Supreme Court Needs to Put the "Just" Back in "Just Compensation"
Yesterday’s decision by the Supreme Court to reject Jim and Jeanne Harmon’s petition to reexamine the constitutional status of New York’s rent stabilization law showed the unwillingness of the Court to reexamine a set of well-entrenched takings doctrines. Unfortunately, local governments are able to trample on property rights not only by regulating rents by also by taking over property for government use. By way of example, right now both the City and State of New York are engaged in extensive condemnation activities associated with the large projects at Atlantic and Hudson Yards. In dealing with these issues, the Supreme Court decision in Kelo v. City of London makes it all but impossible to resist takeovers for such dubious public purposes as new athletic stadiums that always pose a heavy fiscal drain on local budgets.
Yet even when government sets its eyes on these ambitious problems, it has yet another hurdle to overcome—it must pay just compensation to the landowner for the value of the property taken. That guarantee will, however, surely be eviscerated if the state is free to set compensation below actual value. To avert that evasion, the United States Supreme Court held in 1893 that in condemnation cases, “the compensation must be a full and perfect equivalent for the property taken.” In an 1878 decision, the Court had previously elaborated on this standard as follows: “The inquiry in such cases must be what is the property worth in the market, viewed not merely with reference to the uses to which it is at the time applied, but with reference to the uses to which it is plainly adapted; that is to say, what is it worth from its availability for valuable uses.”
The point here is simple enough. The value of property in all circumstances depends on the future uses to which it can be put. It is those potential uses that determine its value. To measure property values in ways that neglect that future development is to allow the government to take property at bargain prices. The usual rule in all these cases stresses the need for the state to pay compensation at the same level as private parties in arm’s length deals, which are always forward-looking.
Unfortunately, this lesson has been lost on the New York courts in River Center, LLC v. Dormitory Authority of the State of New York (DASNY) (2010). A petition for certiorari seeking to revisit the restrictive interpretation of the just compensation requirement in that case was filed by Harvard Law Professor Laurence Tribe. To show the broad nature of the appeal, that petition was supported by separate amicus briefs, one signed by former Attorney General Edwin Meese and a second by myself. This is an issue on which liberal, conservative and libertarian all see eye to eye.
The River Center dispute arose out of the condemnation of a valuable one-block site located in New York City several blocks south of Lincoln Center on New York City’s bustling West Side for a new dormitory for John Jay College. The marathon development process started in 1992, and much had been done in the nine years before the condemnation order against the property was entered in April 2001. As Tribe wrote in his petition: “The developer at the time of the condemnation had invested years of work and many millions of dollars above the secured debt. By its legal rulings the New York Court has permitted all of this value and all of this investment in a rising market to be taken without compensation. . .”
The technique used to work this governmental sleight of hand was simple. The New York state courts treated this prime real estate site in active development as though it were “vacant land” on the ground that the arduous development progress would not come “to fruition in the near future.” The court ignored the extensive distance already traveled because the journey was not close to completion. The greater the government obstacles to prompt development, it seems, the weaker the protection offered developers along their journey.
The New York courts dismissed as “speculative” all of the developer’s work in securing permits, preparing the site, obtaining interim financing and developing a viable marketing plan. That argument might make sense in those cases where there was no market indication of present value. But the real estate market is active in New York City and projects like this are always attractive to private investors who see risky, but large, returns down the road. In this instance, River Center, during its nine-year development process, had secured in an arm’s length transaction over $111 million of borrowed money on non-recourse loans, which meant that River Center’s sophisticated lenders could look only to the project itself for repayment, and not to the personal assets of its principal investors for repayment of the debt. Put otherwise, at the time of condemnation these investors necessarily valued the project in excess of $111 million. A still higher arm’s length estimate of the project’s value came from least four serious outside offers by reputable real estate developers, whose bids pointed to a project valuation north of $160 million right up to the time of condemnation. With bids like these available, there is no need to rely on independent appraisals of what the property might be worth.
In the face of this evidence, DASNY persuaded the New York Courts to value this “vacant land” at $82 million, far below these best market estimates. If allowed to stand, this improper ruling would make valuation turn not on market values, but government fiat. In undermining the traditional constitutional test, this creates three major social risks.
First, undercompensation for property taken imposes unjust and excessive financial burdens on isolated property owners, powerless to resist government force, for a project that equally benefits all citizens. Fair democratic deliberation over the desirability of public projects is not possible if government agencies can short-change condemnation victims at will.
Second, forced sales at bargain-basement rates misallocate scarce social resources by letting government officials eagerly gobble up real estate worth far more in private hands than in government ones. In this case, that economic harm was not confined to River Center LLC. It also hurt New York City proper, whose tax base and economic vitality were effectively undercut when DASNY, a state agency, built a huge dormitory on a site far better suited to high-valued shopping and high-rise use. The point is important because it highlights a key limitation of the just compensation test. By looking solely at the value of the real estate to the owner, it ignores the powerful positive externalities that smart development can create for both the neighborhood and the larger city environment. Dormitories can be better situated on less valuable property.
Third, these unwise condemnations necessarily undercut sound long-term real estate development. The decision in DASNY will not be lost on other developers. Right now, current zoning and permitting restrictions already drag out the development process for years, adding unnecessary cost and delay to a housing market that is already warped in many ways. The low-ball compensation rules of the New York courts now gratuitously add a new hazard to an all-too-risky process, with developers facing huge losses of their time and money in the case of strategic condemnations coming at the eleventh hour. The need for further development work never negates the value of the extensive work previously done.
In response, it will always be said that high condemnation prices are undesirable because they will stop needed development. But that is precisely the point. The function of the just compensation restriction is not solely to provide compensation once the state decides to take property. It is also to give signals that some condemnations are too expensive to go forward. Public projects do create gains, but they also impose losses. The only way to get the right mix is to be sure that local governments take both into account. That can only be done if the just compensation requirement is used to force governments at all levels to take their costs into account. It is not acceptable to give any party, public or private, the absolute right to condemn at a price of its own choosing.
The stakes in this case are high. The issue of principle is, I think, too clear to admit of any serious dispute. The injustices and inefficiencies of these inexcusable government tactics will recur throughout the country unless and until the Supreme Court reaffirms its time-honored standard that just compensation means full compensation, and nothing less. Let us hope that it makes the right decision in this case.