Impact of Fracking on Real Estate Value, Mineral Rights, and Ad Valorem Taxes

I am a commercial real estate appraiser.   The focus of my experience and practice has been primarily on valuation with respect to urban land economic issues with some agricultural land activities.  I am being called upon more to deal with issues involving mineral rights. 

 

I am searching for information and case studies involving the impact of fracking on real estate values and ad valorem taxation, both positive and negative.  These include major increases in values of hotels, apartment buildings, restaurants, bars, commercial properties in general because of drilling and fracking and pipeline activity.  And conversely major declines in value because of the adverse impacts of drilling in a community, or the stigma associated with the potential for drilling activity nearby, or the negative impact of environmental contamination, or perceived or actual stigma associated with environmental issues.   

 

Also, I am grappling with the following hypothetical case.  (I am just making up some of these numbers thinking they bear some resemblance to reality).

 

For many years land in Farmer Joe’s county had been selling for $4,000 per acre before the fracking boom.  Joe has to retire from farming because of ill health and wants to sell the farm.  There are no buildings on the farm itself as he lives in a house alongside his barn and silos across the street from the acreage.  A landman has given him a signed offer to lease his acreage for 5 years for $5,000 per acre with a 15% royalty.  All he has to do is sign the offer and he will receive a check for $5,000 per acre. 

 

There are successful proven wells all over the place near Joe.  He has done his research and consulted with professionals and believes there is at least a 50% chance that the well will be drilled and produce.  His royalty payments per acre, if the well is drilled and produces, are estimated at:

$3,000 in the first year,

$2,500 in the second year,

$2,000 in years 3, 4, and 5,

$1,000 per year in Years 6, 7, 8, 9 and 10, and

$500 per year for the next 30 years.   

 

At a 13% discount rate the Present Value of this cash flow is $11,324 per acre.  At a 50% probability the expected value of this cash flow is $5,662.  Joe believes this is a conservative estimate of value because he has heard there is a rule of thumb that the value of minerals sold outright is typically 3 times the price being paid for lease bonuses.

 

Joe has had several people interested in the property and he is trying to decide what he should accept as an offer for the property as a whole, surface and minerals.  Joe knows that the buyer will get the $4,000 per acre surface value of the property based on all the sales that occurred in the County before the big fracking boom.  The buyer will also get the immediate lease bonus cash payment of $5,000 per acre.  The buyer will also get the 13% royalty payment if the well is drilled and produces which Joe conservatively estimated at a 50% probability of happening. 

 

Thus, Joe calculated that an offer based on the following calculations would be acceptable to him. 

 

                        $4,000 per acre for the surface

                        $5,000 per acre for the lease bonus

                        $5,662 for the expected value of the present value of the royalties

                        $14,662  for surface and minerals

 

 

When Joe sat down with some of the interested parties he made the argument that the land was worth $14,662 per acre based on these calculations saying that the numbers were actually conservatively low because he had heard that mineral rights sold outright typically fetch 3x the lease bonus payment.  Joe got an offer from one of the interested parties for $14,000 per acre.  The offer was from a wealthy prominent attorney in the County who had just won election as a County Commissioner so he felt pretty confident that he had the money and it was a solid offer.   Joe told her he would need time to think about it.  

 

Anyway, it just so happened that one of the other interested parties was a County Assessor.  While Joe’s asking price was way higher than what he was expecting, this got the Assessor thinking as it was time for Joe’s sexennial re-assessment.  After thinking it through, the  Assessor, agreed with Joe’s calculations and promptly sent him a notice that his property assessment and tax bill were being more than tripled from the $4,000 market value that had been placed on the property by the County.

 

Joe was no dummy and promptly marched down to the County Courthouse and reminded the Assessor that in the States of Ohio and Texas  ad valorem taxes are placed on mineral rights  only when the well is producing.  Joe exclaimed, “I am pointing out that I don’t have a producing well.  I have not even signed a lease!” 

 

The Assessor countered, “Well that is exactly the point.  The minerals have not been severed from this property, but you did have a solid offer of $14,000 per acre for your real estate including the un-severed minerals.  What better indication of at least a minimum value of your property is that $14,000 per acre offer?  It could be worth more, because it wasn’t high enough to get you to sell?  Plus I have half a dozen other sales of unleased acreage at around $14,000 per acre.  That is pretty good evidence of value.  And mineral rights are real estate.  Just because there isn’t a separate assessment for the minerals doesn’t mean they don’t have value!  It’s just that the value of the minerals is not assessed separately yet!

 

 

So that brings up the crux of my question.  Has anyone dealt with this issue with an Assessor jacking up the assessment because of the discovery of minerals in the area?  If not how are Assessors dealing with the issue of comparable sales of properties that include un-leased, un-severed mineral rights.  Or even sales of properties that have wells that are non-producing.  I’m trying to get at the problem of separating mineral rights value and surface rights value when looking at comparable sales.  When I see these vast acreages of land being bought and sold by Chesapeake or another oil and gas company for such and such a price are they typically selling the surface and minerals or are they almost always talking about just the minerals?

 

Thank you for bearing with me through this long read.  Any information, insights, corrections, or noting of any misconceptions or blatant errors in the scenario above would be greatly appreciated. 

 

And also any cases where fracking has had a negative impact on value such as in the case where a surface owner does not own the minerals and ends up having a drilling rig showing up in his backyard one day would be very helpful. 

 

Thanks

 Ted

 

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Replies to This Discussion

Permalink Reply by Werner Kostendt on September 21, 2014 at 5:44am

It would not be economically possible to collect taxes on the value of a farmer's undeveloped minerals if they are sitting on top of a huge reserve and the value of the minerals is 4 or 5+ the value strictly as ag land.  The real estate taxes would drive them out of business.  Where would they get the money to pay the taxes if the well is not producing.  As far as trying to break out the value of the surface, in most areas where there has been minerals activity for decades, there are probably plenty of sales of acreage that have sold without minerals.  Thus giving good comparable evidence for the value of the surface which could be taxed on an ad valorem basis even if minerals had not been separated by lease or sale for a subject property. 

I know I am answering my own questions, but could not have done without this forum and the responses I am getting here. 

 

Permalink Reply by Keith A Williams on September 21, 2014 at 3:03pm

Werner,

In Ohio, true farm land is taxed on it's agricultural value. Back when the malls and housing boom of the 70's was forcing farmers out in the same manor you are describing, the legislature responded by creating the CAUV program. The farm land is valued on it's Current Agricultural Use Valuation. Taxes are based on that value. It is also possible to get the land valued on it's use as a timber operation.

I believe PA also has a similar program.

Keith

Permalink Reply by cj wyalusing on September 23, 2014 at 2:20pm

Is it called clean and green  .?

Permalink Reply by Werner Kostendt on September 23, 2014 at 4:05pm

I'm not sure I understand exactly the question?

Permalink Reply by Paul Martinelli on September 24, 2014 at 1:37am

It is just another case of a Govt. Agency wanting to get a bigger slice of the land owner's money.

Why should minerals that are not being produced be taxed?  They only have value when sold.....and then they are taxed.  Are we going to start taxing everything that potentially has a value?  What is the tax rate on trees?

What is the tax rate on water? What is the tax rate on oxygen produced by vegetation? When does it stop?

"When I see these vast acreages of land being bought and sold by Chesapeake or another oil and gas company for such and such a price are they typically selling the surface and minerals or are they almost always talking about just the minerals?"   They are almost always talking about just the minerals.

Permalink Reply by pg guy on September 24, 2014 at 1:54am

Actually, there is a movement among liberal politicians to tax everything with some actual or imputed value.  I believe it was Bill Clinton that proposed (many years ago) that if you own your own home, you are receiving a benefit equal to the fair market rental value of that house, and you should pay income tax on that value.  Never mind that you are the one who paid for it.

Remember too: Elizabeth Warren (later quoted by Dear Leader Barrack) - you didn't build that business......

No limit to how much of your money the politicians, especially (but not exclusively) liberals, are willing to spend.  Vote wisely next month, encourage your friends and family to do so also, because if we don't turn things soon, to bad for everything you and your predecessors worked for.

Permalink Reply by Keith Mauck (Site Publisher) on January 21, 2016 at 12:50pm

I wanted to let everyone posting in this thread know that we have launched ShaleCast. I hope you find it helpful. So far the response has been really positive.

Permalink Reply by D.C. Harris on January 27, 2016 at 9:49am

Ted,

I live in Ohio.  Many individuals here own farmland but not the mineral rights that go with it.  As you know, Ohio taxes only the surface value of the land, not the potential/mineral value, and "minerals" are taxed only when a well is producing--and it is the owner of the mineral rights who pays the tax.  Thus, landowners who do not own their mineral rights are not taxed and cannot be taxed for the value/potential value of their minerals.  The only way the State of Ohio or any individual county could tax or begin to tax "land" based upon the value/potential value of the mineral rights below the surface would be for the State or the county to track down every single mineral rights owner and tax him/her/it (a coal company, e.g.), not the surface owner.  The tax would have to be completely separate from traditional property taxes and equally assessed and applied across the board to all mineral-rights holders in the state/county.  So in the case of a landowner who also still owns his/her mineral rights, that landowner would pay a traditional property tax and a mineral rights tax.  If that ever were to happen, it would simply boggle my mind, and it would be a mess.  Can you imagine families and corporations who don't even own any land getting tax bills for mineral rights that have not and/or may never produce a profit?  I would hope the citizens of Ohio would be in an uproar over it.

Permalink Reply by Billy Park Whyde on January 27, 2016 at 9:24pm

Speculation at it's finest to say the least. With drop in oil prices would a land owner be allowed to receive a refund of the property taxes? Would the land owner be able to declare as a loss the amount of revenue they lost due to the drop in oil prices against former revenue? 

But the idea has no bounds as anyone can guess what a grove of Walnut trees may bring, a crop of corn, or even milk production. 

I liked your hypothetical case though theft in action. " The offer was from a wealthy prominent attorney in the County who had just won election as a County Commissioner " then "Anyway, it just so happened that one of the other interested parties was a County Assessor.  While Joe’s asking price was way higher than what he was expecting, this got the Assessor thinking as it was time for Joe’s sexennial re-assessment. " Lets tax it for our taking then readjust the taxes!

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