Fed., 849, it is evident that any valuation which does not take into
account the appreciation or depreciation of land values cannot be
sustained. There can be no serious objection to the doctrine that the
property of a corporation generally increases or decreases in value in
the same proportion as adjacent property, and it must therefore be
admitted that a value based on the sale value of adjacent lands is a
reasonable one and must stand. This reasoning, of course, will be
subject to exceptions, in the case of terminal properties, docks and
water-front properties, and right of way in large cities, but it is
believed to be sound when applied to right of way in the country and in
small towns and cities.
The next question to be determined is whether the increment of value due
to the use of the land is a proper one. It would appear that in the use
of land for water-works, gas-works, street-car barns, or other isolated
tracts of land used for corporation purposes, this increment would be
much less than in the case of a steam or interurban railroad, the
holdings of which form a continuous and unbroken strip; and, in the case
of street railroads, water-works, and like properties, it would be
indeed difficult to compute and afterward sustain any considerable
increment.
In the case of railway properties, however, it is quite evident that the
following facts can be sustained: The actual cost of property purchased
for railway purposes will range from two and one-half to five times the
selling price of similar and adjacent property used for other purposes.
While the actual percentage will vary somewhat, as between land in
cities and in the country, and as between fully settled districts well
served by roads and sparsely populated regions, yet the difference is
very marked, and is capable of determination by an examination of the
public records.
This difference can be determined either by a comparison of railway
purchases and other transfers, as was done in the later studies in
Michigan and in Wisconsin, or by extending the investigation to include
assessed valuations, and using the averages, as was done in the work of
Mr. Morgan in Minnesota.
In establishing figures for use in a valuation, it would appear to be
better to base them on an analysis of actual transfers than to undertake
to fix values by any methods of examination and personal appraisal.
Enough instances of the wide divergence of expert opinion have been
cited to show conclusively that such a method, applied to the thousands
of acres of a large corporation, may lead to serious error.
A single attorney or real estate man who has had experience in
abstracting and conveyancing, and who has bought some right of way, can
examine the records of an average county the largest city in which has a
population of 20,000 or less, abstract all railway transfers for 5
years, locate them on the maps, secure data as to actual selling prices
of near-by lands, and, in a comparatively short time, be in position to
furnish figures which will establish the relation between sales for
railway and other purposes in that county. The work that half a dozen
such men could do in 90 days would go very far toward establishing with
a fair degree of definiteness the value of the railway purpose increment
for the majority of counties in any average State. Of course, such an
investigation in the large cities is a matter of much greater labor, and
would require sufficient time to make complete examinations, probably
necessitating a special force for such city work.
On every appraisal, the question has been asked, should this railway
purpose increment be added to the value of the property? Clearly, yes.
The Supreme Court quotes approvingly from the Tennessee Court, as
follows (151 U. S., 479):
"The value of the land depends largely upon the use to which it is
put and the character of the improvements upon it."
This is stated again and again. It must be remembered that, for railroad
uses, the strip must be continuous; that it must be located so as to
permit curves and grades which conform to the requirements of the road;
that, no matter what damages may accrue to adjacent property, the road
must take its strip; that its use is entirely changed and is a structure
placed on it which is capable of vastly greater earnings than the
property produced before—all these elements add to the cost of the
property when it is acquired for railway purposes, and in the same
measure to its value under its new use.
In a new country, where transportation facilities are limited and land
cheap, this added increment may be little or nothing, but in a thickly
settled State, with many railroads, this element will increase with a
good degree of uniformity; while, in terminals, the price rises to
almost inconceivable figures. It is capable of being determined, and is
clearly an element in the cost of reproduction. The writer holds to the
view that it is properly to be placed with the physical values, and that
it should not be considered as an intangible element of value.
(_d_) _Depreciation._—Thus far, this discussion has not dealt at length
with the subject of depreciation, and it is not considered essential to
the purposes of this paper that it be done. The State appraisals have
raised a question as to the propriety of using mortality or life tables
as compared with personal inspection and the placing of a percentage
based on individual judgment. Either method is subject to error. It is
certainly desirable to secure the opinion of the man who inspects a
bridge, or building, or locomotive, as to its physical condition. It may
be desirable to use the check secured by the fact that the age of the
building is known and also the average life of structures of its class.
The result of the Michigan inspection of rolling stock was to sustain
fully the rules for valuation issued by the Master Car Builders
Association; and clearly, it is not only proper, but extremely
desirable, to apply tables to such equipment as freight cars, which are
scattered all over the United States, for it would be absolutely
impossible to inspect completely those of any road or system. On the
other hand, the life of steel rails cannot be determined by any simple
table, because the number of car movements, the weight of motive power,
the speed of trains, the location (on curves or on heavy grades), and
many other conditions affect their life. This also pertains to
buildings, locomotives, and other equipment. The character of service
rendered, the nature and extent of repairs, and the way in which they
have been maintained, add to or take away from any life assigned by
tables, so as to render them valueless in many individual instances.
In placing depreciation, allowance should be made, not only for wear and
tear due to use, and decay due to the elements, but also to cover that
which is due to obsolescence, or the fact that the facility is of an
antiquated or inefficient type, and has been superseded in general use
by more efficient and economical devices; this may be called commercial
depreciation, as distinguished from physical depreciation. The method to
be used in placing depreciation is clearly one of the important things
that must be determined by each set of appraisers, and, while the writer
believes that the use of expectancy tables would greatly facilitate the
work in many cases, the data on which to found a complete set of tables
and to support them and justify their use are often lacking; therefore,
any use of tables should be safeguarded in every possible manner, and
personal inspection of fixed property should always be made.
(_e_) _Immaterial Elements of Physical Property._—There are certain
expenses, inseparable from the construction of any public works, which
are a necessary and proper part of the cost, and are arranged for in the
original financing, but are not capable of identification after the
completion of construction work. These expenses are:
(1) Organization,
(2) Legal expenses,
(3) Engineering,
(4) Administration,
(5) General expense.
(1) Organization.—This includes the cost of the original organization of
the company, the cost of securing the charter and franchises, arranging
the financial plan, and securing the funds for construction.
The latter item is intended to include all salaries and expenses of
officials in soliciting and negotiating for funds, the services of
trustees, and all other proper expenses which are usual and unavoidable
in the process of exploiting a projected enterprise and interesting
capital therein. Discount on bonds is not included, and any allowances
for "premium," or "bonus," or other cash payment to any party for
services in securing funds, which are in excess of legitimate expenses,
should receive scant consideration at the hands of appraisers.
(2) Legal Expense.—This is for attorneys and all legal expenses, costs,
and fees in the organization and during the construction of the
property.
(3) Engineering.—This includes reconnaissance, preliminary and location
surveys, supervision of construction, and design and superintendence of
special structures. The cost of engineering on some of the more
difficult properties becomes a very large sum; on certain small lines it
may be comparatively small; and in some cases no engineers have been
employed at all; but the items of cost covered by this charge have in
every case been expended, even if done under the direction of some
superintendent.
(4) Administration.—This comprises the cost of the management during
construction—the direction of the enterprise.
(5) General Expense.—This is the cost of the general office organization
during the construction period, also numerous minor expenses, not
distributable.
It is not possible to build any public service plant without incurring
all these expenses to a greater or less degree. They are essential
elements of cost, and must go into the value of the plant when
completed. It can hardly be argued that cost, which in a large property
runs into thousands or hundreds of thousands of dollars, has no value at
the commencement of operation, nor does it appear that the value is
subject to depreciation as long as the property is an operating plant.
The writer holds the view that the line between physical and
non-physical elements of value should be drawn as follows:
Any value which attaches to the property by reason of any money expended
during the construction is part of the physical property values; while
any value due to the operation of the property which is in excess of the
physical value is a non-physical or intangible element. If the
correctness of this position be conceded, then all the foregoing items
are charges against the physical property, and, as long as it is an
operating property, these items of value remain part of the physical
property, and the writer contends that they should not be considered as
affected by depreciation, as long as the property is a going concern.
Different engineers have included in the appraisal other items which are
of a somewhat different nature, and some of which are open to argument;
among these are "interest during construction." This item is clearly an
allowable one, but serious differences of opinion develop as to a proper
amount to allow in making an appraisal.
The corporate history of the Ann Arbor Railroad, in Michigan, shows that
it was built in sections of from 25 to 30 miles, and that each section
was put into operation as soon as built, so that, while the actual
period of construction of the complete property extended over 15 years,
no section was under construction much more than one year. This is
typical of much of the railroad building of the past, and on such a
property the interest charge would be comparatively small.
A proper charge in such a case would clearly not be sufficient in the
case of a road several hundred miles in length, through mountains, with
tunnels, heavy bridges, and other structures which would extend the
actual construction over periods of from 3 to 5 or 6 years, and this is
particularly true where the road is a main line or artery, and where
local traffic is of minor importance.
The computation of the interest charge is complicated by the fact that
interest begins to run as the bonds are taken up, and but a small part
of the construction money draws interest during the whole period.
The practice in the State appraisals has been to fix a uniform
percentage for all properties. This has had in its favor the argument
that it was conservative valuation where taxation is the ultimate end,
as the amount was less than one year's interest in every case. It would
appear to be more correct to use the corporate history of each company,
determine the actual construction periods, and use a rate based on the
actual time in each case. This can be fixed with a fair degree of
accuracy, and a reasonable percentage determined, to equalize the
varying periods of time on which the interest runs on different parts of
construction.
Discount.—Discount on bonds is claimed by certain railroad men as a
proper item for consideration. As has been argued elsewhere, this is not
a proper charge against capital. It is an adjustment of the interest
rate to the market, or an advance payment of interest; and, in the
writer's opinion, should under no consideration be allowed.
Working Capital.—Working capital is another item claimed and conceded in
some valuations. It is not a part of the "cost of construction." The
money provided for working capital at the outset is not a permanent
investment, but is rather a temporary loan paid back out of earnings.
The writer fails to perceive any possible argument in favor of adding
such an item to the permanent value of the property. In making an
appraisal, after the physical value is determined, it is usual to set up
a statement of stores, supplies, fuel, and cash on hand, and working
capital is certainly shown by the current balance sheet, in the form of
cash or accounts receivable. It would appear to have no place in a
physical appraisal. Although the items of cash, stores, and supplies
were shown in the Michigan appraisal, they did not appear as part of the
physical value, nor were they taken into account in computing intangible
value, but, being taxable property, they were reported separately.
(_f_) _Contingencies._—The use of a percentage for contingencies in the
appraisal in Michigan was bitterly contested by the railroads as
improper and excessive. In Michigan 10% was used, in Wisconsin 5½%, and
in Minnesota 5 per cent.
Subsequent work in Michigan has demonstrated that the use of as high a
figure as 10% was fully justified; and the probability is that the
latest Michigan appraisal did not eliminate omissions, inaccuracies of
description, and excess cost of construction due to difficulties, to
such an extent as to justify much reduction in the percentage.
In making an appraisal, the percentage to be applied to cover
contingencies is a proper matter for consideration, and in some cases
conditions might well be such that even a smaller allowance than that
fixed in Minnesota would be proper, but such cases would doubtless be
the exception. The writer believes it to be proper practice to add
liberally for the contingency item. The strongest argument against it is
that it is incapable of being described and located definitely, and is
difficult of exact proof. Therefore it has been claimed that it partakes
of the nature of a non-physical element, and that if there be any value
over and above the physical property value, it will appear with other
non-physical elements reflected in the earnings, and may be properly
included in the intangible value if such exists. This argument does not
appeal to the writer as being final, and he would advocate the use of
such a percentage of physical values as appears proper in each appraisal
to cover the error due to the extreme difficulty of securing an exact
inventory and construction history of the properties.
(_g_) _Design._—Among the matters which were considered in the Michigan
work was that of adaptability, or the economical questions of location,
design, and construction. It is possible that in some properties, such
as water, gas or electric companies, the efficiency of the plant may be
very greatly affected by faulty design, uneconomical arrangement,
improper construction, and to such an extent that any cost of
reproduction, less any ordinary depreciation, would be greatly in error
without further allowance. This may also be true of railroads. Excessive
curvature and gradients greatly decrease the tonnage hauled by a given
power, without decreasing the cost per train-mile.
It is extremely difficult to treat this as a physical element. It is
impossible to reduce it to terms of dollars and cents by any usual or
customary methods. It is impossible to separate it from any one of half
a dozen other items that may be brought up. It opens the door to endless
speculation as to what might or might not take place under somewhat
different conditions. For these reasons, it was treated in the Michigan
appraisal as a non-physical element of value and dismissed from all
consideration in the physical appraisal. This was clearly proper, and
the subject is only referred to here for the purpose of making clear
that it was fully studied and a definite conclusion reached.
Adaptation.—In the sense that this term is used by Mr. Williams and Mr.
Morgan, the appreciation or solidification of roadbed was considered in
the Michigan work, but given no place in the appraisal. This is a very
proper item to consider, but it would appear to be better to include it
directly with the roadbed item in the physical appraisal as appreciation
or solidification. There can be no reasonable objection to adding to the
contract prices for grading, ballasting, etc., a reasonable amount to
cover, not so much the seasoning and settling of the new roadbed, as the
actual money disbursed in work on this new roadbed during the first 3 or
4 years of operation in order to bring it up to the proper operating
condition. A very considerable part of the money spent on "maintenance
of track" for the first few years after a new line is built is in
reality deferred construction cost.
(_h_) _Apportionment of Values._—The apportionment of values of
locomotives, cars, miscellaneous equipment, shops, and those other parts
of the cost which are not susceptible of separation from the operation
of the property as a whole, is an interesting and at times a perplexing
problem. While the Courts have viewed as equitable the distribution of
values between territorial units when made on a track-mileage basis, it
is hardly likely that a Court would look with favor on an appraiser
appointed by Michigan giving any consideration to values of bridges,
track, or buildings in Ohio. Thus far, every State appraiser has
concerned himself only with the fixed physical property in his own
State, together with his proportionate share of the floating property.
The methods that may be considered are track-mileage, car-mileage,
locomotive-mileage, and train-mileage.
The method finally used must be such as will give the fairest result for
the property under consideration. In some cases one or more of these
methods will give a fair value, while in other cases the same system
would be most unjust.
(_i_) _Terminals._—There is no one feature of the entire problem so big
with possibilities, and so far from solution, as that of terminal
property values and their proper assignment. The property must be
considered as an operating unit. Its value must be made up of the values
of the parts or elements plus an added value that comes from the
operation of the whole. The problem would be simplified if what were
sought were the value of a certain railroad, but, as it has been
presented up to this time, the problem is: what is the value of that
part of this railroad in Michigan? or Wisconsin? or Minnesota? A fairly
satisfactory solution of many of the value questions has been obtained,
but nothing in the way of a solution of the terminal question. A road
owns 300 miles of line in Michigan and 7 miles in Ohio. That 7 miles
includes its largest terminal; its principal connections are there; it
has a fine property, and is in the capacity of landlord to several other
roads. What part of that terminal value, if any, is assignable to the
State of Michigan? Decidedly, it would not be proper to appraise the
entire property as a unit and assign to Ohio only the proportion that 7
miles bears to the whole length; it is equally unfair to appraise it as
a Michigan property down to the State line, and add nothing to the value
by reason of the terminal.
The influence on the value of the property, of the ownership of
terminals in such cities as Chicago, New York, Jersey City, Hoboken,
Pittsburg, Detroit, St. Louis, Kansas City, and other large centers of
population is tremendous, yet a very large part of the railroad mileage
entering those cities belongs to roads which have their largest mileage
outside the State in which the terminal is located.
There can be no doubt that the influence of a large terminal affects in
a measure the value of every mile of line owned by the company; that
this influence is greatest on the principal and direct lines, and less
as more remote parts of the system are reached. As yet, no plan has been
suggested for determining what this value is or for apportioning it.
The final solution in Michigan was to treat terminal properties within
the State exactly as other property was treated, and to assume that, if
there was any value assignable to Michigan by reason of outside
terminals, it would appear as a non-physical value through the earnings.
When all the phases of this question are considered—the enormous land
values, the value due to possession of deep-water terminals, the effect
on the business of the entire property by reason of the ownership of
such properties as those, for instance, in New York City, Jersey City,
and Hoboken—it is evident that no appraisal which has yet been made has
established any rule of valuation which may be considered proper for
terminals.
It is to be hoped that the work now in progress in New Jersey may be so
well supported by the State that it will be possible for the appraisal
board to make an exhaustive study of this subject and reach definite
conclusions as to the real extent, manner of computation, and proper
method of distribution of these values.
(_j_) _Development of the Art._—Is any value assignable to property on
account of expenditures by reason of the rapid development of the art?
This question seems not to have been squarely asked or answered in
connection with any of the past appraisals.
Every piece of material and every facility purchased by a company is
bought with a definite expectation that it will have a certain life,
that during that term of life it will add sufficiently to the earnings
to provide a fund for its replacement and earn a profit. No matter
whether or not such a reserve is created on the books, this is the
theory, and, under it, accident may wipe out certain new property, other
property will outlive its expectation and maintain the average life of
the entire group of facilities.