This blog is used for FIN 181 Real Estate Appraisal by Dr. Hansz and students at the California State University, Fresno.
Tuesday, October 26, 2010
Mineral Rights Appraisal
Mineral rights are the legal rights to produce or explore the resources below the surface of land. Resources below the land include tungsten, zinc, diamonds, coal, oil, natural gas, geothermal, gold, silver, uranium, copper, nickel, palladium, aluminum, iron, lead, molybdenum, and platinum (Appraisal Institute). The ownership of mineral sources was at first granted to the individuals or organizations that owned the surface. Though, once profitable mineral production became possible the ways in which mineral rights are recognized became much more complex. The property titleholders had both "surface rights" and "mineral rights" (Appraisal Institute). This complete private ownership is known as a "fee simple estate". “Surface rights” and “mineral rights” are separate; many mineral right owners retained their mineral rights long after their surface rights were sold (Ellis, T.R.). Once retained, mineral rights can be owned forever. Today, mineral rights are able to be leased, sold, bequeathed and gifted out to one or more individuals and/or businesses, while the original land owner still holds the surface rights of the property (Appraisal Institute). Since a fee simple estate owner is able to sell his or her mineral rights at any time, he or she will most likely want to get the most accurate and highest price for the mineral interests. In order to acquire an accurate market value, an appraiser with mineral rights valuation skills will likely be hired. My blog post will discuss the basic concepts, approaches, methods, and procedures an appraiser would use to determine a value for a property with mineral interests.
Mineral interest properties are appraised with the same basic appraisal process described in USPAP and appraisal manuals, except for the addition of specialized sections that document details of specific items of regional and local geology, mineral deposits, mineral product market details, mining costs and methods, and geological controls (Paschall, Robert). The planning step of the appraisal process tends to be more important in the appraisal of mineral properties than conventional real estate appraisals because of the variety and magnitude of material that is essential for credible mineral appraisals (Ellis, T.R.). An exact definition of the value being pursued is very important, for the forms of ownership of a mineral interest property is typically very complex (Paschall, Robert). Depending on the stage of exploration and development of the mineral interest property, the cost approach, sales comparison approach, and income approach can all be used to determine a value, although the methods typically will not produce the similar value estimations. The cost approach concentrates on the money spent on the property, plus a discount or premium depending on the situation. The value of a mineral interest property is reliant on the mineral products it is capable of generating and by what the marketplace will pay for the mineral products in question (Ellis, T.R.). The sales price of the mineral product is the basis for recovering the exploration and development costs, operating costs of removing minerals from earth, and any further processing that may be needed to get the mineral product to the customer. The value of the mineral deposits on property in question should materially exceed the costs of discovery and development of the mineral, if not than the mineral interest will not be profitable, which could cause appraisal value to be lower (Ellis, T.R.). Using the cost approach, appraisers can determine the current value of past expenditures on mineral interest properties, although the cost approach is rarely applicable due to the fact that presently most mineral interest properties are not in the exploration stage (Paschall, Robert). The sales comparison approach tries to calculate what a likely buyer is willing to pay for the property, based on the investigation of other transactions in the marketplace. Mineral interest properties are typically in a direct search market, which is a market where individual buyers and sellers must seek each other out directly. Mineral property markets often include irregular participation, relatively high-priced, and nonstandard real properties (Paschall, Robert). Because of the lack of total transactions and the specialized property needs of purchasers, such as type of mineral, mineral resource size, and type of mining knowledge and skill required, it does not pay most brokers to seek profits by specializing in such a geologically and mineral interest diverse market. Most transactions in mineral property markets are actually negotiated mining leases with a type of owner financing or mineral production royalties (Paschall, Robert). Many sales of mineral deposits used for comparison will usually require at least as much research and on-site examination as the subject mineral property to accurately identify, measure, and account for any difference that may affect value (Paschall, Robert). This can make using the sales comparison approach even more difficult since most mineral property buyers and sellers will not willingly share the detailed property data, nor allow an appraiser on their property to examine the site to make reliable adjustments. The income approach focuses on the cash flow generated by the property, such as the income being produced from mining and producing the minerals. The first step in the income approach to appraise a mineral property is to determine the general supply and demand situation of the market for the mineral goods to be manufactured. The next step would be to estimate the quality and quantity of mineral reserves available to be mined, treated, and sold. After these steps than a reasonable expected gross income estimate can be calculated (California State Board of Equalization). A primary economic factor used to appraise oil, gas, and hard minerals is the discount rate used to convert the future value of an income stream to a present day value (California State Board of Equalization). The discount factor typically used to appraise properties includes the base discount rate, risk adjustments, and the ad valorem tax rate. By using the income approach formula such as: FI = R X P, where FI= Future Income (est. reserves), R=Rate, and P=Price, mineral interest value can be determined. In most mineral appraisals there are two separate calculations, one for working interest, and one for non-working interests (California State Board of Equalization). The calculations are done for each year into the future, until the appraisal reaches its economic limit and the appraisal stops (California State Board of Equalization). The income approach is primarily the method of appraisal used in the mineral industry to estimate value due to the fact that mining operators only work in mining in anticipation of getting paid. Electing between the cost approach, sales comparison approach, or income approach depends on what stage of exploration or development the mineral interest property has reached. The cost approach is best suited for exploration properties, because future cash flow is unknown. The sales comparison approach is applicable at any stage as long as there are accurate, arms-length transactions. The income approach is useful once the property has reached early development or late-stage exploration. Mineral interest appraisals are one of the most difficult appraisals there is due to their complexity and information needed to determine an accurate value. Selecting a knowledgeable appraiser who spends more than 50% of their time on mineral right appraisals will be the best individual in determining a value for a mineral interest property (Mineral Business Appraisal).
Appraisal Institute. The Appraisal of Real Estate. 10th Edition, Appraisal Institute, 1992.
California State Board of Equalization, Assessors Handbook AH560, Valuation of Mines and Quarries, 1973.
Ellis, T.R., 2001a, U.S. and International Valuation Standards- The Future: Preprint # 01-161, SME Annual Meeting, Denver, Colorado, February 26-28, 2001, 10 pp.
Mineral Business Appraisal. USPAP in Mineral Appraisal. http://www.minval.com/firreauspap_mineral.html, 1999.
Paschall, Robert, H., Appraisal of Construction Rocks, American Institute of Professional Geologists, 1993.