TWCA 2017 Annual Conference

1. Methods and Challenges in the Credible
Valuation of Water Rights in Texas
Texas Water Conservation Association
Austin, Texas, March 3, 2017
By: Charles Porter, Ph.D., Visiting Professor of University Studies, College of Education
St. Edward’s University
www.charlesporter.com (512) 627-3793
and
Edmond R. McCarthy, Jr.
McCarthy and McCarthy, L.L.P.
All Rights Reserved
Use prohibited without prior approval by Charles Porter and Ed McCarthy

2. Time is of the essence.
Absolutely in all water transactions.

3. What is demand?
Demand is an economic principle that
describes a consumer's desire and
willingness to pay a price for a specific
good or service.
I think willingness to pay also means ability to pay. Many
local governments cannot afford it and their constituents
want no new taxes.

4. “Fair Market Value” Texas Water Code
“Whenever the law requires the payment of fair market value for a
water right, fair market value shall be determined by the amount of
money that a willing buyer would pay a willing seller, neither of
which is under any compulsion to buy or sell, for the water in an arms-
length transaction and shall not be limited to the amount of money
that the owner of the water right has paid or is paying for the water.”
“compulsion to sell” or “duress”
Water Code, Title 2, Subt. B Water Rights, Chapter 11, Subchpt. A, sec. 11.0275.

5. Question:
Many water transactions are
completed under “duress” or
“compulsion to buy”…
meaning to a valuation expert that prices
paid during droughts or under pressure due
to court rulings must be adjusted for duress.

6. From: Leidner, et al.. “The Water Market for the Middle and Lower Portions of the Texas Rio Grande
Basin”. Journal of the American Water Resources Association, 2011, p.3.
“Duress” is ever-present in Texas Water?

7. Valuation Methodologies
1.Replacement Cost
2. Income Capitalization (Direct and Yield)
3. Comparable Sales or Leases
and (a non-traditional approach)…
4. Court Rulings

8. 1. Replacement Cost Method
Groundwater with center pivot irrigation.
Reasonably easy to determine:
a. the cost of the irrigation well;
b. the cost of the distribution system (likely
center pivot); and,
c. other expenses such as electricity line to
the well pumps, diesel engines for the
pumps.

9. 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 (assume 80 acres)

10. Conversion of Replacement Cost to Acre-foot Value of the Groundwater
Required
for 80 acres of corn
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
Indicated value adjusted ten year economic life $ 106 per acre foot

11. Corresponds roughly to
Comparable Leases SAWS
in Edwards Aquifer

12. 2. Capitalization of Net Operating
Income Method (Direct and Yield)
What “capitalization rate” to use?
A high one! Why?
RISK

13. Net Operating Income of an 80 Arce Feed Corn Crop
at $4 and $7 per Bushel:
$4 per bushel X 143 bu per acre X 80 acres $ 45,760
Less: $507.51 per acre X 80 acres planting cost 40,601
Less: amortized cost of irrigation well 13,000
----------
Net Operating Income $ (7,841)
$7 per bushel X 143 bu per acre X 80 acres $ 80,080
Less: $507.51 per acre X 80 acres planting cost 40,601
Less: amortized cost of irrigation well 13,000
----------
Net Operating Income $ 26,479
Direct Income Capitalization Method say 10% cap rate = $0 - $264,790
Indicated value per acre foot 122.4 acre feet used = $2,163 per acre foot

14. YieldIncomeCapitalizationMethod Year1 Year2 Year3 Year4 Year5
NetOperatingIncome80AcreCropofCorn@$7/bu $26,479 $26,479 $26,479 $26,479 $26,479
DiscountFactorRate 30% 30% 30% 30% 30%
DiscountFactor 0.769 0.592 0.455 0.35 0.269
DiscountedValue $20,362 $15,676 $12,048 $9,268 $7,123
NetPresentValueofReceipts $64,476
NetPresentValueperAcre-Foot(122.4Acre-Feet)5years $527
NetPresentValue4YearLease $57,354 $469 perac.ft.
NetPresentValue3YearLease $48,086 $393 perac.ft.
NetPresentValue2YearLease $36,038 $294 perac.ft.
Very High Risk Projection Groundwater

15. YieldIncomeCapitalizationMethod Year1 Year2 Year3 Year4 Year5
NetOperatingIncome80AcreCropofCorn@$7/bu $26,479 $26,479 $26,479 $26,479 $26,479
DiscountFactorRate 10% 10% 12% 16% 20%
DiscountFactor 0.901 0.826 0.712 0.552 0.402
DiscountedValue $23,858 $21,872 $18,853 $14,616 $10,645
NetPresentValueofReceipts $89,843
NetPresentValueperAcre-Foot(122.4Acre-Feet)5years $734
NetPresentValue4YearLease $79,199 $647 perac.ft.
NetPresentValue3YearLease $64,582 $528 perac.ft.
NetPresentValue2YearLease $45,729 $374 perac.ft.
Reasonable Risk Projection Groundwater

16. YieldIncomeCapitalizationMethod-30ac.ft. Year1 Year2 Year3 Year4 Year5
SurfaceWaterLeaseUpFrontPaymentSr.Right
NetOperatingIncome $6,000 $6,000 $6,000 $6,000 $6,000
DiscountFactorRate 10% 10% 12% 16% 20%
DiscountFactor 0.901 0.826 0.712 0.552 0.402
DiscountedValue $5,406 $4,956 $4,272 $3,312 $2,412
NetPresentValueofReceipts $20,358
NetPresentValueperAcre-Foot(30Acre-Feet)5years $679
NetPresentValue4YearLease $17,946 $598 perac.ft.
NetPresentValue3YearLease $14,634 $488 perac.ft.
NetPresentValue2YearLease $10,362 $345 perac.ft.
Senior Priority Right Surface Water

17. YieldIncomeCapitalizationMethod-30ac.ft. Year1 Year2 Year3 Year4 Year5
SurfaceWaterLeaseUpFrontPaymentJr.Right
NetOperatingIncome $3,000 $3,000 $3,000 $3,000 $3,000
DiscountFactorRate 30% 30% 30% 30% 30%
DiscountFactor 0.769 0.592 0.455 0.35 0.269
DiscountedValue $2,307 $1,776 $1,365 $1,050 $807
NetPresentValueofReceipts $7,305
NetPresentValueperAcre-Foot(30Acre-Feet)5years $244
NetPresentValue4YearLease $6,498 $217 perac.ft.
NetPresentValue3YearLease $5,448 $182 perac.ft.
NetPresentValue2YearLease $4,083 $136 perac.ft.
Junior Priority Right Surface Water

18. What is the value of a junior surface
water right in a drought of record?
$0.
But… drought, especially record drought, brings
“duress” or causes “compulsion to buy” - $0 is
not fair market value of a junior water right.

19. 3. Comparable Sales/Leases Sources
•Attorneys with experience in water rights/permits.
•Existing sales or lease contracts – willing individuals or government
agencies.
•Real property records.
•Pending lawsuits and testimony district court files.
•County Ag Agent, Implement/Irrigation/Seed Dealers.
•Court rulings such as Bragg v. EAA.
•Petroleum landmen.
•Individual GCDs, EAA, River Authorities.
•Real estate agents?
•Water well drillers, local FSA, Farm Bureau.

20. Simple Value of Leased Water
30 acre feet of groundwater for $200/acre-foot for one year.
Net Operating Income = $6,000 per year
First Year = $6,000 / 30 ac. ft. = $ 200 per acre foot
But over 5 years we need to calculate a net present value by
discounting the proceeds.

21. Comparable Leases SAWS
in Edwards Aquifer

22. From: Leidner, et al.. “The Water Market for the Middle and Lower Portions of the Texas Rio Grande
Basin”. Journal of the American Water Resources Association, 2011, p.8.

23. Sales in Crockett County to Oil Companies in 2013 -
50 Acre-foot tanks (387,918 bbl) at $ .42 to $ .80/bbl =
$3,259 to $6,270 per ac.ft.

25. Court Case Value Ruling
Groundwater ruled in one recent case, to be
$5,500 per acre foot.
Surface water case?

26. 1. Replacement cost method
2. Income capitalization method
3. Sales comparison method
4. Court rulings
Summary of Methodology

27. Thank You
charlp@stedwards.edu
512-627-3793