What Undercompensation Problem?

Many thanks to Eugene for inviting me to blog about The Neglected Political Economy of Eminent Domain. As Eugene notes, I come to this subject with strong priors – I worked for the Institute for Justice (Susette Kelo’s attorneys), and I disagree with (although I was not surprised by) the holding in the Kelo case. In a previous article, I also used the undercompensation risk to justify strong public-use review. Thus, it is fair to say that I was surprised, upon further investigation, to reach the conclusion stated in the article—that legal scholars may overestimate the extent of the undercompensation problem.

I’ll divide my discussion into five posts. This first post explains why legal scholars assume that owners are undercompensated when their property is taken by eminent domain; it also argues that traditional discussions of eminent domain have been too court-centric, leading scholars to overlook the critical role that non-judicial government actors (“Takers”, if you will) play in the eminent domain process. On Tuesday, Wednesday, and Thursday, my posts will discuss three ways that “Takers” may minimize undercompensation. Finally, on Friday, I will explain why I believe that so-called “economic development takings” are problematic even if most owners receive above-market compensation.

The “Undercompensation Problem”

Scholarly concern about undercompensation flows from the fact that the constitutionally mandated measure of compensation in an eminent domain action — i.e, the property’s fair market value — can fail to indemnify owners fully. As Lee Fennell has helpfully described, the losses suffered by an owner whose property is taken by eminent domain may have both a “compensated increment” (the fair market value award) and an “uncompensated increment” (the owner’s losses exceeding that award). The "uncompensated increment" may be made up of any (or all) of the following losses:

• Economic Losses: Fair-market-value compensation does not cover relocation expenses, good will associated with a business’s location; it may also fall short of replacement value. Eminent domain also deprives owners of the gains from trade that a market transaction might generate. The inability to say “no” unquestionably leaves many owners worse off than if they had freely negotiated a purchase price. (This is not surprising. After all, the need to avoid holdouts strategically seeking unjust gains from trade is a common justification for eminent domain.)

• Subjective Losses: An owner may value her property more its market price. Cognitive psychologists and experimental economists have found that possession alone generates an “endowment effect” – i.e., individuals consistently demand more to part with an entitlement than they would be willing to pay for it in the first instance. While this “offer-ask” disparity only trivially affects most markets, it is greatest for episodic events such as an eminent domain action. Additionally, an owner’s sentimental attachment to her property - for example, the attachment resulting from the property's connection to family and community relationships - may widen this disparity between subjective- and market-value.

• Dignitary Losses: Carol Rose has observed that “there is something about land that makes you think that when you own it, it is really, really yours.” Perhaps for this reason, targets of eminent domain may suffer what can be broadly categorized as “dignitary harms.” Owners may feel unsettled upon learning that the government plans to take their property. Expanding the scope of the takings power may increase all property owners’ feelings of vulnerability. As Justice O’Connor observed in Kelo, “The specter of condemnation hangs over all property. Nothing is to prevent the State from replacing any Motel 6 with a Ritz-Carlton, any home with a shopping mall, or any farm with a factory.”

Owners also may attach independent, non-instrumental significance to the economic autonomy that property guarantees. The loss of economic autonomy may be particularly upsetting in the economic development context, for at least two related reasons: First, owners may be offended by the government’s implicit suggestion that the current use of their property is less than socially optimal and that some other private owner would put it to a “better” use. Second, property owners may feel that the government has treated them unfairly vis-à-vis other owners. To borrow from Saul Levmore’s work in the regulatory takings context, every exercise of eminent domain “singles out” individual property owners to bear the cost of broader societal goals. The knowledge that the government could have advanced its plans by taking someone else’s property may leave property owners asking “why me”?

A Non-Court-Centric Approach to Understanding Eminent Domain

The possibility that property owners may be undercompensated in the eminent domain process is frequently cited in the literature discussing the public-use problem. Some commentators—including myself—cite the potential for undercompensation as one reason that judicial policing of the boundary between “public” and “private” takings is needed. Others—most recently Professors James Krier and Chrisopher Serkin—have explicitly suggested additional compensation as an alternative to judicial review of public-use claims. Most of the eminent domain literature, however, ignores the important role of non-judicial government actors (the people that I call “Takers”) in the eminent domain process. Understanding Takers’ role is important because judges play only a bit part in the eminent domain process. Takers, not judges, shape projects, identify the property needed to complete them, and negotiate with property owners prior to instituting formal eminent domain actions. Indeed, in the vast majority of cases, formal eminent domain proceedings are never commenced.

The universal disregard for how eminent domain works outside of the courtroom may have led previous commentators (again, including myself) to overstate the undercompensation problem. Takers operate under incentives that should minimize undercompensation: They need to avoid holdouts and the political fallout from negative publicity. They are legally obligated to bargain with property owners and penalized financially if these negotiations fail. And they almost always are legally required to provide substantial relocation assistance to displaced owners. While the evidence presented here is incomplete—further study is in order—my article represents an important first step toward understanding how Takers’ behavior shapes the nature and extent of the undercompensation problem.

Takers May Minimize Undercompensation by Not Taking High-Value Properties

In yesterday’s post, I suggested that a failure to consider the role of non-judicial actors (“Takers”) in the eminent domain process may have led legal scholars to overstate the undercompensation problem. A number of the comments following the post assume, incorrectly, that I think that fair-market-value compensation will fully indemnify owners. I agree that a fair-market-value award will often result in undercompensation. What my article argues instead is that scholars mistakenly focus exclusively on the constitutionally mandated measure of damages in an eminent domain action and disregard extra-judicial means of minimizing the undercompensation risk.

Academic discussions tend to assume that there are two ways to minimize the risk of undercompensation. The first is substantive limits on the use of eminent domain. The second is above-market compensation. As I will discuss in my posts tomorrow and Thursday, many owners probably do receive more than the fair market value of their property — because they are entitled to substantial relocation assistance, because they settle on above-market prices during mandatory pre-condemnation negotiations with Takers, or both.

The literature overlooks third way that Takers might minimize uncompensated losses — simply avoid taking properties with high subjective value. The complete lack of attention to this dynamic is unsurprising, but unfortunate. It is unsurprising because the government usually owes a property owner nothing until it takes her property — which is why most of the “takings” literature concentrates on discerning when a taking has occurred, rather than how much is owed once it has. It is unfortunate because the government’s plans frequently are flexible: it can pursue policy objectives by various means, and, in the eminent domain context, with different parcels of property.

My article uses a historical case study — the preservation of Catholic churches along Chicago expressways — to explore how Takers can exercise this flexibility to minimize subjective losses. Over two dozen Catholic churches line these expressways. Driving through the city, it is easy to forget that these churches once served as the spiritual and social hearts of neighborhoods now buried under fourteen lanes of concrete. When the expressways were built in the mid-1950s, over two million Catholics lived in the Archdiocese of Chicago, more than half of them in densely populated urban neighborhoods like the ones dissected by these freeways. Yet, while expressways displaced thousands of parishioners, only five Catholic churches were destroyed. Planners assiduously avoided the Archdiocese’s four hundred other churches.

At one point, the Department of Public Works announced plans to reroute the Kennedy Expressway through St. Stanislaus Kostka Church and school. This proposal enraged Chicago’s Polish Catholics — the Archdiocese’s most important ethnic minority. If, as historians argue, the national parish was “the most important Polish-American institution,” then St. Stanislaus Kostka was the most important national parish in the most Polish of all American cities. The parish website claims that St. Stanislaus was, at the time, “the largest parish in the United States, if not the world, with 8,000 families, totaling 40,000 people” and that it remains “the mother Catholic Church of Polish parishes.” The Polish community quickly organized to oppose the demolition. Cardinal Stritch personally approached the Governor of Illinois, and the expressway was rerouted. The freeway bend around St. Stanislaus is evident on Google earth or any navigation system. (Address for curious readers: 1351 W. Evergreen Ave., Chicago, IL.) According to historian Steven Avella, expressway routes were altered at least three other times to preserve the geographic integrity of parish boundaries.

The fact that highway planners in mid-twentieth century Chicago avoided demolishing Catholic churches is hardly surprising. Neil Komesar has described a “two-force” political model, in which democratic actors are prone to both majoritarian and minoritarian biases, leading to both the “fear of the few” and the “fear of the many.” In Chicago, the individuals who rallied to save expressway churches were, in a sense, both the few and the many. Catholics made up a majority of the City’s voters, and certainly Democratic voters. The city’s powerful Irish Catholic mayor, Richard J. Daley, undoubtedly preferred, when possible, to avoid disrupting the spiritual lives of thousands of co-religionists (who also happened to vote Democratic). Indeed, Mayor Daley was the chair of a Transportation Advisory Group which, in the mid-1960s, issued guidelines indicating that “parish boundaries” should be considered when determining freeway routes.

Majoritarian clout is not the sine qua non of successful political advocacy, however. Another important lesson of the Chicago expressway churches may be that high subjective values may correlate with successful efforts to prevent takings. Subjective attachment provides an incentive to oppose takings and increases the intensity of the opposition. While the episodic nature of physical takings may disadvantage property owners in the political process, public-choice theory also teaches that political actors are particularly responsive to cohesive, well-organized and narrowly-focused coalitions like those that characterized parish-preservation efforts. Just as the subjective value that Catholics attached to parishes undoubtedly increased the intensity of the focus of church-preservation efforts, so also did the affected communities’ cohesiveness reduce impediments to organization.

We need to know more about pre-condemnation planning, but the story of Chicago’s expressway churches provides an opportunity to reflect whether, and when, political actors can be expected to refrain from the use of eminent domain. Assuming that many Takers will reasonably prefer the path of least resistance, the planning process itself might minimize the risk of undercompensation. It will zero it out, however. Indeed, the political process may have the troubling effect of shifting the problem to disorganized, politically powerless owners. Judicial review and/or above-market compensation is needed to protect them.

Replacement, not Market, Value

First, a comment on Ilya’s thoughtful response to my post yesterday. Ilya argues that my story about Catholic churches along Chicago’s expressways is more about political power than subjective value. I don’t deny this. Catholics had clout in 1950s Chicago. But, I also stand by my argument that high-subjective value may intensify political opposition to takings (and therefore, increase the likelihood such efforts will succeed). Ilya is also right to point out that many thousands of private homes, with high subjective values, have been taken over the years. As I argue in my paper, subjective value alone may not be enough; homes may not provide the natural rallying points for collective action that the parish churches did.

I agree completely that that the avoidance phenomenon I discussed yesterday will not zero-out owners’ subjective losses. More money (and perhaps public use review) also is needed to protect owners. It is curious, however, that the eminent domain literature focuses almost exclusively on the compensation mandated by the Constitution, rather than the amount of compensation that the Takers actually pay property owners. This literature overlooks the extent to which owners frequently are legally entitled to substantially more than the fair market value of their property. This oversight might be the result of confusion over terminology – the compensation is frequently labeled “relocation assistance”; it also might result from law professors’ constitutional-law-centric orientation. But to even begin a discussion of the compensation question, it is necessary to understand what federal and state laws actually require governments to pay dislocated owners. This post provides a brief outline of these legal entitlements.

Federal Relocation Assistance

Uniform Relocation Assistance and Real Properties Acquisition Act of 1971 (enacted in response to the concern that the individuals displaced by highway and urban renewal projects suffered substantial financial hardship) requires federal agencies, as well as state and local agencies receiving federal funds, to provide relocation assistance whenever they displace property owners. The Uniform Act essentially guarantees that owners receive their property’s replacement value, not its market value, by requiring Takers to ensure that displacees can secure comparable replacement housing,. Takers must take whatever steps are necessary, including, as a last resort, the purchase or construction of a new home “in order to re-house displaces and permit a project to continue in a timely fashion.” Takers must also compensate displaced owners for moving expenses, as well as mortgage, and closing costs; businesses are entitled to receive up to $10,000 for “reestablishment” expenses.

The replacement-dwelling guarantee can substantially improve the housing situation of displaced occupants. Because the replacement dwelling must be “decent, safe, and sanitary,” “adequate in size to accommodate the occupants,” “within the financial means of the displaced person,” and “in a location generally not less desirable than the location of the displaced person’s dwelling” Takers sometimes must secure a larger, more expensive home for a resident—for example, because a family’s current dwelling lacks the appropriate number of bedrooms for their children under local housing codes. Technically, the displacing agency is directed to pay up to $22,500 to enable a homeowner to purchase an appropriate residence. (Tenants are entitled to up to $5,200.) It is fairly clear, however, that that these limits are routinely exceeded.

State Relocation Assistance

Since federal funds help finance many highway and redevelopment projects, the extent of the Uniform Act’s guarantee is quite broad. Moreover, most states extend it to all projects receiving state funds, and a few require it for condemnations by any public entity. In addition, there is a trend toward providing additional compensation for dislocated businesses. For example, direct recovery of business losses, such as a loss of good will, is allowed in a handful of states.

Relocation Assistance In Practice

A handful of empirical studies provide a snapshot of how relocation-assistance programs work in practice. Two themes emerge from these studies: First, the dollar amount of relocation-assistance received by residents displaced by eminent domain usually is quite generous. Second, relocation assistance frequently falls short of fully compensating businesses for their losses. U.S. Department of Transportation’s Relocation Retrospective Study, conducted in 1995, provides the most complete recent picture of residential relocation assistance. This study found that residential property owners were pleased overall with the relocation assistance that they received. In fact, nearly ninety percent of the homeowners (and all but one tenant) surveyed indicated that they were “able to significantly upgrade” their housing.

In contrast, business relocation assistance is almost universally condemned as insufficient. One survey of 224 businesses found that the maxium business-reestablishment payment ($10000) was “almost universally considered inadequate.” Interestingly, business owners’ most significant complaint is that the maximum reestablishment payment falls far short of the costs needed to make modifications required by various regulatory codes, especially the Americans with Disabilities Act. Even in states which have elected to use state funds to exceed the $10,000 maximum, business owners complain that their code-compliance costs are not covered.

Undercompensation Revisted?

Relocation assistance generally provides owners with above-market compensation, but it does not guarantee that they are fully compensated for their losses. To fully understand the nature and extent (if any) of the undercompensation problem, we need to know more about how eminent domain works in practice. We need to understand what happens during pre-condemnation negotiations—the subject of my post tomorrow. We also need to know whether Takers tend to target certain disadvantaged owners (the poor, minorities, the politically powerless), and, if so, whether these owners are also systematically disadvantaged with respect to compensation as well. These empirical questions cry out for more research.

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.