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What is Your Land Worth?

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What is Your Land Worth?

Determining the fair market value of your aggregate reserves or operation involves a number of factors.

By Mike Nowobilski

These two cases — true cases — illustrate the importance of properly evaluating and determining the sales price, typically described in terms of dollars per acre. For example, I do not know enough about the first case to comment, but in the second instance the owner left as much as $1,000,000 on the table.
Financial considerations tend to dominate decisions and the negotiations between the landowner and the producer. A landowner’s first decision is often whether he should sell, or lease his property. A sale of the property offers several advantages to the current owner. If he decides to sell, he must determine price. He does not want to sell too cheaply. Operators tend to focus primarily on the costs of securing the mineral and mining rights. Accordingly, the determination of the fair market value of a mineral property is the primary focus of this article. However, we’ll begin by assessing some of the advantages and disadvantages of pursuing a property sale versus mineral lease from the perspective of both the landowner as well as the producer.

Landowner’s perspective
A property sale offers the landowner several advantages as compared to entering into a mineral lease. One of the most obvious advantages associated with a property sale is the immediate lump sum cash payment that the landowner is free to spend or invest. By contrast, royalty payments may not begin for a number of years, and often continue for decades. Although this tends to be the primary deciding factor for many owners, there are several other factors that should be considered.
Perhaps equally important from an owner’s perspective, a property sale is the “no risk” alternative. That is, it significantly lowers the owner’s risk profile. Examples of eliminated risk include:

• Royalty income is potentially risky. Even if the total income stream projected to be derived under a lease agreement appears greater, associated risks need to be considered. Royalty income could be terminated if the quarry, or mine, were idled and/or closed due to a downturn in the market. Similarly, operations could cease if the mineral deposit’s physical characteristics deteriorated to the point of being uneconomical, or due to premature depletion of the deposit. A property sale transfers this risk to the operator (“new property owner”). Additionally, a sale eliminates the potential future contractual disputes that could impact the amount of future royalty payments received.
• Property ownership, especially of a mine or quarry site, is potentially risky. Although it is common for well drafted mineral leases to contain liability protection for the landowner, including liability insurance requirements, serious accidents and unforeseen events do happen. Sources of potential liabilities include worker injuries, drownings, etc. Furthermore, mining operations may result in environmental or reclamation issues.

In addition to the virtual elimination of ownership risks cited above, a property sale often provides the landowner with significant tax treatment advantages.

Operator’s perspective
Similar to the landowner, producers typically focus on the financial aspects of the purchase option as compared to securing a leasehold interest. A property purchase does often require a significant up front cash outlay, but there are several advantages that should be considered during the decision-making process. The advantages typically associated with the ownership of the mineral property include the following:

• Reduces cash operating expenses due to the elimination of earned royalty expenses. Sometimes this is a significant savings and a competitive advantage;
• Eliminates potentially significant advance royalty or annual minimums that may be payable for several years before mining commences. This obligation can continue for years;
• Protects the investment in the quarry and plant. It eliminates misunderstandings that often result between a lessor (landowner) and lessee (producer) under a long-term mineral lease; and
• Provides flexibility with respect to mining plans and reclamation plans.

Obviously the sale/purchase of a mineral property may offer significant advantages to both the owner and producer. So how do we determine fair market value?

Determining fair market value
What is fair market value? Fair market value is defined as the “most probable” price that a property should bring in a competitive and open market between a buyer and seller who are each acting prudently and knowledgeably. The price should not be affected by special or creative financing or sales concessions granted by either of the parties.
How is fair market value determined? Many are familiar with the use of the sales comparison approach (comps). Comps are commonly used when selling houses, offices, agricultural property, or other fairly liquid real estate. However, comps are not typically used for determining the fair market value of mineral properties. The most important reason comps are not used is that individual properties tend to be unique. Additionally, comps are not readily available as transactions are relatively infrequent and specific sale prices are confidential.
Determining the fair market value of a specific mineral property is typically done using what is referred to as the royalty income approach. As the name suggests, the basis for determining a property’s value is the projected royalty income that would be derived under a mineral lease. For example, if a mining company were expected to mine 250,000 tons per year and the fair royalty rate were $0.50 per ton, the projected annual royalty income would be $125,000.
Projecting the potential royalty income stream that would result from the development of a tract of land requires a careful assessment of several of the drivers discussed in a previous article (see “Mineral Leases: Royalty Rates Only Part of the Story,” AggMan, June 2002). The first step is developing a reasonable forecast of annual sales volumes and sales prices. The primary drivers that determine this forecast include:

• Mineral’s physical characteristics — Type of mineral, extent of the deposit (tons), deposit quality, depth of overburden, mining costs, and processing requirements.
• Sales and market data — Commodity pricing ($ per ton) and market demand for the finished product. Typically the historical sales volumes and prices are considered as well as future demand forecasts.
• Mine design — Mine design and the associated level of capitalization determines annual production and sales capacities of a mine, or quarry. This may or may not be equal to the level of demand. In some instances, the operation may operate below capacity due to sales limitations. In others, capacity may not fill available sales opportunities.

In addition to developing the sales forecast, the applicable market royalty rates need to be estimated. These rates are determined, in part, on commodity pricing, the competitiveness of the deposit, demand, and market forces.
After the sales forecast has been completed and applicable royalty rates estimated, the associated royalty income stream can be determined. Figure 1 illustrates the methodology for a hypothetical mineral property that is forecast to be depleted in 10 years.

The hypothetical royalty income forecast presented in Figure 1 totals $1,258,000. However, the mineral property’s owner should not expect to receive this amount from the producer. Typically, the fair market value is considerably less than this amount. Why? The reduction is due to the application of a financial analysis technique called discounted cash flow analysis. In simple terms this means that a rational person would be willing to pay more for a note providing for the receipt of a cash payment of $100,000 in one year versus an identical amount payable in 10 years. If nothing else, the earlier payment could be invested in interest bearing securities (such as a CD). For example, if the $100,000 is invested at 5 percent interest for a period of 10 years, the balance would be worth approximately $250,000.
Selecting the discount rate takes into account several financial factors as well as adjusting for risks associated with the project. Figure 2 illustrates the fair market value is only about half of the total royalty being projected. However, considering that the owners get the cash payment today, can reinvest the proceeds, and may shift any risks associated with the property and the royalty income forecast to the operator, the reasoning for the discount may be apparent.

Both case studies presented at the beginning of this article illustrate the benefits of utilizing the principles of this article to determine the fair market value of a mineral property. Following a thorough analysis that considers the deposit’s characteristics, the market, applicable royalty rates, and the appropriate discount rate, a reasonable and defendable estimate of value can be derived. For Case A’s owner this will help him arrive at a fair and defendable price before beginning negotiations. Unfortunately for Case B’s owner, the additional $1,000,000 is a lost opportunity.

Mike Nowobilski is president of Mid-America Energy & Mining Services, Inc. He can be reached at 618-624-0155, or nowobilski@midam-inc.com.

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News Across the Nation

Compiled by Angie Moehlman

Aggregate issues

Waldorf, Md.—The Mineral Information Institute recently recognized Chaney Enterprises’ efforts to promote Natural Resource Literacy in America in their 2002-2003 National Education Sponsor Award. Chaney Enterprises is a leading supplier of concrete, concrete block, construction materials and supplies, and sand, gravel, and stone.

Columbus, Ohio—The Ohio Aggregates and Industrial Minerals Association was approved by the Ohio Environmental Education Fund and Ohio Environmental Protection Agency Director Chris Jones for a grant to update the Aggregate Industry’s Environmental Compliance Manual. The project, “Environmental Compliance Outreach Program for the Aggregate and Industrial Minerals Industry,” will provide an online, updated resource on environmental compliance issues relating to the industry.

Berkeley Springs, W. Va.—Better Minerals & Aggregates Company, a U.S. producer of industrial minerals, announced it completed the sale of Better Materials Corporation, its crushed stone and hot mixed asphalt business, to a subsidiary of Hanson Building Materials America, Inc. on July 18, 2003.

Permitting Scoreboard

Vancouver, Wash.—According to The Oregonian, a proposed 3.3 million-cu.-yd. gravel mine east of Vancouver received a tentative environmental green light from county planners. The 40-acre site is located across the street from a controversial proposed landfill for construction debris. Pacific Rock Products named the project the Reebs-Parr Surface Mine. The company’s goal is to remove gravel to a depth of 68 ft. The company stated that it may seek permission later to mine adjoining parcels or it may add the land to the Columbia Tech Center.

Spokane, Wash.—According to the Spokesman Review, the Kootenai County Planning Commission voted 4 to 3 to deny Spokane Rock Products’ proposal for a 490-acre mine at Stateline. The commission could not come to an agreement on the best way to periodically review the mine, how to protect the aquifer, or how to buffer neighbors. The request will now go to the County Commission.

New Melle, Mo.—Fred Weber, Inc., recently asked the St. Charles County Planning and Zoning Commission for a conditional-use permit to start mining the New Melle quarry underground. The company proposes drilling straight into the quarry face approximately 175 ft. below the ground surface to remove limestone. In June, residents from areas near the mine objected to the proposal, with concerns related to possible increased truck traffic and blasting vibrations. The Planning and Zoning Commission made its recommendation in July, and the St. Charles County Council considered the recommendation on Aug. 11 and is scheduled to vote on the measure Aug. 26.

Coopers Plains, N.Y.—According to the Star-Gazette, Dalrymple Gravel and Contracting Co., Inc., Pine City, N.Y., will soon receive a state mining permit for its proposed gravel mine. State Department of Environmental Conservation Commissioner Erin Crotty recently ruled that two outstanding issues involving the mine’s environmental impact have been resolved. To start mining operations at the site, Dalrymple will also need a permit from the town of Erwin.
However, the Erwin Town Board unanimously approved in June a nine-month moratorium on the expansion of mining operations.

State Funding Status
Lansing, Mich.—According to The Bond Buyer, the Michigan Transportation Commission recently approved increasing the amount of bonds it issues to fund road projects. The commission voted last month to issue $40 million a year for projects that would be cut under Governor Jennifer Granholm’s budget.

Trenton, N.J.—According to the Courier News, the Tri-State Transportation Campaign sued the state Department of Transportation in 2001, asking the court to order the DOT to live up to the provisions of the Transportation Trust Fund renewal law. The law requires it to reduce the number of structurally deficient bridges and highways with bad pavement. In June, a panel of appellate judges wrote that the DOT’s capital investment plan “violates the legislature’s command...that it articulates a plan that focuses upon the goal of repairing the state’s aging infrastructure.”

Chicago—According to the Chicago Tribune, the state of Illinois is rerouting a total of $367 million that was earmarked for transportation in an effort to reduce the multi-billion-dollar state deficit. Funding cutbacks threaten to postpone repair and expansion of secondary roads in the Chicago area and will mean the loss of almost 10,000 construction jobs, according to an analysis by industry experts.

St. Louis, Mo.—According to the St. Louis Post-Dispatch, Linda Wilson, a spokeswoman for the Missouri Department of Transportation, stated that officials will have about $150 million a year to spend on projects in the St. Louis area, compared with $300 million in the fiscal year that ended June 30. The state will need $100 million a year to preserve and maintain its roads and bridges in the area.

Washington—U.S. House members representing states that will lose highway funding if the current spending formula is changed have formed a group, the Fair Alliance for Intermodal Reinvestment. The group is working to avoid a change contained in a bill House Majority Leader Tom DeLay introduced in May. DeLay’s bill would require that states receive at least 95 cents back for each $1 contributed to the Federal Highway Trust Fund. The FAIR coalition is pushing for a “needs-based” formula, which would focus on a state’s transportation needs rather than states receiving a targeted amount of money.

For complete coverage of state news and construction forecast, go to State by State.