January 04, 2018

Three Considerations When Seeking Compensation for Lost Income Due to a Government Taking

Almost all real estate has the potential to generate income. An owner may rent out her property to commercial or residential tenants, or she might harvest and sell its natural resources, such as oil, gas, mineral deposits, or crops. When a public project results in the taking of real property, owners sometimes ask the government to compensate them for their lost income. This article focuses on how courts address lost income under eminent domain law.

At its heart, this issue comes down to whether “income” impacts a property’s fair market value. Generally speaking, when the government condemns private property, it must provide the owner with just compensation for the taking. Just compensation is typically based on market value—in other words, what a willing buyer would pay for the property if the owner had voluntarily offered it for sale. A property’s potential for generating income is certainly a factor that a willing buyer would consider when making an offer. However, there are a few fine distinctions courts make when considering income as evidence of market value.

Income Does Not Equal Value

First, income does not equal value. Although income potential may influence a property’s market value, there is rarely, if ever, a one-to-one ratio between the two numbers. For example, an appraiser will typically apply a capitalization rate to a property’s net operating income in order to determine its value. The appraiser may also compare that value with estimates derived from other valuation methods, taking into consideration such factors as inflation, the prime interest rate, and the expenses and rate of return on similar properties over a long period of time. Thus, recovering lost income is not simply a function of calculating the property’s economic rent for the duration of the taking; it must be converted into a factor that a reasonable buyer or seller would consider in determining a property’s market value.

The Type and Source of the Income Matters

Second, real estate profits are not necessarily the same as business profits. In some jurisdictions, evidence of income generated by a business located on condemned property is not admissible to establish its market value. (The rationale behind this is that the business itself is not being condemned and can be relocated, and that business profits are really just a function of good entrepreneurship and management.) Accordingly, in those jurisdictions, for lost income to be admissible in eminent domain proceedings, it must be derived from the highest and best use of the land itself—or income that is “tied to the land.” On the other hand, when the business itself is being taken, either directly or because of the practical inability to relocate it, most jurisdictions recognize that compensation is owed for such business losses. And some jurisdictions have special statutes that allow for the award of business losses even when only the real estate is being condemned.

Income-Generating Potential Must Be Well-Supported

Finally, evidentiary issues arise when a property is not actually producing income at the time of the taking, but the owner nonetheless wants to recover damages for her loss of the property’s future income-generating potential. If the income is difficult to predict or quantify, the court may reject such evidence as too speculative, so it is important for an owner to provide as much support for the projected income as possible to protect against this. And if another use of the property would fetch a higher price on the open market, then the court may reject the evidence as too particular to the owner’s special plans for the property. The result will vary according to the special rules of each jurisdiction and the facts at hand.

In Conclusion: Know Your Jurisdiction

Courts have generated special rules to govern the admissibility of income evidence for the purpose of proving market value. Although some of these rules can be difficult to navigate—and different jurisdictions may have their own interpretations—income is still regularly used as a factor in determining the just compensation owed for a taking. By tailoring the considerations above to the rules of a given jurisdiction, owners can make their most effective argument as to how lost income should influence an award of just compensation.

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