221 Week 5 A /For WIZARD KIM

P e e r-R e v ie w e d A r t ic le

Identifying Rights and Interests to Be Appraised in Rural Property E x c e rp t f r o m t h e 2 0 1 7 A p p r a is a l I n s t it u t e b o o k Rural Properry Valuation

A bstract T he fe e s im p le e s ta te o f ru ra l p ro p e rty m a y be d iv id e d in to s e p a ra te e c o n o m ic , le ga l, a n d p h ysica l in te rests.

This a rtic le discusses th e c o m m o n p ro p e rty rig h ts a n d p a rtia l in te re s ts re la te d t o ru ra l p ro p e rtie s .

T he term real property refers to a compli­ cated legal concept that is often mis­ interpreted as the physical parcel of land.

Proper usage of the term relates to the benefits and rights inherent in the ownership of the phys­ ical real estate. In other words, the property con­ sists not of real estate but of rights to real estate.

The property rights inherent in real estate include the right to occupy, sell, lease, or bequeath it and any other rights or benefits that can be derived from the ownership of the land. These various benefits of ownership are known as the bundle of rights. W hen a property owner has all of these rights, he or she has a complete own­ ership interest in the property, which is known as the fee simple estate. To best illustrate the bundle of rights, imagine a group of sticks. Each one of these sticks represents a right inherent in the ownership of property. T he total number of sticks represents fee simple ownership. A lease, an ease­ ment, or a deed restriction takes one of the sticks away from the bundle of rights, leaving the prop­ erty with an encumbrance.

Fee simple title, the complete bundle of rights, can be divided in many ways:

• by a lease (leased fee or leasehold estate) • through an easement (for a highway, power

lines, pipelines, etc.) • by deed restrictions • through a life estate

In the appraisal of rural and agricultural properties, one or more property rights are usually encum­ bered or have been severed from the fee simple estate. A n estate may be subject to access ease­ ments, utility easements, mineral reservations, or other encumbrances. For example, consider a farm that has had the mineral estate severed. In this case, the property rights appraised are “fee interests in the surface estate.” A n analysis of sales in the market area reveals that surface interests in farm properties are selling for $6,000 per acre, and fee mineral interests contribute $1,000 per acre. If the property were appraised in fee simple at $7,000 per acre, it would be overvalued by $1,000 per acre.

Possession of a title in fee establishes the fee sim­ ple estate— i.e., absolute ownership unencumbered by any other interest or estate, subject only to the limitations imposed by the governmental powers of taxation, eminent domain, police power, and escheat. The fee simple estate includes air rights, subsurface rights, and all other property rights asso­ ciated with real estate ownership. A fee simple estate that is mortgaged, however, does not include the full bundle of rights. Because an appraiser usu­ ally is not valuing the fee simple estate in agricul­ tural properties, a conditional statement clearly describing the estate is often required. In most rural areas, minerals have been partially or totally sev­ ered from property rights and many properties are subject to access easements, deed reservations, and

This material originally appeared as chapter 2 in Rural Property Valuation (Chicago: Appraisal Institute, 2017).

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Identifying Rights and Interests to Be Appraised in Rural Property

other restrictions. The comparable sales used to value a property should reflect the same or similar estates. In some instances, certain rights may not be included in the estate appraised, but these miss­ ing rights may have little or no value, meaning that they do not contribute to value in the context of the highest and best use of the property. A n appraiser’s job ;s to determine which rights con­ tribute to value and how much value they add.

A n interest in real estate is defined by degrees. A fee simple estate denotes complete, but not absolute, ownership. A leased fee estate typically describes a property subject to a lease that has a definite expiration date. A leasehold estate is the interest of the tenant or lessee.

A partial interest is any interest or group of interests that makes up less than the entire bun­ dle of rights. Fartial interests can be created in several ways:

• economically • legally • physically • financially

Economic Interests

The most common type of economic interest is created when the fee simple estate is divided by a written lease, such as a farmer who leases lands for crops or for grazing livestock. In that circum­ stance, the lessor and the lessee each obtain par­ tial interests, which are stipulated in contract form and are subject to contract law. The divided interests resulting from a lease represent two dis­ tinct but related interests— the leased fee inter­ est and the leasehold interest.

A leased fee interest is the lessor’s, or land­ lord’s, interest. A landlord holds specified rights that include the right of use and occupancy con­ veyed by the lease to others. The rights of the lessor (the leased fee owner) and the lessee (leaseholder) are specified by contract terms contained in the lease.

Although the specific details of leases vary, holding a leased fee interest generally provides the lessor with the following:

• rent to be paid by the lessee under stipulated terms

• the right of repossession at the term ination of the lease

• default provisions

W hen a lease is legally delivered, the lessor is obligated to surrender possession of the property to the tenant for the lease period and abide by the lease provisions. The lessor’s interest in a property is considered a leased fee interest throughout the duration of the lease.

The leasehold interest is the te n a n t’s position. A leasehold is the right to use property for a stated term under the conditions of the lease. W hen a lease is signed, the tenant acquires the right to possess the property for the leased period and to sublease it subject to the conditions of the lease. In return, the tenant is obligated to abide by the lease terms, pay rent, and surrender possession of the property at the term ination of the lease.

In some instances a property is subject to ver­ bal sharecrop arrangements. State laws address the rights of the lessor and lessee w ith regard to verbal agreements. In some states a verbal sharecrop arrangement must be term inated in writing by the lessor prior to a specified date set by the statute. Cash leases th at are unw ritten may carry the same term ination rights, depend­ ing on state law. In some areas, local custom calls for w ritten agreements or a w ritten lease th at is extended from year to year. Appraisers should be aware of local customs and state laws relating to agricultural leases and their implied effect on value.

Lease D ocum ents Leases can be verbal or written contracts. Verbal contracts are normally for less th an one year and may or may not be enforceable under state law. Both written and verbal leases obligate the tenant to pay rent to the landlord and may include other agreements between the parties. A lease document should include a legal descrip­ tion of the land and any improvements included with the property.

Leases typically include clauses that specify the following:

• the length of the agreement • the amount of annual or monthly rent • the amount of any deposit • the required insurance on the buildings and

liability coverage on the land • the landlord’s right of entry • provisions for subleasing, maintenance, and

repair on all structures • which party is liable for taxes

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T a b le 1 Payments fro m C onservation Reserve Program s

P a y m e n t Type D escrip tio n L im it S ig n -u p Type

Rental payment Annual payment to participants. Based on soil productivity for each county and the average dryland case rental rate.

$50,000 annually for any person or legal entity

General and continuous sign-up

Cost-share payment Payment for a percentage of installing or establishing an eligible practice

No more than 50% of the actual or average cost of establishing the practice

General and continuous sign-up

Maintenance incentive payment

Reimburses participants for the average annual cost of certain practice maintenance

$5 per acre per year Certain continuous sign-up practices

One-time sign-up incentive payment (SIP)

One-time incentive payment made to participants that enroll certain practices

$ 10 per acre per year enrolled (not to exceed 10 years)

Certain continuous sign-up practices

One-time practice incentive payment (PIP)

One-time incentive payment for eligible installation costs for certain practices

40% of the eligible cost of practice installation

Certain continuous sign-up practices

Other financial incentive Additional incentives, as part of annual rental payments, for windbreaks, grass waterways, filter strips, and riparian buffers

Up to 20% of the annual rental payment

Certain continuous sign-up practices

S o u rc e s : 1 6 U .S .C . 3 8 3 4 , 7 C.F.R. 1 4 1 0 . 4 0 - 1 4 1 0 . 4 2 , a n d U S D A , FS A , C o n s e r v a tio n R e s e rv e P r o g r a m C o n t i n u o u s S ig n - U p , F a c t S h e e t, J u ly 2 0 1 0 ,

w w w . f s a . u s d a . g o v / ln t e r n e t / F S A _ F ile / c r p _ c o n t s ig n u p _ 0 7 2 6 1 0 . p d f

Leases may also include an em inent domain clause, direct payment for a possible taking or damages, a default clause, and renewal options.

It is important th at appraisers understand the effect leases have on the property interest being appraised. Local custom and state laws are of prime importance. A property’s value can be influenced positively or negatively by the terms and conditions of the lease agreement, just as the value of a property involved in a sales trans­ action may be influenced by the terms of the financing agreement.

Similar to leases are Conservation Reserve Pro­ gram (CRP) contracts, which are agreements between landowners and the federal government to leave cropland idle for a specified period of time—usually 10 years. For example, the Grass­ land Reserve Program (GRP) contracts limited

future development and cropping uses of the land and retained the right to conduct common graz­ ing practices and operations related to the pro­ duction of forage and seeding.1 In most cases, CRP contracts are not recorded, but the land- owner is subject to very restrictive language during the holding period and a substantial pen­ alty can be imposed if the lease terms are compro­ mised. Appraisers should research and understand the implication of the language in CRP contracts and assess the quality of the income stream during the holding period. Table 1 describes the pay­ ment types under the CRP.

R e n ta l P a y m e n ts The three most common types of agricultural leases are gross leases, net leases, and cropshare leases. Farmland is typically leased on a cash rent

1. T h e GRP w a s re p e a le d in t h e 2 0 1 4 F a rm B ill, b u t g r a s s la n d p r e s e r v a tio n c o n t r a c ts — s im ila r t o w h a t w a s a v a ila b le u n d e r t h e GRP— a re

c u r r e n t ly e lig ib le u n d e r t h e CRP.

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Identifying Rights and Interests to Be Appraised in Rural Property

or cropshare basis, both of which may or may not involve expense sharing. These leases delineate different responsibilities for the tenant and land­ owner. In a gross lease, the landlord receives the stipulated rent and is obligated to pay some or all property expenses, including real estate taxes. In a net lease, however, the tenant pays all or most of the property expenses in addition to the stipu­ lated base rent. Property expenses usually include real estate taxes and the costs of insurance, man­ agement, maintenance, and structural repairs. In a cropshare lease, the landlord receives a share of the annual gross income and may participate in some of the annual expenses. Again, local cus­ toms often outline the level of responsibility ascribed to each position.

Rental payments are typically flat or level payments made throughout the contract term. A step-up or step-down lease provides for a cer­ tain rent for an initial period, followed by an increase (or decrease) in rent over stated peri­ ods. An index lease provides for periodic rent adjustments based on the change in an eco­ nomic index. Index leases are usually long-term. A revaluation lease provides for periodic adjust­ ments to contract rent based on the prevailing market conditions.

Rental payments can be monthly, quarterly, semiannual, or annual, depending on whether the property is subject to a cash lease or a share- crop arrangement. Cash agricultural leases usu­ ally call for annual or semiannual payment in advance or partially in advance. Sharecrop leases are sometimes verbal and typically call for a share of the crop with payment at the time of harvest. Payments can be set on a percentage basis—i.e., one-quarter to one-third of the crop payable to the landowner or a 50-50 split for crop production. The tenant and landlord may also share in any government payments. Under sharecrop leases, the landlord is usually obli­ gated to pay raxes and property maintenance costs, while the tenant provides the labor for maintenance and operation of the property. In analyzing sharecrop agreements, appraisers should look for automatic extensions and con­ sider the perceived risk to the landlord in com­ parison with a cash lease arrangement.

The most .mportant obligation associated with the rights to use and occupy a leasehold interest is the payment of rent. Contract rent is the actual rental income specified in a lease.

The rent is paid by the tenant to the lessor according to the terms in the lease contract. A leasehold has positive value when contract rent is less than market rent, i.e., the rental income that a property would command in the open market. In turn, the leased fee value may be neg­ atively affected by a positive leasehold. A leased fee encumbered with a long-term, below-mar- ket, fixed rental rate may be worth less than an unencumbered fee simple estate.

Legal Interests

The most common legal partitions of the com­ plete bundle of rights in rural property are life estates, easements, and transferable develop­ ment rights.

A life estate is defined as the total rights of use, occupancy, and control of a specified property limited to the lifetime of a designated party. The designated party is generally known as the life tenant and is obligated to maintain the property in good condition and pay all applicable taxes during the term of the life estate. Life estates can be created in several ways:

• by operations of law • by wills • by deeds of conveyance

For example, a fee owner may leave a will that gives farmland to his widow for her remaining lifetime and, at her death, passes the land on to their children. Thus, the widow acquires a life estate and functions as a life tenant with the chil­ dren becoming the remaindermen. The income stream flowing to the life tenant is normally the basis for valuing a life estate. An appraiser can estimate the duration of the income stream by consulting actuarial tables, which indicate the expected remaining life of the tenant. Once the duration of the income stream is set and the net operating income from the estate is established, an appropriate market discount rate can be selected and applied to estimate the value of this property interest.

Obviously, the income from a real property interest subject to a life estate would be dis­ counted at a market rate derived from other, similar real estate interests. For example, if actu­ arial tables indicate a 15-year life expectancy for the life tenant, a 15-year discount period would

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be applied to the reversionary interest of the estate. Life estates are common in rural areas where parents sell their property to their chil­ dren and retain a life estate in the buildings and a small acreage around the structures. The value of the whole property depends on when the buildings and acreage are rejoined with the remainder of the property. The contribution of the portion containing the structures and acre­ age would be discounted at an appropriate mar­ ket rate and added to the remaining value of the unencumbered property.

A n easement is an interest in real property that transfers use, but not ownership, of a por­ tion of an owner’s property. Easements usually permit a specific portion of a property to be used for identified purposes, such as access to an adjoining property or as the location of a certain utility. Surface easements are the most common easements on agricultural property. Subter­ ranean and overhead easements are used for public utilities, fiber-optic cables, subways, and bridges. O ther easements such as conservation easements and scenic easements may prohibit the owner of the underlying fee simple estate from certain uses of the property without giving the holder of the easement any possessory inter­ est in the real estate.

Clearly a property or entity that enjoys the benefit of an easement gains additional rights, while a property that is subject to an easement is burdened. The easement attached to the prop­ erty benefitted is referred to as an easement appur- tenant. The property whose owner acquires an easement is known as the dominant tenement. The property that is subject to the easement is called the servient tenement.

A conservation easement is a typical example of a contract between private parties, in which a land owner enters into an agreement with, say, a conservation group that limits the future use of a portion of the owner’s property, often to ensure that some natural environment will not be devel­ oped. The property owner hands over certain specified rights of use and may receive a tax deduction. In exchange, the conservation group may or may not pay compensation (and offer ongoing property tax savings). A n example of an easement created by prescription might be a right of access granted to the public who for many years have used a trail as a shortcut through a parcel of privately owned land. Prescriptive ease­

ment cases often require proof similar to that found necessary for adverse possession. Open space easements can inhibit the overall use of a property. The basic procedure for valuing these easements is similar to the procedure applied in eminent domain appraisals— i.e., the value of the property before the easement is compared to the value after imposition of the easement.

Transferable development rights (TDRs)— sometimes referred to as severable use rights (SURs)— became popular in the real estate industry during the 1970s. A TDR is a develop­ m ent right th a t is separated from a landowner’s bundle of rights and transferred, generally by sale, to another landowner in another location. Some TDRs preserve property uses for agricul­ tural production, open space, or historic build­ ings. In this arrangement, a preservation (or sending) district and a development (or receiv­ ing) district are identified. Landowners in the preservation district are assigned development rights that they cannot use to develop their own land but can sell to other landowners in the development district. The landowners in the development district can use these transferred rights to build at higher densities th an zoning laws in the development district would normally permit. Development rights may also be trans­ ferred to land trusts or governmental agencies to curtail development and preserve environm en­ tally sensitive properties.

Physical Interests

The partition of real property among physical interests can include vertical interests, such as air rights above the surface of the land, and subsur­ face rights, such as an ownership interest in an oil or gas deposit below the surface. For rural prop­ erty that will be used for agricultural purposes, the water rights related to a particular parcel can have a significant effect on the productivity of that land and thereby the value of the real property.

The most common vertical interests in real property are subsurface rights and air rights. A subsurface right is a right to the use of and profits from the underground portion of a designated property. Air rights are the property rights associ­ ated with the use, control, and regulation of air space over a parcel of real estate.

The vertical division of real property is signifi-

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cant because engineering advances have dramat­ ically affected land use and, therefore, highest and best use considerations. Congress has declared that the federal government has com­ plete and exclusive sovereignty over the nation’s airspace and that every citizen has “a public right to freedom of transit in air commerce through the navigable air space of the U nited States.”2 Many states restrict the ownership and use of subsurface areas, such as underground aquifers and oil or gas reserves.

Mineral Rights Minerals include, but are not limited to, several broad categories including sand and gravel, pre­ cious metals, stone, clay deposits, gemstones, oil and gas, and quarry types such as building stone. Essentially, minerals is a term used to refer to any subterranean commodity that has or may have economic value.

Mineral rights consist of the right to extract some or all minerals contained in or below the surface of a property. Mineral rights may be granted with surface rights or without surface entry because the “mineral estate” is the domi­ nan t tenant in most states. W hen mineral rights are severed from the surface, the owner of the mineral interest has a right to occupy the amount of surface area that is reasonably necessary for extraction purposes. In these cases, however, the mineral rights holder must pay the market value of the surface acres occupied and any damages. In some areas, the surface damage income is greater than the owner’s share of the mineral income from royalties.

A mining right for a specific tract of land is a right to enter and occupy the land for the purpose of extraction, either by underground or surface methods. In some instances, this right may also include the use of vegetative resources, such as timber, on the surface for the extraction process.

Types of Ownership Substantial mining and quarry properties are own­ er-operated. The owner may have purchased the property from another private party or by patent­ ing a mining claim. The development or transfer of the mineral rights in privately owned (fee title)

land is accomplished within the framework of state laws relating to property titles, sales and convey­ ances, leases, licenses, and contracts. Private rights are typically subject to federal or state statutes relating to conservation, wildlife and wetlands mitigation, taxation, safety, and other matters.

W hen fee title is not owned, leases provide the vehicle for mining lands owned by private parties or federal and state agencies for specified types of minerals. Leases between mining operators and private owners have the following characteristics:

• They may include a purchase option. • Lease payment may take the form of a roy­

alty based on production. • The rights may be subject to abandonment

or forfeiture. • W ritten leases may cover subletting.

Leases between mining operators and public own­ ers have the characteristics illustrated in Figure 1.

F ig u re 1 C haracteristics o f Leases b e tw e e n M in in g O perato rs and Public O w ners

• The state "land commission" or a similar agency has jurisdiction over all mineral operations on state-owned lands o r lands th a t contain minerals reserved by the state.

• M ining operations on public lands are subject to assessment as possessory interests just as possessory rights fo r other purposes are assessed fo r tax purposes.

• A perm it or lease to prospect fo r minerals other than oil and gas may be required by the state.

• Leases include a production agreement, w hich w ill likely call fo r reclamation bonds and possible escrow fo r road w ork, utilities, and other requirements.

• The right to extract minerals on federal lands may be obtainable by lease or perm it from the Secretary o f the Interior, as opposed to filing a claim or patenting.

• Federal mineral deposits subject to "leasing" include coal, petroleum, natural gas, phosphates, oil shale, sodium salts, and potash.

• Federal "p erm its" are available fo r extracting pumice, clay, sand and gravel, and other "com m on varieties."

2. The A ir Comm erce A c t o f 1926 (form erly 49 USC 171 e t seq.), th e Civil Aeronautics A ct o f 1938 (form erly 49 USC 401 et seq.), and the Federal Aviation A ct o f 1958 (see 49 USC 401).

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A royalty originally was the rent or tax paid for the privilege of mining. In the U nited States, a royalty is a reservation to the lessor or seller of a portion of the minerals, or proceeds from their sale, at no cost. There have been many sales of mineral properties in which the seller retained a royalty interest even though title changed hands. The royalty is actually part of the production costs (gross royalties are typically deducted from net sales). The royalty should be included in valuing the leasehold estate when it can be accu­ rately determined and is not contingent on unknown future commodity prices, profit levels, or other intangible measures.

Valuations of minerals may entail analysis of the following:

• a patented claim • an unpatented claim • a mill site • in-place reserves (i.e., proven and probable

reserves) • structures only (leasehold or improvements

held in fee) • an operating mine

Patented mining claims are legally equivalent to a fee simple title acquired from the United States under the 1872 mining law. A patent is the conveyance by the U nited States of title to a citi­ zen, in a situation in which the property was in the public domain and is being conveyed into pri­ vate ownership for the first time. A patent is the equivalent of a quitclaim deed from the sover­ eign. All valuable mineral deposits (i.e., gold, sil­ ver, iron, lead, copper, and other metals plus many nonmetallic items like gypsum, limestone, and rare earths) on or in public domain lands, not withdrawn from mineral entry, are open to explo­ ration, occupation, and patent. Patented claims are subject to taxation since they are, in effect, fee property. They can be mortgaged or sold like any other fee interest. Lands not open to mining claims include federal lands not in the public domain— e.g., acquired lands, public domain lands withdrawn from mineral entry, privately held lands, patented town sites, and land deeded to the state for unpaid taxes.

U npatented claims are, in effect, the right to explore and produce locatable minerals under the 1872 mining law. No application for a patent is necessary to operate a mine on public domain land. In most cases, a legal opinion is required as

backup to determine the disposition of unpat­ ented claims. U npatented claims include mill site claims, lode claims, and placer claims. Lode claims must be based on the discovery of a valu­ able mineral deposit. Lode claims may include extra lateral rights, if they include the top or apex of the vein or lode. Each lode claim is lim­ ited to about 20 acres (600 feet x 1,500 feet, or slightly more than 20 acres) regardless of the number of locators. A placer claim may be located on all other types of valuable and identi­ fiable mineral deposits. The placer location must also be based on a discovery, but a discovery that is not in a vein or lode formation. The maximum size for a placer claim is 20 acres per person. However, an association placer may contain 20 acres per associate, up to a maximum of eight associates, and 160 acres in a single claim.

Mill site claims may be located on a maximum of five acres of nonmineral land in conjunction with either lode or placer claims for the purpose of milling or processing the mineral. If the m in­ ing claim is forfeited or abandoned, the right to the mill site may also be lost, unless it is used for custom milling.

Ownership o f Oil and Gas Deposits Oil and gas properties tend to be more compli­ cated than other mineral entities because of the wide range of ownership interests that may be encountered. Ownership can be broken down into several categories. It is necessary to know what type of ownership is being evaluated in the appraisal process. Various ownership interests are described in Table 2.

To further complicate many oil and gas proper­ ties, vertically segregated mineral ownership may exist. One company may have a leasehold inter­ est in a given mineral property down to a certain depth below ground level, such as 8,000 feet below the surface, while a second company may have the leasehold for all zones below 8,000 feet.

Water Rights The legal right to water is as important to the value of a property as the physical source of the water. A water right is a right to a definite or con­ ditional flow (quantity) of water, generally for use at stated times and in stated quantities, for irrigation, livestock consumption, real estate developments (subdivisions), hydroelectric power development, and other uses. Water rights vary

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Table 2 Ownership Interests

Mineral owner The person or entity possessing title to the mineral property. The mineral ow ner may or may not hold title to the associated surface o f the land. In this case, the mineral estate is considered severed from the surface ownership.

Leasehold owner The person or entity holding a lease on the mineral estate w ith the right to extract the oil and gas reserves present.

Royalty interest owner That portion o f the produced oil and gas retained by the mineral ow ner as partial compensation fo r leasing to the leasehold owner. This is normally a percentage o f the gross production and is subject only to severance and income taxes.

Overriding royalty interest That portion o f the produced oil and gas generally retained by a third party or parties owner as compensation fo r services o r subleasing o f a particular mineral property. This is also

normally a percentage o f the gross production and is subject only to severance and income taxes. This interest is created from o r carved o u t o f the leasehold interest.

Working interest owner The party w h o pays 100% o f the costs o f production. W orking interest owners are usually, but not always, the leasehold owners.

Reversionary interest Sometimes called a back-in, a reversionary interest is an interest th a t w ill revert normally to the leasehold ow ne r at a predesignated tim e, such as pay o u t o f the drilling and com pletion cost o f an oil or gas well. This interest is usually an option to continue w ith a given overriding royalty, or to convert th a t interest to a larger w o rking interest.

Net revenue interest The net revenue to the w orking interest owners after all production costs, royalty, and overriding royalty interests have been paid

greatly throughout the United States and are affected by numerous compromises, exceptions, and changes. Most water rights, however, are con­ trolled by state law. Many disputes occur because of the fluid nature of water and the fact that laws were passed without scientific knowledge of the interdependencies of the water cycle.

S u rface W ater D o c trin e Laws regarding surface water rights in the U nited States are complex primarily because of differ­ ences in the availability of water. The riparian doctrine is applied in states where water has his­ torically been plentiful. In the most arid states, water rights are based on the doctrine of prior appropriation. Some states employ both doc­ trines, with the appropriative doctrine being dominant. The major differences between the riparian and appropriative doctrines of surface water are summarized in Table 3.

The riparian doctrine of surface water is based on English common law and gives the owner of the land bordering a lake or stream the right to

use the water on the contiguous land. The ripar­ ian right exists solely because the land is located next to a natural water supply, and the right to the surface water resides in the ownership of the land.

T he riparian owners up and down the stream have equal usufructuary rights. The term usu­ fructuary refers to the “use of the fruits.” In other words, the riparian owners up and down the stream are entitled to share the water for reason­ able use without seriously diminishing the quan­ tity or quality of the water used by other owners. The owners’ rights are equal, regardless of loca­ tion along the stream or the time when each property was purchased. T he riparian doctrine does not define “reasonable use” or guarantee any particular quantity of water. The resulting uncertainty can lead to legal conflict among the owners along a watercourse. Reasonable use is determined in a particular case only when one party brings suit and the court makes a decision. As long as the practical application of riparian rights is confined to areas where the supply of water generally exceeds the demand, all users

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Table 3 Sum m ary o f Riparian and A p p ro p ria tiv e Rights to Surface W a te r

Riparian Right A p prop riative Right

Prevails in eastern United States Prevails in western United States

Is based on English common law Assumes public ownership of water

Is linked to land ownership and physical contiguity Is acquired by diverting water for beneficial use and meeting specific Ideal requirements

Entitles user to reasonable use, w ithout materially diminishing quality of watercourse; "right to simple usufructuary while it passes along"

Entitles user to physical consumption of a certain amount of water for specified land

Entitles user to equal sharing Entitles user to consumption on a seniority basis; "first in time is first in right"

Depends on ownership of land in physical proximity to water and transfers automatically with the land

Is a real property right, separate from right to land and separately transferable

are able to share th e available water and there is n o need to specify quantity or reasonable use.

A riparian right can be lost by selling th e land n e x t to th e water, leaving th e rem aining land cut off from the supply of water. Similarly, th e right can be lost if th e stream shifts or moves away from th e riparian land. A riparian right can also be lost by condem nation or by failing to prevent someone else from diverting water for a certain num ber of years, as set by th e statute of lim ita­ tions (prescription).

U n d e r th e doctrine of prior appropriation, water is owned by th e state and may be granted for beneficial use through appropriation. A ppro­ priative surface water rights are acquired by use and th e perform ance of certain legal require­ m ents, as directed by the state, th e county, or an irrigation district. T hese rights apply to a specific quantity of w ater and often to particular times of use, places of use, and m ethods of diversion. U nlike riparian surface rights, w hich depend on the ownership of land in physical proxim ity to water, appropriative surface rights can en title th e owner of th e w ater right to surface water th a t is n o t contiguous to th e land on w hich it is used. In addition, th e owners of appropriate surface rights are en title d to consume or use th e appropriated quantity of water, provided th a t th e use for the w ater is beneficial. T h e oldest water right has precedence over more recently acquired water rights. Simply stated, first in tim e means first in

right. T his m eans th a t in times of scarcity, the holder of th e oldest right is en title d to a full quantity of w ater before any is given to later holders. T his principle of seniority clearly differs from th e equal sharing o f water in th e riparian doctrine. M any appropriative w ater rights can also be transferred independently of th e land.

A lth o u g h th e details vary w ith state regula­ tions, th e usual p a tte rn for establishing appropri­ ate water rights is:

1. T h e landow ner files an application to use a certain quantity o f w ater o n specifically designated land, taking th e water from a designated diversion point.

2. T h e landow ner proves beneficial use for this water.

3. T h e appropriate authority in th a t state grants a decree or adjudication.

T h e water rights may be evidenced by a co n ­ tract w ith the W ater and Power Resources Ser­ vice (formerly the U S Bureau of R eclam ation), w ith th e Secretary of th e Interior, or w ith a public utility water distributor. W ater rights may also be given by an individual state certificate or decree, by shares of stock in an irrigation company, or by location in an organized irrigation district. These agencies differ widely in adm inistration and the terms on w hich water is granted. Appraisers must therefore be aware of the different regulations, local considerations, and any changes in th e reg-

48 The Appraisal Journal • Winter 2017 www.appraisalinstitute.org

Identifying Rights and Interests to Be Appraised in Rural Property

ulations. If water is obtained from public agen­ cies, the laws governing use can be changed, and that change can put limitations on the number of acres for which federal water can be used. For example, the Reclamation A ct of 1902 specified that federal water can be provided for only 160 acres per owner (320 acres for a farm couple). The Reclamation Reform A ct of 1982 increased the acreage limitations to 960 acres for a family farm. The act also affects the use of federal water on corporate-owned lands, methods for calculating the cost of water used on excess acres, and the sale of lands in excess of the acreage limitations.

Private agencies can also change the cost of water, the terms of delivery, or the dependability of delivery. For this reason, appraisers should be aware of the management practices of the agency, the condition of indebtedness, the type of pay­ ments or assessments, and any shares or voting rights accorded the owners of water rights. The members of a private irrigation company could, for instance, vote to raise the individual assess­ ments on water rights, with a corresponding increase in the expenses of the irrigator depen­ dent on this water. These organizations usually keep records of the amounts, timing, and costs of water used by irrigators, which can be employed by appraisers in estimating the amount, suffi­ ciency, dependability, and expense of the water used for a particular tract of land.

To m aintain an appropriative right, the owner must demonstrate “beneficial use.” A n appropri­ ative right can be lost by condemnation, pre­ scription, abandonment, or nonuse for three to five years, depending on state law. W ith regard to water, the general rule is, “Use it or lose it.”

G ro u n d w a te r D o ctrin es Most state groundwater laws were developed after the surface water laws. Sometimes, ground- water doctrines follow or are combined with the surface water laws of a state.

Resembling the riparian doctrine for surface water, the absolute ownership doctrine states that a landowner can take as much water as desired from beneath the owned land. The water is considered part of the landowner’s soil. The reasonable use doctrine is a modification of the previous principle because use of groundwater can affect the water supplies of other landowners. This modification limits each landowner to reasonable use, recogniz­ ing equal rights to groundwater resources. A fur­

ther modification of the reasonable use doctrine is the correlative rights doctrine, which states that the landowner’s use must be correlated with the use of others, especially during times of water shortage. W hen water is in short supply, each landowner is entitled to groundwater in proportion to the per­ centage of land he or she owns in relation to the other lands overlying that groundwater supply.

U nder the doctrine of prior appropriation, groundwater, like surface water, belongs to the people of the state and is subject to appropriation for beneficial use through a priority system simi­ lar to that used for surface water. In 1959, Hawaii passed a groundwater use act providing for regu­ lation of groundwater withdrawals from desig­ nated areas by a state commission.

O th e r W ater R ights A neighbor may gain prescriptive rights by openly diverting water to which others have prior rights. If the diverted water is used without interruption for the number of consecutive years prescribed by state law and other legal requirements are met, a prescriptive right against the original owner is granted. A prescriptive right may be lost in the same way— i.e., it may be prescribed by someone else openly diverting the water for the specified period of time. A vested right is a clause in appro­ priation law that protects the rights of persons who appropriated water for beneficial use before the passing of appropriation laws. A vested right can also be lost by lack of use.

T he water rights in a particular location can affect the value of property in different ways. In an appraisal of irrigated property, an appraiser must know whether the water rights are appurte­ nant to the land or transferable separately from the land. If they are separate, the legal source, conditions, terms, and value of the water rights should be known and noted by the appraiser. If water rights are not transferred with the land, the property’s value may decline significantly and its highest and best use may be changed.

Financial Interests

A n exceedingly common division of the complete bundle of rights in real property is the separation created by equity and debt ownership interests— i.e., a property with a mortgage. The availability of capital for investment in rural property has a

www.appraisalinstitute.org Winter 2 0 1 7 * The Appraisal Journal 49

Peer-Reviewed Article

significant effect on the frequency of sales and consequently on the prices asked and achieved in the market. In individual transactions, the financ­ ing terms are of great concern in the valuation process, particularly if the financing terms for transactions of comparable properties differ greatly from the financing terms for the property being appraised, requiring a significant adjustment to

the sales prices of the comparable properties in the application of the sales comparison approach.

Rural property includes several primary prop­ erty types and uses, each with its particular capital needs and sources. Rural property valuers need to be aware of how the availability of capital influences the property market and how capital requirements are met.

A d d itio n a l Resources______________________________ S u g g e s te d by t h e Y. T. a n d Louise Lee L u m L ib ra ry

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