interests can be factored into the fair market value under the unit rule and whether they produce a compensable interest require nuanced factual analysis. The consistent characteristic in all of these cases is that, no matter the interest, the condemned property must generally be valued as a single undivided fee, and any interests attached thereto may be a compensable interest to be claimed during the distribution phase of an eminent domain proceeding.

Options to Purchase / Life Estates / Leases

            A similar analysis arises when an option to purchase is contained as a covenant in a lease on property that is condemned by the government. The Washington Supreme Court has ruled that options to purchase property possessed by a leasee are compensable in the amount over the option purchase price.[7] In Spokane School District v. Parzybok, the government condemned property possessed by leasees with an option to purchase, but who had not yet exercised that option and so were not owners in fee simple. The issue was whether an optionee in possession has a compensable interest in the condemned property. The Court ruled that they did, noting that:

Where the land has increased in value after the option was granted, it cannot be denied that the option is a valuable contract right which is destroyed by the condemnation of the land to which it pertains. Thus, without access to just compensation, the optionee suffers a damage. The optionee clearly expects to realize any value in excess of the option price and often will spend considerable time and expense in furthering the expectation. To deny the optionee participation in the condemnation award under such circumstances provides the optioner an unjustified and inequitable windfall. It strips the optionee of the expected benefit of his bargained right, while relieving the optioner of his bargained duty at a profit. To deny compensation to the optionee is to deny justice.

Thus, the Court awarded the optionees the difference between the unpaid purchase price specified in the covenant ($22,000) and the amount of the condemnation award ($47,000), less the rent for the remainder of the lease term.

Similar to Adaman, despite not having an ownership interest in the land, the covenant rights advanced (the option) were so strongly tied to the land itself that principals of equity demanded that the optionees be compensated for their expected benefit. Rather than ensure access to water rights, the covenant here incentivized property development in anticipation of ownership. Parzybok furthered the rule that the infringement of real covenants are compensable for non-owners when they directly concern the land.

Without belaboring the point a similar analysis arises when property is subject to a life estate or lease[8]. The whole property, as if owned fee simple absolute must first be valued and only after that are the discrete interests evaluated. See RCW 8.04.140, RCW 8.12.120, and RCW 8.20.110[9].    

In analyzing the impacts of leases, appraisers should be mindful of the rationale in the leading California case on this subject, People, etc. v. Lynbar, Inc. 253 Cal. App.2d 870, 62 Cal.Rptr. 320 (1967). In that case the court stated: “It seems to us that this whole must be the total of what the various involuntary sellers had to sell and not the undivided fee which the condemnor is seeking to acquire...” To some this would seem to be an endorsement of the “aggregate of interests” rule and a repudiation of the unit rule. It could have also been a recognition of the fact that actual capitalized rents need to be taken into account when valuing property, because the market will recognize rents which substantially exceed market rent – think of drug stores and fast food chains which for various reasons want specific locations. While the site may not seem all that different, it is. The market tells us so.  

Now consider the situation of rents lower than market rate.  Why should a property owner who voluntarily keeps rents low for reasons such as tenant loyalty be punished? The analysis should be no different than holding property and not putting it to its highest and best use. The analysis will always look to the highest and best use.  The problem however occurs in the distribution phase. While the award might increase, the “bargain rent” will also grow.  This means the award given to the tenant from the award based on the undivided fee also increases. Thus, as has happened in the past, a property owner with a long term tenant in a bargain rent lease may see a quarter or more of the award taken by the tenant for bargain rent in the distribution phase. This total forced buyout rarely occurs in market transactions.

Again,

“Much of the inequity that may result from a rigid adherence to the undivided fee rule in cases where there is a negative leasehold may be eliminated by applying appraisal techniques which are consistent with market realities.”

Nichols on Eminent Domain, Section 12. 05 [4](1), pg 12-111.

Development Restrictions – Zoning v. Covenants

            While covenants may create compensable interests in property that would be essentially ignored as part of an initial valuation under the unit rule, zoning rules cannot be ignored.  Under Washington law:

[The jury is] to value the property in view of uses permitted under present zoning. However, if [the jury] find[s] there is a reasonable probability that zoning will change in the near future, [the jury] may consider the effect of such probability on the fair market value of the property.^[10]

The difference is essentially that covenants are a commodity that can be bought and sold whereas theoretically, zoning cannot. Therefore, while it may appear that certain uses to which a property may be adapted to could be acquired through certain dedications or concessions, these potential uses and considerations should be analyzed as a highest and best use.

Current Law

Washington State follows the unit rule.[11] In State cases in the event an eminent domain case is presented to a jury, RCW 8.04.110 requires the jury to return a lump sum just compensation verdict. Then, following the jury’s determination of just compensation, an apportionment hearing is held to apportion the funds amongst the property interest holders based on their respective interests in the land.  This is a two-step process: the jury determines the value and then the court allocates an award under RCW 8.04.140. However, when cities condemn, the jury does both; RCW 8.12.150 allows for separate findings when there are several interests and the jury is charged with determining the interest of the respective parties.

The statute states in relevant part:

In making such findings, the jury shall first find and set forth in their verdict the total amount of the damage to said land and buildings and all premises therein, estimating the same as an entire estate and as if the same were the sole property of one owner in fee simple; and they shall then apportion the damages so found among the several parties entitled to the same, in proportion to their several interests and claims and the damages sustained by them respectively, and set forth such apportionment in their verdict.

The statute reiterates that, even when the jury is called upon to decide how to allocate the reward, the jury is first required to determine value under the undivided fee rule. This process is less clear in actions brought by other entities.  

Accordingly, when hired by a city or town an appraiser should be prepared to value not only the whole, but the various estates as well. 

Conclusion

            The unit rule is in essence a legal fiction that can create a great deal of confusion when valuing property, because rarely is property bought and sold free of all encumbrances. It essentially requires appraisers to ignore the separate estates in the property that affect the properties open market value. The complete elimination of all estates in the land, such as the easements or covenants which generally add value to the purchase, would be expensive if not impossible to acquire in an open market.    

While appraisers must have a comprehensive understanding of the nuanced interplay between these issues when valuing property consistent with the unit rule in an eminent domain proceeding, it is imperative that they receive specific instructions from the condemning authority as to what to value when asked to do anything less.