Methods and Challenges in the Credible Valuation of Water Rights in Texas (Presented at the University of Texas School of Law Texas Water Law Institute, November 4, 2016)

Methods and Challenges in the Credible Valuation of Water Rights in Texas

By

Charles R. Porter Jr.

Visiting Professor, St. Edward’s University College of Education[1]

and

Edmond R. McCarthy, Jr.

 Jackson, Sjoberg, McCarthy and Townsend, L.L.P.

 

I believe that this is as much about the taking away of a lifestyle as it is about the decrease in the value of land. The Braggs invested their lives, labor and money in a good family farm . . . That life plan has been undermined, and their investment severely devalued. [2]

 

 

 

Many Texans, when asked, profess confusion about how to identify their water rights, what government entities regulate those water rights and, of utmost importance, the true market value of the water they own. Everyone believes their water rights have value, but few have experienced the sale of those water rights.  There is no Multiple Listing Service or “MLS” available similar to residential property sales markets to allow both buyers and sellers to instantly find true, reliable comparable sales in water transactions.  Similarly, there is no “Blue Book” for guidelines on how to value automobiles.  To begin the process of valuing a water right for sale or lease, the buyer, seller and/or lender must gain a fundamental understanding of the water rights to be sold or otherwise affected.  This process includes the identity of the person or entity who owns the water, what regulations apply, if any, and any other limitations that may impact the ability to transfer the water to the purchaser or lessee, and what process is required to close a sale or lease of the water right.  A thorough investigation must be undertaken to determine the credible, defendable fair market value of water. This can be an especially challenging task irrespective of the methodology used.

When it comes to water valuation, the commonly heard saying that “water is the next oil” is fundamentally flawed. Unlike oil, which is a truly finite resource that is only renewable over millennia, and is intended to be mined by the highest bidder, water is a renewable resource that can be conserved and, ideally, allocated fairly.  Certainly, water has real value; it has been said, “water renders the land its value.”[3]  This is particularly true especially in most farm and ranch real estate transactions.  To begin to discover an answer to what is the credible, defendable valuation of water and/or water rights proposed to be sold or conveyed, it is important to understand some basics about water ownership and applicable regulations.

A Brief Water Primer

Water rights in Texas vary between water flowing on the surface and water percolating underground. They can also vary from regulatory agency to regulatory agency, as well as from place to place, and from time to time.  A good example of the “conventional wisdom” that water rights in Texas are convoluted and, at times in the recent past, incomprehensible, is found in a ruling in 1955 made by Federal Judge James V. Allred, a former attorney general and governor of Texas.  Allred wrote,

For years it has been a matter of common knowledge that the Texas water laws and decisions are in hopeless confusion; that even if they are clear as some attorneys profess to believe them, their application and administration would be difficult … .[4]

When a well-known jurist such as Judge Allred expresses confusion and frustration with our water laws and decisions, in a published decision nonetheless, it is understandable why the general public may share his feelings.  Still today, few Texans understand the wider view of the legal, social, and economic consequences of our State’s water rights systems.

Water rights are the most fundamental “stick” in the “bundle of sticks” that determine all the “property rights” and much of the market value of any real property in Texas. Real estate simply sells at higher prices when it is (i) adjacent to surface water, (ii) has access to surface water irrigation diversion rights, and/or groundwater irrigation rights, or (iii) overlies bountiful amounts of fresh potable groundwater.  In many instances, the prices for such real estate are many multiples higher than comparable land without adequate water.

Why else is it important to know about water rights in Texas? In addition to the significant impact water rights have on the value of real property, statutory obligations burdening the use of such water resources have created a need to understand water rights because all known defects in real property must be disclosed to any potential purchaser during the time the purchasers are making their decision to buy.  This “duty” to disclose any defect known, including a known defect in a water right, is shared by sellers, lessors, and their real estate agents.  Buyers and lessees should be knowledgeable about the water rights associated with a property they are considering acquiring, and they must know what questions to ask about water rights in general.

The duty to disclose all known defects has become a part of our everyday real estate transactions in Texas and in most parts of the United States. As water becomes scarcer throughout Texas due to population growth and our inevitably recurring droughts, it has become imperative for sellers, buyers, and real estate agents to understand fully the water situation associated with any property.

Today, assessing the water characteristics of any particular property presents unique challenges not only to the buyers, sellers, lessors, lessees, and real estate agents, but also to their accountants, attorneys, and estate planners. The state’s predicted long-term water shortfalls require potential buyers to consider a variety of heretofore less often considered assessment criteria as a fundamental aspect of any real estate transaction.  Likewise, the potential of future water scarcity requires sellers and their real estate agents to exercise extreme caution and prudence in their fiduciary duties to their clients, and their duties to the public as a whole, regarding the water rights situation of any property offered for sale or under consideration for purchase.

Further complicating the often confusing and seemingly contradictory myriad of state water regulations, is the fact that several United States government agencies may have supra-legal[5] authority over Texas water policy either directly or indirectly.  Agencies such as the Environmental Protection Agency and the United States Fish and Wildlife Service promulgate rules that can significantly affect water rights.  Similarly, the Congress passes laws like the Clean Water Act that can affect private water rights.  The federal court decisions interpreting those rules and statutes historically have significantly modified water policies nationally and in Texas.   Local, state, and federal regulations can, and do, significantly affect the calculation of the fair market value of a water right.

Most Texans’ understanding of their water rights goes only as far as their ability to read the monthly water bill; as long as the faucet turns and water flows, assuming they pay the monthly bill, their water right is only limited by their ability to pay for the service The ubiquitous press reports, and everyday experience, proves to all but the most “asleep-at-the-wheel” Texan that we have recently “emerged” from the throes of yet another prolonged, record-setting drought.  Yet, even as eyewitnesses to the devastation of water scarcity all around us, the great majority of Texans do not have the most basic knowledge of how water rights are characterized and regulated in their state.  Texas’ Legislature, the state agencies, the real estate industry, and our educational institutions have offered the public little, if any, support in gaining this knowledge.   Due to our recent drought and the demonstrated existing shortages of water, and the predicted water shortages we will face in our not so distant future,[6] coupled with the obvious impact water has on our everyday lives, especially our property values, Texans must educate ourselves about water rights in Texas.

Texas Water Rights Overview

Characterizing a water right in Texas depends on which of four “geological containers”[7] holds the water.  The first container is our rivers, streams, lakes, bays and estuaries.  Known as surface water, this is the water that flows on the surface of the ground in a watercourse.[8] The State of Texas owns the water in a watercourse, held in trust for the citizens of the state, and may only be used as authorized by state law either pursuant to a water right or an exempt use.  The Texas Commission on Environmental Quality (TCEQ) regulates use of surface water in Texas by a system of water rights.[9]  The TCEQ, as part of its authority to manage and allocate the state’s water rights, oversees the 17 statewide river authorities, 4 Watermasters,[10] and hundreds of special purpose districts.

The second so-called geological container is known as diffused surface water.  This rainwater, also known as “sheet flow” is the water that runs off your roof and/or over the surface of your land before it enters into a flowing stream or channel.  The water in this container is owned by the landowner as private property.  The TCEQ ostensibly oversees this geological container, but there are no permits issued related to its use or management.

The third container is groundwater or water that percolates underground in aquifers and pools.  Ownership of groundwater in Texas was debated for many decades.  In the spring  of 2011 the debate about ownership of groundwater ended for all practical purposes: The Texas Legislature passed a bill (Senate Bill 332 by Fraser) amending Section 36.002, with this simple language:  “The legislature recognizes that a landowner owns the groundwater below the surface of the landowner’s land as real property.”[11]  In February 2012, the Texas Supreme Court confirmed the landowner’s ownership of the groundwater as his/her private property, constitutionally protected from “taking” without due compensation in EAA v. Day.[12]

The majority of groundwater in Texas is regulated by 100 local Groundwater Conservation Districts (GCDs) with 100 different sets of rules and regulations.[13]  Of the special groundwater districts created by the legislature, perhaps the best known is the Edwards Aquifer Authority (EAA).[14]  The EAA regulates the groundwater in the Edwards Aquifer.  It is safe to say that most citizens in the  jurisdictions of the GCDs and special districts are unaware of the regulatory agencies.

A fourth geological container, known as “developed” water, has been described by one commentator as follows:

Developed water is generally considered to be new water because it has been artificially introduced into the watercourse, i.e., it is water that would not be part of the normal flow of the watercourse but for the activities of the developer. Developed water can include drainage, return water, groundwater delivered to a watercourse, and surface water that is returned to a watercourse other than the originating watercourse or river basin. In the context of surface water owned by the state, so long as the owner of the developed water retains physical control over it, he has the right to its continued beneficial use for the purpose(s) authorized by his water right, e.g., permit, certificate of adjudication, or certified filing. Like diffused water, once physical control of the developed water is either lost or abandoned and it is allowed to flow into a watercourse and again become part of the ordinary flow, it loses its character as developed water and reverts to state owned surface water. Additionally, once the water right holder has beneficially used the surface water, it cannot be claimed as developed water if by the terms and conditions of the authorization it must be returned to a watercourse.[15]

Surface Water Regulators and Regulations

The “buck-stops-here” surface water regulator in Texas is the TCEQ.[16]  Absent a statutorily authorized exempt use,[17] a permit is required from TCEQ in order to use surface water in Texas.[18]   According to the TCEQ, “ . . . anyone who wants to use surface water in Texas must first get permission from the state unless they are using the water for one of several exempt uses. These exempt uses allow anyone to use surface water without getting permission.”[19]  Domestic and livestock use, wildlife management use, and emergency use by fire departments and other similar public services comprise the bulk of these exemptions.[20]

Surface water rights in Texas River Basins are, for the most part, fully allocated. The decades’ long implementation of the Water Rights Adjudication Act of 1967 clarified individual surface water rights for agricultural (generally irrigation), industrial, municipal, and other specific uses.[21]  It is likely that the surface water found any place west of IH 35 in Texas is  over allocated, at least on paper, due to the recurring droughts.

An example of the public’s lack of knowledge about surface water regulations is found in the all but standard question asked about lake water use. Most often this question comes from Lake Travis property owners or potential purchasers of land there: “May I pump water from the lake to my home since I am adjacent to the water?”  The answer is “no, you must obtain a permit from the Lower Colorado River Authority to do so.”  Many times upon hearing that answer, the questioner moves to a rather lengthy uniformed and incorrectly reasoned discussion of why he or she has “riparian” rights that overrule the LCRA’s regulations, that they are going to take the water anyway, and they cannot wait to see the LCRA in court.  Usually the questioner completes their comments with a rave about how the state needs to stay out of their business.  The potential severity of the fines for violation of water use on a lake emphasizes the TCEQ’s authority over the use of surface water or the river authorities’ jurisdiction within their boundaries.  There is another level of water regulation that even fewer Texans understand – the jurisdiction and duties of our 4 state Watermasters.

Our water rights system and management is rooted in our Spanish heritage developed over the past 300 years.[22]  The role of the watermaster is one of the oldest regulatory and management of water in Texas.  The first mayordomo[23], or “ditch boss”, in what would become later the state of Texas was appointed by the King of Spain in 1732 in Villa San Fernando, the predecessor village to modern San Antonio. The work of the mayordomo in Spanish Colonial Texas was very similar to the work of our modern watermasters.  Today, according to the TCEQ,

Watermasters divide the water in their areas based on the adjudicated water rights, regulate as necessary the controlling works of reservoirs and diversion works, and monitor stream flows, reservoir levels, and water use. Watermaster programs ensure compliance with water rights by monitoring stream flows, reservoir levels, and water use. Watermasters also coordinate diversions and regulate reservoirs as needed to prevent the wasting of water or its being used in quantities beyond a user’s right.

Before diverting, a water right holder must notify the watermaster of the intent to divert at a specific time and the specific amount of water to be diverted. If the water is available and the water right holder will not exceed its annual authorized appropriation of water, the watermaster then authorizes the diversion and records this against the right. The watermaster programs include staff “deputies” who perform regular field inspections of authorized diversions to insure compliance with the water right.[24]

Decisions made by the four Texas watermasters can open the door for misunderstanding and at times, litigation absent full disclosures of conditions to a potential buyer. For example, in the Concho River Watermaster jurisdiction, those owning valid, but junior in priority rights to divert water from the river have not been able to take their full appropriation of water for many years due to low flow conditions and the requirement to satisfy senior downstream water rights first.

Here is an example of the problems that can occur when the watermaster’s regulations and practices are not disclosed to a potential purchaser of land. It is normal and quite acceptable for sellers of real property and their real estate agents to advertise the positive features of the property being offered for sale.  Without doubt, a prior appropriative right, especially if the right is a senior diversion right, to take water from the Concho River for irrigation purposes is a valuable feature of any property for sale.  Yet, caution must be taken to fully and accurately disclose the details about the actual process and true volume of water the watermaster allowed to be taken.

Assume the seller has a senior appropriative right to divert 30 acre feet[25] annually from the Concho River, but the watermaster has only allowed diversions equaling to 10 acre feet annually in the past few years due to drought conditions and resultant low flow conditions. The seller and real estate agents must modify their representations to inform the potential buyer that although the senior water right allows diversion of up to 30 acre feet a year, the amount diverted has not exceed 10 acre feet for the precise number of years.  If not, especially since appropriative water rights are very valuable, the buyer may have claim for misrepresentation against the seller and real estate agent.  This example is just one of many, and as surface water continues to grow scarcer hence more valuable, surely more opportunities for “misunderstandings” will occur.  Groundwater regulations across our state can be even more complicated and just as “unrealized” by the general public.

Groundwater Regulators and Regulations

Groundwater Conservation Districts (GCDs) were first authorized by an act of the 1949 Texas Legislature; the first district formed in 1951. There are now 100 GCDs in Texas covering about 3/4ths of the state. [26] These districts can be created by the TCEQ or by direct actions of the legislature.[27]  Each district has its own set of rules and regulations, its own definition of terms such as “domestic and livestock uses,” and its own permitting requirements.  Many of the districts have boundaries coincident with county lines, as if the groundwater below recognized and followed political boundaries.[28]

Unless they are very savvy or have discovered they had to apply for a permit from their water well driller or other source, the general public in Texas has little or no knowledge that GCDs exist, even when they are in the jurisdiction of the few that have ad valorem taxation authority.[29]   In 2015, the Legislature amended the Texas Property Code to require sellers to disclose the fact that property was located within a groundwater district.[30]

GCD managers all over the state express their frustration in the lack of involvement by their constituency; few citizens other than those directly requesting a permit, ever attend their Board of Directors meetings. The general public simply rarely understands the regulations effecting their groundwater rights or even knows if their property lies within the jurisdiction of a GCD.

Accordingly, when involved in the sale or purchase of water rights, an attorney who understands and has experience in transfer of water rights, should be consulted prior to making a decision to buy or sell.

Water Valuation Methodologies and Challenges 

The three traditional and widely accepted methods or approaches to determining the fair market value[31] of real property are the replacement cost also known as cost approach, the sales comparison approach, and the income capitalization approach or capitalization of the net operating income stream generated from operation of the property.  Another method that may prove useful in the determination of credible water valuations is the valuations offered in rulings and judgments of our courts.  All of the methodologies should be considered to determine the value of a water right.

The generally accepted short definition of “fair market value” is the price a buyer and seller will arrive at to consummate the sales transactions with neither party being under duress.[32] A more thorough definition of fair market value however is more appropriate to use in estimating the value of water or a water right.  Academics William B. Brueggeman, Ph.D. and Jeffrey D. Fisher, Ph.D.[33] offer the best and most comprehensive definition of fair market value as follows:

Market value is a key consideration when financing or investing [emphasis added] in income-producing properties. It is defined as follows:

The most probable price [emphasis added] which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller acting prudently and knowledgably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby:

 

  1. Buyer and seller are typically motivated;

 

  1. Both parties are well-informed or well-advised, and acting in what they consider their best interests;

 

  1. A reasonable time is allowed for exposure in the open market;

 

  1. Payment is made in terms of cash in United States dollars or in terms of financial arrangements comparable thereto; and,

 

  1. The price represents the normal consideration for the property sold unaffected by special or creative financing or sale concessions granted by anyone associated with the sale.[34]

Due to the depth of analysis it contemplates, definition developed by Brueggeman and Fisher appears to be appropriate for use in water valuation. The basis for this conclusion is important to fully understand.

First, the term “the most probable price” makes a very specific and realistic point that must  always be kept in mind when offering any fair market valuation of water because water valuation is not like traditional real property valuation. The value of water is based upon so many variables that any value or price opined should be given only as “most probable.” It should also be coupled with the qualifier of “most probable” because water transactions, maybe more so than in traditional real estate transactions, are the epitome of “time is of the essence” transactions.[35]

Buyers of water or water rights, especially agricultural operators growing fragile crops, factor the timeliness of the actual delivery of the water purchased heavily into the price they agree to pay. The phrase “Implicit in this definition is the consummation of a sale as of a specified date” in the  Brueggeman and Fisher definition incorporates this “time is of the essence” concept.  Water valuation is greatly influenced by “time.” The market for water is so dynamic that significant changes often occur in very short periods of time.

Additionally, the proffered definition includes the idea that the buyer and seller are both acting prudently and knowledgably, an idea that experience shows can be rare in water transactions.  Buyers and sellers of water rights today in Texas are faced with the arduous task of self-education into the intricacies and complexities of water rights and regulations, knowledge that is simply not readily available from any one source. For example, with 100 different GCDs each having a unique set of rules and regulations, coupled with the widely variable nature of water resources around the state, acting “knowledgably” is a difficult goal to accomplish and takes on a new urgency.

Water policies change often and are further complicated by several factors, including the permitting process, the overlapping jurisdictions between federal and state agencies especially in surface water, and by the wide variances in rules and regulations of the GCDs. Complicating  the groundwater conservation district challenges is that experience has shown that the ways in which GCD boards grant permits for groundwater transfer can be inconsistent and unpredictable at times.   Any water valuation must include a realistic assessment of the potential impacts of any regulatory permitting process, the cost in time and money to discover feasibility information, and the conflicting doctrines and practices of the regulatory agencies involved to achieve the final permit.

Third, Brueggeman and Fisher’s “undue stimulus” refers to the widely accepted concept of  “duress” on either party used in the traditional definition of “fair market value.”  “Undue stimulus” takes into account not only the idea that parties could be under personal duress, but also includes notions such as the case of an oil exploration company that must have water for hydraulic fracturing at the exact time it is needed and not a minute later. During the normal conditions of drought experienced west of IH 35 in Texas, duress and undue stimulus are much more likely to enter into a water valuation equation. Any valuation must be adjusted for the drought conditions at the time the valuation is made in order to more credibly meet the “most probable price” goal of the valuation opinion.

Brueggeman and Fisher’s definition also recognizes that “reasonable time of exposure to the market” is another challenge in water valuation, especially in groundwater transfers. What constitutes a “reasonable time” in a proposed groundwater transaction can vary greatly from GCD to GCD; in a proposed surface water transaction, “reasonable time” can vary by watermaster and geographical regions, river authority jurisdictions, and the level of the backlog of overall TCEQ surface water application processing.

The exposure to as broad a group of potential buyers or lessors usually does influence the most probable price attainable. Traditionally, it is not easy to discover water rights for sale or lease so it is incumbent on the seller or lessor, more so than in other real property transactions, to find a path to full exposure of their offerings in order to reach as vast a market of buyers or lessees as possible.

Brueggeman and Fisher’s concept of normal “consideration” without creative financing is highly germane to water valuation. An important element that requires an adjustment in the most probable price of a water right is any impact  “creative” financing could have on the eventually agreed to price. Very short term loans without longer term loan take out commitments skew agreed upon prices.  Loosely underwritten seller or lessor financing do the same, as any other non-traditional underwriting criteria.  Typical lenders in water rights acquisitions face first and foremost the challenge of understanding the basics of water rights in order to to begin to properly underwrite and assess the risk of any water-related loan.  Their underwriting process must be prepared to meet the stringent requirements of the eventual audits from government agencies or other assessors of risk, especially by bank deposit insurers such as the Federal Deposit Insurance Corporation.  It is highly likely that federal Office of the Comptroller of the Currency’s bank auditors will not immediately understand water rights transactions; most of their experience is in more traditional real estate loan valuation.

Keep in mind also that the vast majority of real estate related loans over the past decade have been underwritten to allow the loans to be sold in the secondary market. It is very unlikely that a loan made to acquire a water right will be able to be sold into a secondary market easily.  Similarly, it is unlikely that a water right loan could be “securitized” as more recent real estate loans have been, constituting a real time damper on financing any water right acquisition.  An even more basic aspect influencing the ability to find financing for a water project or right is the simple question – will enough water be present at the water’s source to fulfill the long term obligations of volume in any water contract?

Another potential complication to these four methodologies to arrive at fair market valuation of water is the chemical and geological nature of the subject water itself. For example, in the traditional valuation of real estate, scientific investigation is usually limited to physical inspections of the land and improvements and defects thereto.  The concept of a “Phase I Environmental Assessment” easily is well understood in traditional real estate deals; however, it does not easily translate into the valuation of water which requires at the least a chemical analysis of the quality of the water.  The reliability, availability, and amount of the water to be sold must also be reasonably estimated based on scientific testing and analysis at the source of the water.

The natural fact that all of the “geological containers of water” described above are constantly in changing and subject to drainage in many ways can greatly influence the long term reliability of the availability of the water source. For example, most groundwater does not lie in a static “bath tub” like formation.  The amount and accessibility of the water stored in the aquifer can be affected in many ways, including being impacted by pressure changes in the aquifer that do not reduce the available volume of water, but dramatically change the aquifer level and the lifting/pumping requirements to access the water that are difficult if not impossible to observe or predict.[36]  Gaining the confidence of the buyer, lessee, or lender as to the reliability of the source water in volume and quality just might be the most basic hurdle in fair market valuation.

Demand for a water right is also fickle and highly dependent upon rainfall amounts, very dependent upon the immediate varying needs of water buyers, and at times strange local politics. Most people forget that “demand” has two dependent elements in order to be “effective” demand – desire for the product or good welded with the ability to pay for the product or good.[37]  In many areas of our state, the ability of any community to pay for water can be quite limited, even though there is strong desire and/or even need.  According to then State Comptroller Susan Combs’ 2012 report titled “Your Money and Local Debt,” many local governments in Texas were deeply in debt.  A reasonable conclusion to be drawn from reading Combs’ report is simple: many local governments in Texas simply cannot afford any more debt nor should they seek it, even if they desperately need water.[38]

Determining Whether a Water Market Even Exists?

Of the most critical consideration, more so in water valuation than traditional real property valuation,[39] is whether or not the water sold or leased is truly deliverable both legally and/or politically.[40] In order for a water transaction to be consummated, the water must be delivered to the buyer. Accordingly, the three groups of questions below offer a starting place to determine if a potential market for the water actually exists in any given area.

Questions about transferability and deliverability.

  • Would the ability to transfer/deliver the water to the buyer from surface rights or groundwater rights be a factor in the “value” of that groundwater?
  • Will the TCEQ rules allow the water right to be sold and delivered?
  • Will the local GCD rules allow the groundwater to be sold or leased and transferred out of the district and in what quantity?
  • Will the local people “revolt” against the transfer out of their district and cause expensive delays making the potential sale or lease infeasible and imprudent?
  • Is acquisition of right of way able to be acquired in a timely manner to fulfill any sale or lease contract?
  • Can a distribution system be installed including lift stations with ingress and egress from the well sites for maintenance and operations in a timely manner to fulfill the contract?

Questions about the use of the water.

  • What is the ultimate use of the water? Use of the water has a great impact on its market value. Use of the water for a corn crop or other agri-business uses surely influences the market value and generally indicates a lower value for the water. Of course, this varies from crop to crop and varies geographically. Use for bottled water or other industrial uses certainly influences the market value of the water and generally indicates a higher value for the water.
  • Is the use “beneficial”?[41]
  • Is the use of the type that will not cause subsidence?

Questions about market demand, depth, and absorption.

  • Will the market be able to absorb the amount of water offered for sale or lease?
  • Can the water be delivered in a timely manner to meet current demand?
  • How “deep” is the demand, how many buyers are there?
  • What factors must be considered if the water is being sold or leased to a municipality?

These groups of questions are a sample starting list that must be asked and answered by both buyer and seller before considering purchase or sale of any water right. There are surely many other questions that might need to be considered as determined by the uniqueness of any certain water sale or lease.

If the answers to the three groups of questions above indicate the proposed water transaction is feasible, then prudent value experts should next use all four aforementioned valuation methodologies to generate a complete picture of fair market value. We will begin our analysis with an examination of the replacement cost method.

The Replacement Cost Method

How can the “replacement” cost[42] of water be calculated?  “Water” as a molecule cannot be rebuilt in the traditional way a real property improvement can be, but development of a surface or groundwater-sourced irrigation system is a good example of an actually “built” water replacement system of definable parts whose the costs are readily discernable and defendable. Take for example, a typical center pivot groundwater irrigation system. It is comprised of these three basic parts:

  1. The groundwater well. Across the state, the cost of drilling a well ranges from $10-$35 per linear foot in depth to the water source. This cost is highly variable dependent upon the depth of the groundwater, the geology of the strata that must be drilled through to reach the water, the cost to create ingress and egress to the drill site, the size of submersible pump required to pull the water up, and the cost of the casing to secure the drill hole.  In recent years due to the strong market in scrap metals mostly purchased by China for dams and other needs, heavy steel casing has become very expensive.  In fact, the largest portion of deeper groundwater wells recently has been the cost of the casing.[43]
  2. The distribution system. Most modern day irrigation systems in Texas use center pivot sprinklers in lieu of canal or flood irrigation. As the name implies, a center pivot system pivots like a compass around a central point, usually the groundwater well itself. The cost of center pivot equipment is based upon the overall length of the sprinkler system and the type of individual nozzles attached.
  3. The power source for the well pump. This could include a new electricity line to power the well pump or the purchase of a diesel engine.

Certainly in many situations, there are other elements needed to complete a center pivot irrigation system. However, for the example below to determine the replacement cost of a center pivot irrigation system to provide water for an 80 acre corn field three basis elements are the focus:

  • Well depth,
  • Pivot arm length, and
  • Distance required to run power lines.

The following is an estimate relying on these three elements.

A Basic Center Pivot Irrigation System

Item                                                    Cost                            Total Cost

600 foot deep groundwater well with casing              $   35 per foot             $  21,000

1,000 foot center pivot sprinkler system                     $ 104 per foot              104,000

1,000 feet of electricity line and poles                           $    5 per foot                    5,000

Total System Replacement Cost Estimate                                                    $ 130,000

or $1,625 per acre[44]

Water is valued based on a per-acre-foot measure. How then can this cost be converted into a per-acre-foot water valuation or replacement cost/acre-foot of water? This is accomplished by estimating the amount of water needed to make a potentially profitable crop.

For example, according to the University of California (adjusted in acre-feet instead of acre-inches) an 80 acre crop of corn requires 500,000 gallons of water per acre over the roughly six months from planting to harvesting.[45]  500,000 gallons per acre equates to 1.53 acre-feet per acre in this 80 acre corn crop.  Assume in the example below that all the water required by the crop is provided by the irrigation system in lieu of any rainfall.

 

Conversion of Replacement Cost to Acre-foot Value of the Groundwater Required 

                                    Item                                                                                        Total

1.53 acre-feet of water per acre X 80 acres                                          122.4 acre-feet water

Replacement cost of irrigation system                                                           $ 130,000

Indicated value of the water required                                              $ 1,062 per acre-foot[46]

Indicated value adjusted for the ten year economic life                $106 per acre foot

These calculations use highly conservative assumptions and indicate the water value to the $1,062 per acre-foot.  If the replacement cost of the irrigation was amortized over the very conservative 10 year estimated economic life of the system, then the indicated replacement cost value of the water is $106 per acre-foot.  An adjustment for the economic life of the water system yields a much more realistic value of the water.

There are obvious and challenging adjustments that may need to be considered in the replacement cost methodology in water valuation. One adjustment that must be considered is to follow the way in which the United States Internal Revenue Service allows an individual farmer to amortize capital expenses. Another consideration is very basic: different crops need different amounts of water.  Still another variable to be considered is the probability that some amount of rainfall will provide some moisture to the corn during the growing season.  Complicating this variable is the general moisture conditions of the cropland itself. Clay type soils require less water to be drawn from the irrigation system than do more sandy soils; the water holding ability of the soil type itself can impact the amount of water to be drawn from the ground.

Yet with all these challenges, we feel that with full disclosure and consideration of all the assumptions made in a model similar to ours, a range of replacement cost value can be offered reasonably and reliably as a replacement cost of water methodology.  The main point is not the assertion that the replacement cost value of the water needed to make every 80 acre field corn crop is always $1,062 per acre-foot of $106 per acre-foot.  Our model is designed to stimulate thought about what possible adjustments for the unique characteristics of any property and its water and water needs must be made in a reliable fair market valuation of the water.  All valuation experts must consider the particular water buying farmers’ individual choices such as the type of crop to be planted.  It is reasonable that in certain situations, the valuation expert should look at several crops and offer the reader a range of replacement cost possibilities.

Detailed individual crop characteristics are readily available from universities across the country, and in Texas from the Agri-Life Extension agents in any given county. Agricultural extension agents around the United States regularly assist in finding any local area’s cost to drill groundwater wells, purchase and install center pivot irrigation systems, and acquire electricity for irrigation systems.  Public universities such as Texas Tech, the University of California, or Texas A&M University are reliable sources for supporting data.  Certainly a prudent valuation expert would also contact the local contractors and suppliers to hone down even further actual bid estimates of the cost of a local irrigation system.  The seed suppliers and the implement dealers in the local area are generally another reliable source of data.  The point here is that any fair market valuation of water should result from exhaustive research into every conceivable permutation of water use.

Yet another challenge is just that – there are an almost infinite number of permutations. However, each property will be greatly influenced by local open market conditions and it is realistic that the likely number of permutations and variables could be narrowed.  This leads to the next methodology, comparable sales data. 

The Comparable Sales Method

Of course the most reliable method of fair market valuation of water is the comparable sales method.[47]  But finding and confirming actual closed water sales or leases in any given location, while certainly possible, can prove to be very frustrating.  The work requires a great deal of personal labor and a little bit of luck.  Why? Water transactions typically are highly confidential to the parties involved.  Like traditional real estate transactions, there is no requirement to report any details about the transaction to the public.

While the transaction is always recorded in the real property records (or should be),[48] rarely is the actual consideration paid stated in the transfer instrument.  Most transfer instruments mention the consideration not in actual dollars paid. The payment is usually described only as “for $10 and other valuable consideration.”

Discovering the existence of a water transaction and the parties thereto is at times the proverbial “needle in the haystack” search. More significantly, the word “comparable” takes on a new urgency in credible water valuation.

Another old trite saying that continues to remind us of this ongoing hurdle to credible market valuation is “comparing apples to apples and oranges to oranges.” For decades, savvy real estate professionals have expressed their dismay at the use of the mass appraisal technique by Texas central appraisal districts. [49]  In lieu of the all but impossible task of annual individual property appraisals, the districts apply statistics and sales “comps” supposedly “uniformly” to a number of properties in an area.   The mass appraisal approach has little or no place in a credible market valuation for water rights.  The application of “comps” in the manner in which is allowed by the mass appraisal methodology simply will not reasonably assess the value of water.

The chemical composition of water is infinitely variable across the state. This scientific fact alone is a major challenge to finding truable comparable closed water transactions. Another similar challenge in the true comparability of closed water transactions include the unique  local rules and regulations in both groundwater and surface water; the ease or difficulty in acquiring permits for transfer do impact the value of the water in the transaction.  Even the ease of the right of way and distribution system required to consummate the transaction are elements of comparability that could dramatically affect the value of the water being sold or leased.  For these reasons and many more a reliable water valuation must be made based upon true comparability considering all elements of a delivered and completed water transaction on the unique characteristics of individual past closed transactions.

Comparable sale prices from other regions are useful, but must be adjusted to the conditions that exist in the area of the proposed water transactions. The following is a brief list of basic factors in determining comparability in water valuation:

 

  1. The chemical composition of the water;

 

  1. The amount of water available to sell (or amount owned) and its probability of maintaining the amount purchased over the time required by the contract to purchase;

 

  1. The rules and regulatory process required for any permit at all levels including required permits from the local GCD (if one exists), the county, the state, and the United States government via the Environmental Protection Agency and/or the Army Corps of Engineers;

 

  1. The distribution system available or required to be built in order to deliver the water to the buyer which could require years of expensive right of way acquisition to build pipelines or other transfer vehicles;

 

  1. The intended use for the water – oil and gas, agricultural, municipal, and industrial intended uses are rarely comparable; and,

 

  1. The resistance (or support) of the local community from which the water is drawn has great impact on the ultimate valuation of the water being sold or leased.

Each of these six basic factors require diligent investigation and at times, costly professional advice and scientific testing of the water to be sold or leased.

To be defendable and absolutely credible, closed water transactions must first be found, then the sale of lease price and actual terms of these transactions must be confirmed by both parties or with evidentiary documentation from one party.   This work requires personal interviews and determined research and investigation.

Confirming a comparable sale or lease of water is more about patience, politeness, and perseverance than specialized technical skills.  In this regard, petroleum landmen could prove to be a very useful resource since their daily work involves face-to-face negotiations with individuals after rigorous research in county real property records.   How many confirmed comps should be sought to develop  a credible valuation?  Of course, the answer is as many as possible.

In that regard, recent well-publicized water transfer transactions offer a starting point for base date in comparable sales and leases.  One in particular is may be more readily available than others, the Vista Ridge water project transaction in which 3,400 water rights holders in Burleson and Lee counties agreed to lease or sell their water rights for eventually delivery to the San Antonio Water System (SAWS).   The entire contract is publically available on the SAWS website. The water transfer via a pipeline will travel some 142 miles to San Antonio, roughly on a northeast to southwest path across central Texas. For comparable transactions in 2015, 2016, and maybe even into 2017 this water project has the potential to provide highly credible base comps that could  enhance, with appropriate adjustments, the reliability of any water valuation in a vast area of central Texas at least.

Another source for comparable sales and leases is the San Antonio Water System or SAWS. SAWS periodically offers the public the opportunity to offer their transferable Edwards Aquifer water rights for lease to SAWS.[50]  For example, below are the published results of a similar SAWS water solicitation in 2015.[51]

saws1

saws2

Notice the detail SAWS provides, but keep in mind the water is Edwards Aquifer Authority (EAA) water and pre-determinedly transferable Edwards rights under their established and accepted rules. ( is interesting to note however, that the price of $125 to $130 per acre-foot is very close to the $106 per acre-foot most probable price in our replacement cost method sample.)

Other possible sources for comparable sales are real property record searches, title companies, county agents (Texas Agri-life Extension Agents), Farm Service Administration offices across the counties, area central appraisal districts not so much for details of water transactions but for leads from the appraisers who keep up with all real property transactions in their areas, the TCEQ, the 100 groundwater conservation districts, attorneys, accountants, hydrologists, well drillers, local newspapers, implement dealers, irrigation equipment dealers, and fertilizer and seed distributors.   There certainly are many other possible sources for comparable sales and leases of water.  Time staking on-the-ground personal research is the key to developing a proper matrix of comparable sales or leases of water or water rights.

The recent oil boom based on hydraulic fracturing technology offered readily obtainable and confirmable water sale and lease comparables.  For example, in the Crockett County area close to Ozona, one rancher confirmed to me that he had sold his groundwater on short term contracts to oil explorers at $ .80 per 42 gallon barrel of water.  The sales were quick and not subject to any waiting period for permitting as oil and gas exploration activities are exempt from local permitting.  The     $ .80 per 42 gallon barrel of water equates to a $6,207 per acre-foot.  The rancher told me that one oil company said they were willing to go upwards of $1.00 per 42 gallon barrel in the future dependent upon the success of their drilling activities.  This discussion took place in 2013 during the heyday of the shale/frack boom.  Today, the boom is all but over. At best, a comparable such as this one would have a limited credible life, but in its time, no better comparable could be found.  Due to the urgent demand for water and the amount needed to frack a well, in many cases, confirmation by both parties proved easier during the oil boom period. 

The Income Capitalization Method

One of the most used methods of real property valuation is the income capitalization method[52] or capitalization of the net operating income generated from the property being sold.  It is a rather simple calculation but full of difficulties.  Once the net operating income (NOI) from a property is determined, the valuation expert simply selects a suitable market capitalization rate, commonly known as “cap rate” and divides the NOI by that rate.  If the NOI is $100,000 and the capitalization rate chosen is 10%, the income capitalization method indicates a value of $1,000,000 ($100,000/.10).  Like a bond, the higher the cap rate, the lower the value. The income capitalization method is based on an assessment of the risk of the investment and comparables are readily available to the public.  The risk free rate in the United States is generally recognized as  the 10 year United States Treasury Note or “bill.” This risk free rate has hovered around 2% or even less (on September 6, 2016 the 10 year US T Bill rate is trading at 1.6%) over thepast few years.  Why would anyone invest in any water  project or water lease or purchase unless the potential return from the proposed project will return some multiple of the risk free rate?  Investment has opportunity costs; once capital is invested it has used up its opportunity to be inserted into another investment.

Another tool in assessing investment risk is the present value of the net operating income stream based upon discounting annual income streams considering the “time value of money.” The “time value of the money”  in present value analysis is based upon the traditional idea that money received now is worth more than money received later.  All investors hope the value of their investment will grow over time..  Savvy and experienced investors seek first return of their investment and then return on their investment. Since today’s risk free rate of return is under 2%, then over time an investor, based solely upon his or her own criteria, will normally require a higher return on the money invested. Municipal and industrial water uses will likely have very specific contract terms such as price or lease rates and the net operating income can be readily determined from the duties and obligations (if any) of the seller or lessor.  The rate of return required or the discount rate selected in a valuation analysis are at the sole discretion of the investor and can vary greatly.  Water sales or leases have risk and that risk must be assessed considering other investment opportunities and sure the current risk free investment rate of return.

A more problematic aspect of capitalization of the net operating income from a water project is determining the true net operating income; the net operating income level is more important than the capitalization rate. Following the example of our 80 acre crop of irrigated corn demonstrates a way the value of water can be determined using the income capitalization method.   Pioneer Seeds provides the public with at “corn yield calculator” an example of which is in found in the figure belwo.  The expected yield in Texas for feed corn in 2015 was around 143 bushels per acre and the expected market price was approximately $4 per bushel.[53]

Inserting our 80 acre corn crop example at a sales price of $4 per bushel and 143 bushels per acre in production, the Pioneer Seed calculator indicates a net operating income of $5,159.20. Their calculator forces us to assume the irrigation well and center pivot as well as the land is owned outright since no debt amortization costs are included! The Pioneer Seed calculator does include a machinery cost item, but keep in mind the cost of all the equipment needed at a minimum would include a John Deere or equivalent tractor, cultivator, disk harrow, and planter.  This equipment can easily cost $150,000 or more new.  For our example, we assume the equipment is owned by the producer and the Pioneer calculator machinery cost item equals depreciation and maintenance on all equipment used.

Figure . 80 Acre Corn Crop Calculation[54]

dupont

Courtesy Dupont Pioneer

 

Using the Pioneer Seed calculator, the following calculations emerge:

Net Operating Income of an 80 Arce Feed Corn Crop at $4 per Bushel in Price:

$4 per bushel X 143 bu per acre X 80 acres =           $  45,760.

$507.51 per acre X 80 acres planting cost* =            $ 40,601.

                    Net Operating Income                                  $   5,159.

* Out of pocket to plant corn, not including land, or the irrigation well including center pivot.

What, therefore, is the indicated groundwater value on the 80 acres at a 10% capitalization rate? The calculation divides the NOI of $5,159 by 10% to result in an indicated capitalized value of the crop of $51,590.  What then is the per acre-foot indicated value of the groundwater? Recall that our example assumes an 80 acre crop of corn needs 1.5 acre-feet per acre therefore, the water need is 120 acre-feet.  To determine the value of the groundwater per acre-foot based upon a capitalized value of $51,590 for the corn crop, divide the $51,590 by 120 acre-feet of water. The result is the indicated value of the groundwater in our example is $430 per acre-foot.

Using a 10% capitalization rate, which is 5 times the current risk free rate, is a conservative estimate to adjust for the risk in any corn crop. Even with irrigation, crops are subject to deluges or rain at the wrong time, insect infestations, feral hog destruction, early or late freezes, equipment breakdowns, and of course, widely variable market fluctuations which in today’s globalized economy are more out of control of the American farmer than ever in history.  A more conservative capitalization rate, more indicative of the typical risk in a corn crop in Texas, likely would be 16%. Therefore, the capitalized net operating income drops to $32,244 (NOI of $5,159 divided by 16%).  The value of the water needed then falls to $269 per acre-foot ($32,244 divided by 120 acre-feet).

If the corn market in our example was at its peak of $7 a bushel as in recent years, the net operating income could increase to $39,479.  Capitalizing the $39,479 net operating income at 10% results in an indicated value of $394,790 or $3,287 per acre-foot of groundwater. Capitalizing the $39,479 net operating income at 16% results in an indicated value of $246,744 or $2,056 per acre-foot of groundwater.   A reasonable range therefore for our use of the 120 acre-feet of groundwater is from $269 per acre-foot to $3,287 per acre-foot.   This is quite a wide range, but the calculation offers a model to use to determine the value of water using the income capitalization method. It also demonstrates the astounding leverage that the market price paid for the final corn product grown has on any given year’s value of groundwater.  Again keep in mind that a prudent valuation must be completely transparent to the audience with all variables and assumptions clearly and concisely made available.

A key question that must be investigated  in our corn crop example is whether the farmer had in place at least a 120 acre-foot permit from the GCD, assuming the property was in the jurisdiction of a GCD.   A use that emerges from our income capitalization model can be to offer an indication of the potential value of an irrigation permit for farming.  Certainly different crops use different amounts of water, but the estimates of the amount of water needed can be easily found from irrigation equipment suppliers, the fine agricultural colleges and universities in our country, the county agents, the feed/seed suppliers, and the implement equipment dealers.

At this point the fair market values of water per acre-foot generated from our models are:

  1. Using the replacement cost method – $1,062 per acre-foot of water for an 80 acre crop of feed corn adjusted for the ten year economic life of the irrigation system or $106 per acre-foot;
  2. Using the sales comparison method – From $130 per acre-foot based on the SAWS leases in 2015 to a high of $6,207 per acre-foot of water in 2013 using the water for fracking new oil wells; and,
  3. Using the income capitalization method – our 80 acre feed corn crop indicates a range at $4 per bushel price for the crop $269 per acre-foot of water to $3,287 per acre-foot of water if the farmer enjoys $7 per bushel price for the crop.

These three methods demonstrate a wide variation in value estimates, but collectively they offer a thorough range of potential values based upon uses and market variables. The method not usually recognized as a traditional method is valuation based on a court ruling, but for water, this source cannot and should not be overlooked.  It is safe to assume that any court ruling is based upon testimony from many sources and valuation experts whose opinions have been thoroughly debated in deposition and court testimony therefore court ruling and judgments are another credible source of localized and very specific water fair market values.

Court Rulings and the Water Market Valuation

There are a number of ongoing lawsuits in which the value of water is in issue, usually in the calculation of damages.  Of course, the trial court’s ruling on value can be appealed up the chain to the Texas Supreme Court based on the circumstances of the individual case.  One advantage to using court rulings in valuation estimates is that, under most circumstances, the entire case file is available to the public and the opinion of the court is public information as well.  Without doubt, these rulings can be highly controversial and in most cases, any valuation information may only be applicable to the locality and uniqueness of the facts of the case.  However, since court rulings in our legal system set precedents, these rulings on water value have germane and significant impact.

For example, take the case with a long life, apparently resolved recently, Bragg v. the Edward’s Aquifer Authority (EAA). The newspaper reports around the state proclaimed the Braggs won the retrial of their case and were awarded $2,500,000 in damages. At this time we have not had access to the full details of how the damages were calculated however, as an indication of the use of a court ruling to color a water valuation, we will next discuss the 2010 award of damages to the Braggs which was overturned in 2013, when the San Antonio Court of Appeals ordered a remand of the damages calculation.

Jo Lynn and Glenn Bragg operate two farms in the Medina County area which require irrigation to be productive, one named the D’ Hanis Orchard (approximately 42.16 acres) and the other named the Home Place Orchard (approximately 58.51 acres).[55]  The irrigation wells for these farms required permits from the Edwards Aquifer Authority (EAA).  The Braggs requested more groundwater than the EAA granted.  The long years of litigation resulted in decisions generally in favor of the EAA.  However, the Braggs persisted in the face of unfavorable rulings and filed another lawsuit under a “takings”[56] claim against the EAA for the amount of groundwater they were denied.  Judge Thomas Lee of Hondo ruled favorably for the Braggs on May 7, 2010, with the following language:[57]

The implementation of the Edwards Aquifer Act, and the denial ofan Initial Regular        Permit (IRP) on February 8, 2005, for anamount less than requested or needed by the Plaintiffs to operate their Home Place Orchard, unreasonably impeded the Plaintiffs’ use of the Home Place Orchard as a pecan farm, causing them severe economic impact; interfered with their investment-backed expectations, and constituted a regulatory taking of the Plaintiffs’ property . . . the Plaintiffs are entitled to be compensated for their loss.[58]

The difference in the amount requested by the Braggs and the amount the EAA granted them was 108.65 acre-feet of water. At trial the original trial the Plaintiffs had requested that their compensation for this water would be based upon $7,500 per acre-foot for a total of $814,875.[59]  Judge Lee determined that the water was worth $5,500 per acre-foot for a total award on this portion of the damage claim of $597,575.[60] The further language he chose on page 2 and 3 of his 2010 ruling seems to be written to meet the requirements that the actions of the EAA constituted a “taking.”  Many water rights attorneys and experts took close notice of this section of Judge Lee’s ruling:

I believe this is as much about the taking away of a lifestyle as it is about the decrease in the value of land. The Braggs invested their lives, labor and money in a good family farm that could be passed on to their heirs.  That life plan has been undermined, and their investment severely damaged.[61]

Judge Lee assigned additional damages to the D’Hanis Orchard because the found that the EAA’s denial of water for this orchard no longer allowed it to be considered an “irrigated” farm. He determined that the difference between a dry land farm and an irrigated farm was $134,918.40 or $3,200 per acre.[62]  Judge Lee’s total compensation award to the Braggs for both elements of damage was $732,493.40.[63]  The total acreage of the two orchards is 100.67 acres making this award $7,276 per acre.

This ruling is one benchmark that can be used in determining the market value of irrigated land and of groundwater. It may not reflect a fair market valuation at any one time in the future, but at the time of his finding, it is a strong indication of the value of water and the incremental value of an irrigated farm over a non-irrigated farm. The incremental value of an irrigated farm is a significant by highly subjective new consideration in land valuation[64] Considering that both tracts of land were valued at the appraisal district at $4,000 per acre in 2010 apparently without adjustment for the irrigated value found by Judge Lee, simply the fact the farm is considered “irrigated” at a premium of $3,200 an acre almost doubled the land value. The water rights, therefore, could also be said based on Judge Lee’s opinion, to more than double the value of the land.

This ruling is yet another confirmation that water availability and adequate water rights strongly enhance the value of land. His findings also assume the Braggs’ interest in groundwater was a “vested” property right,[65] a right government has a primary duty to protect.  Since water rights or the lack thereof so significantly affect land values, the characteristics and especially any defects in those rights are material and significant considerations that must be disclosed by sellers and their real estate agents to any potential purchaser of property during their decision to purchase.

The court of appeals disagreed with Judge Lee’s ruling and made an effort to determine a formula to calculate the value of the taking. Judge Lee’s ruling is an indicator of the value of groundwater in 2010 in the Medina Valley/Castroville area of Texas.  While Judge Lee’s additional award adding damage to the value of the land that he opined now could not be called an “irrigated farm” has many flaws, the most simple of which is a definition of an “irrigated” farm.  What is an “irrigated” farm?  Defining an “irrigated” farm would have to consider the varying needs of differing types of crops, the volume of water scientifically and physically obtainable, and the volume of water allowed by permit. Without doubt there is an increase in value for land that has  an irrigation permit and irrigation system. Nothwithstanding the reversal of the damages calculation in the 2010 decision Bragg case, court rulings should  be researched and can provide yet another reliable and credible source of information to fairly value water and water rights in Texas.

Conclusion

The fair market valuation of a water right in Texas is beset with challenges due to the wide variability of the chemical nature of all water, the regulations affecting water including allocation and transfer, uses of the water, and the strength of the demand for water at any given time.  Simple rules of thumb such as water being more valuable during drought are obvious.  Not so obvious though are the complicated sets of rules and regulations that ultimately hold the key to water sales and leases.  Texas is especially challenged in groundwater sales and leases since there are 100 individual groundwater conservation districts across the state with 100 unique sets of rules and regulations.  Couple the variations of regulations across the groundwater conservation districts with the fact that some 25% of the area of the state has no groundwater regulation at all.

Since the people in those areas have chosen not to create a district, the valuation of groundwater becomes a distinctly local issue. Valuing surface water, allocated by the TCEQ based on “first in time, first in right” appropriative permits and rights, has its own hurdles  of water quality, quantity, and transferability, but at least there is only one ultimate regulatory agency in the state overseeing surface water  management.  The federal supra-legal authority via the Clean Water Act of 1972 and the controversial and pending Waters of the United States ruling along with the various long time environmental regulations such as the Endangered Species Act of 1973 also must be considered in credible fair market water rights valuations.

Here are some of the sources to assist in developing a credible and reliable valuation of a water right:

  • Real estate appraisers;
  • Existing sales or lease contracts – willing individuals or demands of public agencies under the “Public Information Act;”
  • Real property records in the counties for recorded transfers or leases;
  • Pending lawsuits and testimony from review of district court files;
  • County Ag Agent and Implement/Seed Dealers;
  • Court rulings such as Bragg v. EAA by Judge Tom Lee in 2010;
  • Petroleum landmen;
  • Central Appraisal Districts;
  • Individual GCDs, EAA, River Authorities, and the San Antonio Water System (SAWS) – some have “marketplace” opportunities to put buyers and sellers in touch;
  • Real estate agents, attorneys, and accountants;
  • Water well drillers;
  • Local FSA, Farm Bureau; and,
  • Open advertising by parties seeking sale or lease of water.

Remember that there’s no Multiple Listing System (MLS) for water transactions as in traditional residential real estate transactions, therefore, difficult and time consuming research is required into what has traditionally been the most highly confidential closed sales information, water sales and leases. With due diligence, hard work, and a keen eye for a rapidly changing water marketplace, timely and credible valuations of water rights can be made and used appropriately.

 Endnotes:

[1] Charles Porter is an author, teacher, and testifying water rights and real estate expert named in over 475 cases.  His website is www.charlesporter.com . He is a Visiting Professor in the College of Education – University Studies at St. Edward’s University in Austin, Texas. He is the author of Sharing the Common Pool: Water Rights in the Everyday Lives of Texans (College Station: Texas A & M University Press, 2014). Ed McCarthy is a partner in the Law Firm of Jackson, Sjoberg, McCarthy & Townsend, L.L.P.  After graduating from St. Mary’s Law School in May 1981, Ed served as a Briefing Attorney on the Supreme Court of Texas assigned to former Texas Supreme Court Justices James Denton (deceased) and Ruby Kless Sondock. Following his service on the Court, Ed served as a Captain in the Judge Advocate General’s Corps, United States Army, as a member of the United States Army Government Appellate Division, representing the United States in appellate matters before the United States Court of Military Appeals and the United States Army Court of Military Review.  In 1985, Ed returned to Austin and joined McGinnis, Lochridge & Kilgore L.L.P., where he became a Partner in 1989, and practiced until 2003.  Focusing his practice on water and wastewater related matters since returning to Austin, Ed represents governmental entities, public and private businesses and individuals in surface water and groundwater projects, including permitting matters before the TCEQ and local Groundwater Conservation Districts statewide, wastewater collection, treatment, disposal and reuse permits and projects, and project financing at the Texas Water Development Board.  He also represents clients in legislative initiatives, litigation, and project and project infrastructure development.

[2] Retired District Judge Thomas Lee, Hondo, Texas, May 7, 2010.  From his ruling in Bragg v. Edwards Aquifer Authority, May 7, 2010 in Glenn and JoLynn Bragg v. Edwards Aquifer Authority; Cause No. 06-11-118170-CV in the 38th District Court of Medina County, Texas

[3] Letter from George W. Brackenridge to “Brother Tom” [his brother Thomas] recommending Thomas’ land in Junction, Texas should only be sold if it included the section with water on it, “as water render the land its value.”  November 19, 1879.  Austin History Center, Robert Thomas Brackenridge Papers, La Prelle-Brackenridge Papers.

[4] Martinez v. Maverick County Water Control & Improvement District No. 1, 1955, 219 F. 2d 666, 670 (5th Cir. 1955).

[5] Superior authority. “Supra” means “above” in Latin.

[6] The Texas Water Development Board’s (TWDB) State Water Plan for 2012 asks the question in its preface:  “Do we have enough water for the future?”  The startling, but unequivocal answer, was: We do not have enough existing water supplies today to meet the demand for water during times of drought.  According to the State Water Plan, in the event of severe drought conditions, the state would face an immediate need for additional water supplies of 3.6 million acre-feet per year with 86 percent of that need in irrigation and about 9 percent associated directly with municipal water users.  Total water supply needs are projected to increase by 130 percent between 2010 and 2060 to 8.3 million acre-feet per year.  In 2060, irrigation represents 45 percent of the total and municipal users account for 41 percent of needs.”

[7] The term “geological container” to describe water types in Texas can generally be traced to the writings of Dr. Ron Kaiser of the Texas Real Estate Center, Texas A & M University.

[8] “Watercourse”  in Texas law is not found in the statutes but in the 1925 case Hoefs v. Short, 273 S.W. 785 (Tex. 1925).  “When it is said that a stream in order to be a natural water course to which water rights attach must have bed, banks, a current of water, and a permanent source of water supply, we have only described in detail such physiographic and meteorological characteristics as make the use of the stream for irrigation practicable. When it is once shown that the waters of a stream are so confined and persistent in their course, and flow with such frequency and volume that it is both practicable and valuable to irrigate therefrom, it is a stream to which such water rights attach.”

With reference to the phrase “definite and permanent source of supply of water,” frequently used by the courts as describing a necessary requisite of an irrigable stream, all that is meant is that there must be sufficient water carried by the stream at such intervals as may make it practicable to irrigate from or use the stream. . . . The authorities frequently say that a natural watercourse must have a permanent source of water supply.  This however merely means that the stream must be such that similar conditions will produce a flow of water, and that these conditions recur with some degree of regularity, so that they establish and maintain a running stream for considerable periods of time. See FARNHAM ON WATERS, Vol. 2, § 457; Ruling Case Law, Vol. 27, pp. 1065, 1066; KINNEY ON IRRIGATION, Vol. 1, § 306.”

[9] Texas Water Code Ch. 11.

[10] See 30 TAC Chapters 303-304.

[11] Texas Water Code § 36.002.

[12] 369 S.W.3d 814 (Tex. 2012); see EAA v. Bragg, 421 S.W.3d 118 (Tex. App. – San Antonio 2013, pet. denied).

[13] See Appendix “A” – TCEQ Map of Texas GCDs available online at http://www.tceq.texas.gov/groundwater/district/html.

[14] Edwards Aquifer Authority Act, Act of May 30, 1993, 73rd Leg., R.S., ch. 626, 1993 Tex. Gen. Laws 2350; as

amended by Act of May 16, 1995, 74th Leg., R.S., ch. 524, 1995 Tex. Gen. Laws 3280; Act of May 29,1995, 74th

Leg., R.S., ch. 261, 1995 Tex. Gen. Laws 2505; Act of May 6, 1999, 76th Leg., R.S., ch. 163, 1999 Tex. Gen. Laws

634; Act of May 25, 2001, 77th Leg., R.S., ch. 1192, 2001 Tex. Gen. Laws 2696; Act of May 28, 2001, 77th Leg.,

R.S., ch. 966, §§ 2.60-2.62 and 6.01–6.05, 2001 Tex. Gen. Laws 1991, 2021 and 2075; Act of June 1, 2003, 78th Leg., R.S., eh. 1112, § 6.01(4), 2003 Tex. Gen. Laws 3188, 3193; Act of May 23, 2007, 80th Leg., R.S., ch. 510, 2007 Tex. Gen. Laws 900; Act of May 28, 2007, 80th Leg., R.S., ch. 1351, §§ 2.01-2.12, 2007 Tex. Gen. Laws 4612,4627; Act of May 28, 2007, 80th Leg., R.S., ch. 1430, §§ 12.01-12.12, 2007 Tex. Gen. Laws 5848, 5901; Act of May 21, 2009, 81st Leg., R.S., ch. 1080, 2009 Tex. Gen. Laws 2818; and Act of May 20, 2013, 83rd Leg., R.S., ch. 783, 2013 Tex. Gen. Laws 1998.

[15] Edmond J. McCarthy, Jr., “Mixing Oil and Gas with Texas Water Law.” Texas Tech Law Review, Vol. 44, 2012, 883-938.

[16] Texas Water Code §§ 5.012-5.013, 11.121.

[17] See, e.g., Id. §§ 11.142, 11.1421, 11.1422, 11.143.

[18] Id. §§ 11.081, 11.121.

[19] See generally Texas Water Code § 11.121; 30 TAC Chapters 295, 297; “Rights to Surface Water in Texas” Texas Commission on Environmental Quality, GI-228 (Rev. 3/09), available online at http://www.tceq.state.tx.us/publications/gi/gi-228.html/at_download/file.

[20] Id.

[21] See generally Texas Water Code §§ 11.301 et seq.

[22] Charles Porter, Spanish Water/Anglo Water, 64 (Texas A & M University Press, 2009); Charles Porter, Sharing the Common Pool: Water Rights in the Everyday Lives of Texans, 95-104 (Texas A & M University Press, 2014).

[23] Modern watermasters serve much the same functions as the Spanish Colonial “ditch boss”. see Porter Spanish, 64.

[24] http://www.tceq.state.tx.us/permitting/water_rights/wmaster/wmaster.html/#about

[25] An acre foot of water equal 325,851 gallons.

[26] The newest GCD is the Reeves County Groundwater Conservation District, which was confirmed as of November 3, 2015. See Appendix “A”.

[27] Texas Water Code §36.011 et seq.; see generally Texas Special District Local Laws Code.

[28] Charles Porter. “Financing Groundwater Conservation Districts in Texas: Results of a Preliminary Study.” Texas Water Journal 4, no. 1 (2013): 57-59.

[29] The GCD taxing authority and tax rate is listed on all annual ad valorem tax invoices in Texas.

[30] Texas Prop. Code § 5.008(b).

[31] “The price the property would bring when offered for sale by a seller desiring to sell, but not obliged to do so, and bought by a purchaser desiring to buy, but under no necessity of doing so as modified by evidence § 51.003(b) authorizes the trial court to consider in its discretion, to the extent such evidence is not subsumed [included or absorbed (something) in something else] in the historical definition.” See Plains Capital Bank v. William Martin. No. 13-0337, 459 S.W.3d 550 (Tex. 2015); see Tex. Prop. Code §51.003., From Hirsch Westheimer, Michael D. Conner, April 9, 2015. http://www.hirschwest.com/fair-market-value-under-texas-property-code-section-51-003/. Simply put, it is the price a willing buyer and willing seller, neither being under any duress, will agree to in order to transfer title.

[32] See Texas Water Code §11.0275 (defining “fair market value” vis-à-vis surface water rights).

[33] William B. Brueggeman is the Corrigan Chair in Real Estate at the Edwin L. Cox School of Business at Southern Methodist University.  Jeffrey D. Fisher is the Charles H. and Barbara F. Dunn Professor of Real Estate at the Kelley School of Business Indiana University.

[34] Brueggeman and Fisher. Real Estate Finance and Investments, Fourteenth Edition. (New York: McGraw-Hill Irwin, 2011) 296.

[35] “Time is of the essence” means that the specified times outlined and agreed upon in a sales or lease contract are vital and any delay, what constitutes a “delay” is usually determined at the buyer’s or the lessee’s sole discretion, could be grounds of cancellation of the contract.  Buyers and lessors that need water will not and many times cannot wait for delivered acquisition of the water, hence as a seller or lessor typically has a limited timeframe in which to prove their water being sold or leased is truly deliverable to the buyer or lessor legally and physically.

[36] Porter set up a focus group with Dr. Robert Mace of the Texas Water Development Board, May 25, 2016. The other member of the focus group was a water rights attorney who had practiced water law for over 50 years, Tim Brown, the “Dean” of Texas water law. The focus group discussed Mace’s professional scientific expertise in pressure implications in aquifers in Texas.

[37] Grant & Vidler. Economics in Context, 28 (Oxford: Heinemann Educational Providers, 2000).

[38] www.TexasItsYourMoney.org. Susan Combs, 2012.  “Local government debt has more than doubled from 2001 to 2011.”

[39] Deliverability in traditional real estate valuation is the concept of planning and zoning regulations and processes including the impact of the political will of the people affected by any proposed real estate development.

[40] The political deliverability of water in any market transaction or lack thereof is best demonstrated by the controversy between the citizens of Wimberley, Texas and Electro Purification in 2015.  Literally thousands of Wimberley citizens became involved in stopping a proposed transaction between Electro Purification and the City of Buda for transfer of groundwater.

[41] See Texas Water Code Chapter 11, Water Rights, Subchapter A. General Provisions, Sec. 11.002. Definitions.

“In this chapter and in Chapter 12 of this code: ‘Beneficial use’ means use of the amount of water which is economically necessary for a purpose authorized by this chapter, when reasonable intelligence and reasonable diligence are used in applying the water to that purpose and shall include conserved water.”

[42] Cost to replace an improvement assuming no reasonable person would pay more than it costs to buy the land and replace the improvement.

[43] Professor Porter’s personal experience:  On my ranch in Wilson, I drilled a new groundwater well in 2007.  The easier and less expensive to reach groundwater on my place up to 300 feet has high levels of dissolved solids including sodium chloride (salt).  It tastes bad, smells sulfurous, and while it does not kill the grass or plants, they take on a yellowish-brown tint for a good time after watering from the well.  I asked my driller, Thomas Moy to quote the cost of drilling to the Carrizo-Wilcox aquifer some 1,400 feet deep on my place to reach fresher water.  While the drilling cost would be around $10 per linear foot or around $14,000, the cost of the casing itself exceed $60,000.  I chose not to drill to that depth because I do not farm anymore. I converted my agricultural valuation to a wildlife valuation which has greatly improved my property and has been much more enjoyable though frankly much more difficult labor-wise than planting crops or raising livestock.

[44] Some sources indicate that drip irrigation systems can be built for as low as $500 to $1,200 per acre, if proven true, then the total amount of groundwater required would be significantly less.  However, our research has found no 80 acre fields of feed corn that use drip irrigation at this time.

[45] University of California Drought Management adjusted for acre-feet by the authors. http://ucmanagedrought.ucdavis.edu/Agriculture/Crop_Irrigation_Strategies/Corn

[46] The indicated replacement cost value in this example “expenses” the entire cost of the irrigation system in one year, likely not allowed under generally accepted accounting principles. The system could be required to be capitalized and would also be subject to depreciation.  This model offers no tax considerations as the complications of any unique tax situation is incalculable.

[47] The sales comparison method is based on closed sales of comparable properties in our case, water rights.

[48] See Texas Water Code §11.136.

[49] According to “Property Tax Basics” by the Texas State Comptroller’s office, “The Tax Code authorizes appraisal districts to use a method called mass appraisal to calculate the value of a large number of properties. In a mass appraisal, the appraisal district classi­fies categories of properties according to a variety of factors.

Using data from recent property sales, appraisal districts determine the value of properties in each class. They con­sider differences such as age, location and use to appraise all the properties in each class. The market value of a residence homestead must be determined solely on the basis of its cur­rent use regardless of its highest and best use. This means that your homestead must be appraised as such, even if it is located where its best use might be as the site for an office building or a parking lot for a mall. In addition, individual characteristics of property must be considered in developing appraisal models and schedules, as well as adjusting values as a result of taxpayer protests.” One of the best and most understandable definitions of mass appraisal is offered by the City of Fargo, North Dakota. Found at http://www.cityoffargo.com/CityInfo/Departments/Assessor/AssessmentProcess/MassAppraisal/ “Mass appraisal is the systematic appraisal of groups of properties as of a given date using standardized procedures and statistical testing. This differs from single-property appraisal, commonly referred to as “fee” or “bank” appraisal, which normally deals with only a particular property as of a given date. Mass appraisal includes the application of single-property appraisals, as well as the development of appraisal formulas and statistical models, that can be applied uniformly to a number of properties at a time.”

[50] http://www.saws.org/business_center/ContractSol/Drill.cfm?id=1577&View=Yes

[51] http://www.saws.org/business_center/ContractSol/IFB/1577/Table%20of%20EAA%20Bids_040116%20.pdf

[52] According to Brueggeman and Fisher, “The income approach [method] is based on the principle that the value of money is related on its ability to produce cash flow.”

[53] Source from Texas A & M University.

[54] https://www.pioneer.com/home/site/us/agronomy/tools/production-cost-calculator

[55] Exact size of the farms from the Medina County Appraisal District Office.  Also, see Texas Supreme Court Justice Deborah G. Hankinson’s description of the farms in No. 00-0436, in the Supreme Court of Texas, Glenn and JoLynn Bragg, Petitioners v. Edwards Aquifer Authority and Gregory Ellis, General Manager of the Edwards Aquifer Authority, Respondents, On Petition for Review for the Court of Appeals for the Fourth District of Texas, Argued on October 2, 2001: “The Braggs own two commercial pecan orchards in Medina County. The first orchard is located on approximately sixty acres of land, along with the Braggs’ residence and pecan processing facility. That orchard is known as the “Home Place Orchard.”  The scond orchard, known as the “D’Hanis Orchard,” is located on approximately forty-two acres.  The Braggs drilled a well into the Edwards Aquifer on the Home Place Orchard in 1979.  They began drilling a well on the D’Hanis Orchard in December 1994, and completed it in February 1995.” Also see Judge Thomas Lee’s findings letter of May 7, 2010 in Glenn and JoLynn Bragg v. Edwards Aquifer Authority; Cause No. 06-11-118170-CV in the 38th District Court of Medina County, Texas.

[56] Greg Ellis. “Regulatory Takings and Texas Groundwater” an article pending publication found at http://www.schreiner.edu/water/pdf/RegulatoryTakings&TexasGroundwaterLaw.pdf; Also Black’s Law Dictionary defines taking as “There is a ‘taking’ of property when government action directly interferes with or substantially disturbs the owner’s use and enjoyment of the property. Grothers v. U.S., C.A.Or., 594 F.2d 740,741.  To constitute a “taking, within constitutional limitation, it is not essential that there be physical seizure or appropriation, and any actual or material interference with private property rights constitutes a taking.”

[57] Judge Thomas Lee’s findings letter of May 7, 2010 in Glenn and JoLynn Bragg v. Edwards Aquifer Authority; Cause No. 06-11-118170-CV in the 38th District Court of Medina County, Texas

[58] Ibid. 2.

[59] Ibid.

[60] Ibid. 3.

[61] Ibid. 2-3.

[62] Ibid. 3.

[63] Ibid.

[64] It is highly subjective because different crops may require differing amounts of water, irrigation techniques and equipment use differing amounts of water and so on.  What level of water constitutes an “irrigated farm” may be ultimately only in the mind of each individual buyer.

[65] Black’s Law Dictionary defines “vested rights” – “In constitutional law, rights which have so completely and definitely accrued to or settled in a person that they are not subject to be defeated or canceled by the act of any other private person, and which is right and equitable that the government should recognize and protect, as being lawful in themselves, and settled according to the then current rules of law, and of which the individual could not be deprived arbitrarily without injustice, or of which he could not justly be deprived otherwise than by the established methods of procedure and for the public welfare.” 1564.

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