[Nicole Garnett (guest-blogging), February 15, 2007 at 2:41pm] Trackbacks
Precondemnation Negotiations

Most academic discussions of eminent domain also overlook the fact that the compensation that a property owner receives almost always results from a bargain between the owner and a Taker, rather than a judicial determination of the property's fair market value. State and federal laws require Takers, in most instances, to seek to purchase property on the market before resorting to eminent domain. Even if pre-condemnation bargaining were not required, the government would have important incentives to negotiate to avoid the high "due process costs" associated with a formal eminent domain proceeding.

Anecdotal accounts accusing the government of "low balling" property owners during pre-condemnation negotiations are common. It is difficult to evaluate these claims. Certainly, the negotiations that precede a condemnation differ in material respects from arms-length negotiations between private individuals. Pre-condemnation negotiations really do occur in "in the shadow of the law." Eminent domain is the classic example of liability-rule protection of an entitlement: both parties understand that an objecting property owner cannot ultimately say no. Owners have little incentive to ask for more than market value if they realize that they will not get it. Of course, if a property owner believes that the government is understating the value of her property, she could exercise her legal right to challenge the amount of compensation offered in court. But, a rational property owner will not force the government to condemn her land unless the expected value of the proceeding—that is, the award minus litigation costs—exceeds the government's offer.

That said, Takers operate under significant incentives to reach a mutually advantageous agreement. For example, many states penalize the government for failed negotiations by awarding the property owner attorney fees and costs if the final judgment in an eminent domain proceeding exceeds the government's final offer. These fee-shifting statutes penalize the government for unreasonably refusing to settle prior to trial. As a California appellate court recently observed, "one would expect a prudent condemnor to offer its best estimate of fair market value plus some reflection of its own savings from avoiding trial, with a further upward adjustment for elimination of potential liability for the condemnee's litigation expenses." Building the H2 Plant: A Bargaining Case Study

Because the negotiations between property owners and Takers are opaque and decentralized, it is difficult to gain information about how the bargaining process works. The remainder of this Post therefore outlines a case study that I conducted of an economic-development project near my home in South Bend, Indiana. This project required the assembly of fifty-two parcels in order to construct a manufacturing facility that promised to generate significant economic benefits to a relatively depressed economic area. This case study is not generalizable, but it does yield insights into the kinds of factors influencing Takers' negotiations with property owners.

AM General has manufactured "Humvees" in northern Indiana since 1984. In 1992, AM General began to use this plant to manufacture ultra-luxury sports utility vehicles (known as the "Hummer" or "H1") for civilian use. In 1999, GM acquired exclusive rights to the Hummer trademark, but agreed that AM General would manufacture a smaller, more affordable, "H2," for GM. This agreement was conditioned upon AM General acquiring the property for a new 630,000-square-foot manufacturing facility quite quickly. AM General and GM decided to build the new plant directly adjacent to the existing Humvee facility. The property needed for these purposes consisted of fifty-two separate lots in a low-density, blue-collar, residential neighborhood.

AM General itself acquired the seven parcels directly adjacent to its property; these property owners received, on average, 141% of the appraised value of their homes. St. Joseph County, Indiana agreed to acquire the remainder of the needed land, by eminent domain if necessary. The County began to take steps to pave the way for condemnations. These initial legal moves upset residents, causing the the County to allow more time for private negotiations. Between March and June of 2000, the County purchased the remaining parcels voluntarily. The County now leases the property back to AM General.

In preparation for negotiations with property owners, county officials consulted with several private companies that had assembled land for large projects in the area. These experts indicated that assembling property that is not currently on the market usually requires prices that exceed market value by 20 to 25 percent. Apparently in response to this advice, county officials decided to comply with the federal relocation assistance guidelines. While the County did not believe that it was bound by these rules, generous relocation assistance was seen as a way to expedite the bargaining process. Before approaching a landowner, the County acquired two appraisals of the targeted properties. The County also presented the property owners with an estimate of the relocation assistance that they would receive, in an effort to demonstrate that the fair market value award was only part of the compensation that they would receive. Finally, AM General independently offered to pay every property owner a $5000 bonus for meeting the voluntarily negotiated time schedule, half of which was paid at the closing and the other half when the owner vacated the property.

I collected data on the appraisals, sales prices, and relocation assistance for each of the parcels purchased by the County. This data reveals several very interesting things about the bargains between the County and the targeted property owners. First, property owners received, on average, 157% of the average appraised value of their property. Second, a significant part of the total compensation that owners received came in the form of relocation assistance. As a result, the total compensation received by owners displaced by the County actually exceeded the compensation received by the seven owners who negotiated directly with AM General. Third, the high compensation levels were almost universally attributable to replacement-value payments. With one exception (an unoccupied house), the county paid some form of replacement subsidy. The average replacement value stipend received by homeowners was $40,529.10 (nearly twice the statutory maximum); the payments ranged from a low of $441.74 to a high of $85,500. On average, owners received a replacement-value stipend equal to 44.81% of their sale price. Some stipends exceeded the sale price: One owner received $56,000 for his house and $85,500 to secure a replacement dwelling; another received a $74,300 replacement subsidy for his $69,000 house.

This case study is not intended to demonstrate how the pre-condemnation bargaining process works in every case. Pre-condemnation bargaining is context specific and undoubtedly is influenced by local legal, political and economic circumstances. But to understand eminent domain, we need to learn more about the ubiquitous -- but almost universally disregarded -- practice of precondemnation negotiations.