New Perspectives on Environmental Stigma and Property Values

Thomas O. Jackson, Ph.D., MAI, CRE

The earliest notions of stigma and its effect on property values held that any adverse environmental impact on property value could be categorized as environmental stigma. This notion of stigma made it difficult to explain and even more difficult to measure. Further, the effects of stigma on real property were considered relatively permanent and reductions in property value from contamination were assumed to last indefinitely, even after the remediation of a contaminated site has been completed and a "no further action" status has been achieved. This view was supported by such early cases as Bixby Ranch Co. v. Spectrol ElectronicsM, 8 Toxics L. Rep. (BNA) 955 (Cal. Super. Ct. 1993), which awarded damages based on finding a 20% post-remediation loss in the value of California industrial properties. Interestingly, valuation experts in this case presented little empirical evidence of such a loss, but rather relied on their "judgement."

Current thinking has focused on a more precise and measurable concept of environmental stigma. Rather than viewing it as a somewhat amorphous effect of contamination, stigma may be more accurately viewed as an effect produced by the market's perception of increased environmental risks. These risk perceptions and their effect on value are derived from perceived uncertainties concerning:

• The nature and extent of the contamination;
  
• Estimates of future remediation costs and their timing;
  
• Changes in regulatory requirements;
  
• Liabilities for cleanup;
  
• Potential off-site impacts; and
  
• Other factors.

These increased risks can occur before, during or after cleanup, and will vary considerably over the remediation cycle. As perceptions of environmental risk increase, the value and price of real property diminish. For commercial and industrial properties, environmental risk increases the equity investor's required rate of return, which lowers the amount that can be paid to achieve the higher return, adjusted for environmental risk. For residential properties, perceptions of increased risk also reduce property values due to perceived uncertainties about future utility (use and enjoyment) of property ownership because of environmental risk.

Recent empirical research has found that parties to real estate deals are increasingly knowledgeable and experienced in dealing with environmental risks. As knowledge and experience increases, risk is more accurately assessed, and generally risk related effects on property values decrease. This experience was evidenced in a 1999 survey of U.S. lenders and investors, which found that 74% of all mortgage lenders had been involved with a loan application on a property having environmental problems. Further, 52%, or over half, of these lenders had extended the loan. Of the investors, 76% had considered investing in or acquiring a property with environmental problems and 48% of these had proceeded with the acquisition or investment of the property with contamination related issues. This increase in experience and knowledge about environmental contamination has led to more frequent transactions involving contaminated properties, and a more accurate evaluation and pricing of environmental risk by the market.

As to the permanence of the effects of environmental risk, 93% of the lenders in the nationally representative survey indicated that they would not provide a mortgage loan on a source site property with groundwater contamination before cleanup without an approved remediation plan. During cleanup proceeding under an approved plan, 61% of the lenders would provide a first mortgage loan secured by the property. After cleanup to applicable regulatory standards, 96% of the lenders would provide a mortgage loan on the previously contaminated property, with little or no adjustments to their credit underwriting. National survey data on equity investors show a similar pattern. Before cleanup, 59% would not invest in a contaminated property, while after remediation 91% would invest, with most investors indicating "typical pricing." The investors were generally less averse to environmental risk than the lenders, although risk perceptions for both groups declined significantly over the remediation cycle. These risk perceptions virtually disappeared after cleanup to appropriate regulatory standards.

Many contaminated properties are being sold at a discount prior to completion of remediation and then resold at or above market levels. A recent study of transactions involving contaminated or previously contaminated properties found that such properties were sold at discounts of 20% to 30% prior to remediation, but at no discount after cleanup. In more scientific parlance, the prices of previously contaminated properties that had been remediated to applicable agency standards were not statistically significant from otherwise similar properties, after controlling for non-environmental property characteristics. In fact, many of the previously contaminated but remediated properties sold at premiums relative to their uncontaminated comparables. These findings are consistent with the survey research findings concerning perceptions of environmental risk before and after remediation. Thus, any stigma effects from increased environmental risks are temporary and diminish after remediation. These well-documented findings contradict the notion that stigma is a residual effect that persists after cleanup.

These research findings, and underlying changes in the market, have important implications for litigation and damage assessments involving contaminated properties. As the adverse effects of environmental stigma diminish over time, and as a result of remediation and regulatory compliance activities, the date at which damages are calculated will be critical. Secondly, if cleanup to regulatory standards lessens or eliminates the effect of stigma and risk on property values, then damages should be limited to remediation costs or risk related value diminution, but not both. Thirdly, since stigma is a temporary effect, it may not be an appropriate source of damages at all. Indeed, if only permanent stigma effects are compensable, given these research findings on the temporary nature of these effects, there is a diminishing economic rationale for stigma damages for previously contaminated properties.

Dr. Jackson is with the Land Economics and Real Estate Program, Dept. of Finance, Texas A&M University, College Station, Texas, and Real Property Analytics, Inc., Bryan, Texas (tomjackson@real-analytics.com). The studies referred to were conducted by Dr. Jackson with funding from the Decision, Risk and Manage-ment Science Program of the National Science Foundation and the Program on Land Markets of the Lincoln Institute of Land Policy. His analysis of environmental impacts on industrial properties won the 2001 Manuscript Award from the American Real Estate Society and the Society of Industrial and Office Realtors® as the best paper on industrial real estate.