1. Economics and the Valuation of “Contaminated” Residential Properties Louis Wilde Gnarus Advisors LLC and Almost Convex Economics 323 684 6885 louiswilde@gmail.com Jack Williamson Almost Convex Economics 323 683 5004 jwmson@almostconvex.com Presented at the Appraisal Institute’s 47 th Annual Litigation Seminar Los Angeles, November 13, 2014 Various citations and the presentation itself are available for download at http://www.almostconvex.com/downloads/

2. 1. Informational Efficiency Type of informational efficiency most relevant to valuation of contaminated residential properties is so-called “semi-strong form efficiency.” A market is semi-strong form efficient if information about a potentially relevant event is relatively quickly reflected in market prices once it is public, if at all. “Relatively quickly” depends on the type of market. Securities markets are expected to respond almost immediately. Real estate markets may take one or more months to respond, but not years. As a practical matter, if a market is semi-strong form efficient, then valuations should be based on actual sales prices. One court recently has held that even if a real estate market is not semi-strong form efficient, valuations still should be based on actual sales prices (ExxonMobil Corp. v. Albright et al., 2013)

3. 2. Informational Efficiency Evidence for semi-strong efficiency generally is based on “event studies,” known in the appraisal literature as before-and-after studies. See Randall Bell, Real Estate Damages: An Analysis of Detrimental Conditions, The Appraisal Institute, 1999. Both securities markets and real estate markets have long been held to be informationally efficient. See Louis Wilde, Gail Wurtzler and Jack Williamson, “Real Estate Markets are Informationally Efficient: Evidence from Buyer and Agent/Broker Surveys,” Environmental Claims Journal, 26(3):215–237, 2014. The implication is that if actual sales prices are not effected by public information relatively quickly, they are unlikely to ever be affected unless new information is made public. There are no credible examples of an “informational lag” in a real estate market.

4. 3. Informational Efficiency Buyer and broker surveys conducted by expert witnesses in litigation strongly support the conclusion that real estate markets are informationally efficient with respect to contamination events. E.g., Kellum, et al. v. Kuhlman Electric Corporation, et al. (2000): PCB contamination of groundwater; 83% of subject area buyers reported awareness of the contamination. Carol Antolovich et al. v. Brown Group Retail et al. (1998): TCE contamination of groundwater and air (vapors); 64% of subject area buyers reported disclosure or awareness of the contamination (but only 58% response rate to survey). Jayne Palmisano, et al. v. Olin Corporation, et al. (2002): Perchlorate contamination of groundwater; 94% of subject area buyers reported awareness of the contamination. Nancy Sher, et al. v. Raytheon Company (2008): TCE and other contamination of groundwater; 83% of subject area transactions involved disclosure of the contamination as reported by participant brokers. See Wilde, Wurtzler and Williamson (2014).

5. 4. Economic Methodologies Hedonic Regression Analysis Contingent Valuation Methodology and Related Surveys Meta-Analysis

6. 5. Hedonic Regression Analysis (HRA) Many decades of published studies in the appraisal and real estate economics literature rely on this methodology. Presumes that the relevant real estate market is informationally efficient. Focuses on systematic market-wide effects; should not be used to predict individual sales prices. Until recently was generally immune to motions to exclude.

7. 6. Example of Hedonic-Based Projected Values From Louis Wilde and Jack Williamson, “A Hedonic Analysis of the Effects of Sequential Environmental Events on Residential Property Values,” draft, March, 2014 See also Louis Wilde, Christopher Loos, and Jack Williamson, “A Long-Term Study of the Effect of a Natural Gas Pipeline on Residential Property Values,” Journal of Real Estate Literature, Vol. 22(1), 2014

8. 7. Exclusion of Opinions Based Upon HRA The Ponca Indian Tribe of Oklahoma, et al. v. Continental Carbon Co., et al. (2008) Failure to specify “trigger date” (i.e., no “before and after” analysis). Cannon, et al. v. BP Products North America, Inc. (2013) Improper control area. Misspecification - omission of key dummy variable. Failure to account for alternative explanations for diminution in value. David and Rikki Patrick, h/w, et al. v. FirstEnergy Generation Corporation (2013) Improper trigger date (based on irrelevant event).

9. 8. C ontingent Valuation Methodology (CVM) Surveys Imported from Natural Resource Economics. Historically used when market prices are not available. Use in valuing contaminated residential properties often assumes relevant real estate market is not informationally efficient. Yields unrealistic estimates of ultimate property value diminution, as high as 75%. No evidence that such dramatic effects subsequently occur. Increasingly vulnerable to motions to exclude.

10. 9. Exclusion of Opinions Based Upon CVM Examples of the exclusion of pvd opinions based on CVM surveys include the following cases. In general, the courts found such opinions to be speculative and/or less reliable than those based on actual sales prices. The court in Cannon raised additional issues such as the lack of a proper control area and a disconnect between the survey and the facts of the case. Baker v. Motorola et al. (2000) Jayne Palmisano, et al. v. Olin Corporation, et al. (2005) Abicht v. Republic Services of Ohio II, LLC (2013) ExxonMobil Corp. v. Albright et al(2013) Cannon, et al. v. BP Products North America, Inc. (2013) David and Rikki Patrick, h/w, et al. v. FirstEnergy Generation Corporation (2013)

11. 10. Meta-Analysis Widely used in scientific and economic disciplines; essentially a quantitative literature review using multiple regression techniques. Key published papers using meta-analysis related to the valuation of impaired properties, Simons and Saginor (2006) and Lipscomb, et al. (2013), are problematic. Seemingly used primarily by appraisers or real estate economists in litigation. Both papers suffer fatally from, among other things, the “apples and oranges” problem; that is, the studies included are too disparate for the results to mean anything.