and out-of-date conditions. Old wrought-iron rails of antiquated
pattern, old cast-iron frogs, etc., of a pattern which had not been in
general use for fifty years, were found in the track. On some of the
little-used sidings, the old wrought-iron rails were so worn that the
tread of the rail was entirely gone, only the web remaining to carry the
traffic, and such rails were still in use.
In such a valuation, also, many items, some of considerable magnitude,
were found which were extremely difficult to classify and assign to
their proper place. Such a one, for instance, as a soft, sand rock
deposit beside the track, which for many years had furnished engine
sand. Many thousand cubic yards of this material had been excavated, but
it had not gone into the roadbed as ballast, or to make fills, or to
widen embankments. It would hardly have been proper to classify such
excavation as grading, for it was an item of engine maintenance and
train operation. This is only one of numerous problems which had to be
solved.
After all the survey had been made, most of the work of compilation had
to be done. Some of it had already been done in the office by the small
office force, but the great mass had to be done by the men who did the
work in the field. This task was of almost incomprehensible magnitude.
There were thousands and thousands of items, and such a great mass of
figures that the ordinary man would become lost in the maze. The data
had to be checked and re-checked by men who were not accountants, and
sometimes most ludicrous mistakes were discovered. However, it was at
last accomplished, and the writer's recollection of the "Present Value"
of the Chicago and Northwestern property in Minnesota is that it was
somewhat more than $23,000,000 for the entire mileage (about 625 miles),
or an average of about $37,000 per mile of track. Hardly any of the
mileage would be called high-class or trunk-line track, but most of it
might be classed as second-class or important branch-line railway.
E. KUICHLING, M. AM. SOC. C. E. (by letter).—This paper is a very
valuable addition to the literature of a comparatively new subject that
is rapidly attaining great political importance, and it gives abundant
evidence of deep research and thought by the author. The reasons for
determining the true value of such properties, as well as the general
principles of making the valuation or appraisal, have been set forth so
clearly and convincingly that little can be added in this respect;
hence, there is room for comment only about details.
One of the perplexing questions is the determination of the proper value
of the right of way and real estate of a railroad. The land was
originally acquired at a certain cost, essentially for public use, and
in the course of time its value, as determined by reproduction cost,
usually becomes greatly increased by the development of the adjacent
land by its various owners. Without the railroad, such development and
appreciation of land values would probably not have occurred, and,
therefore, it has been argued by many persons that, for taxation
purposes, the railroad lands should be appraised at only their original
cost, while, for capitalization purposes, they should be appraised at a
value measured by that of the adjacent land at the present time. This
claim is based on the theory that the railroad is like any other piece
of public work, such as a canal, highway, or pavement, which is built
for the use of the public, and on which no tax is levied by State or
municipality. On the other hand, it has been held by some of our Courts
that a proper valuation must take into account the appreciation or
depreciation of land values; but, as the opinion of a Court is not
unalterable, the soundness of this doctrine cannot be regarded as
permanently established.
The author states[41] that there can be no serious objection to this
doctrine in relation to rights of way in the country and small towns,
although he admits that it is subject to exceptions in the case of
cities and terminal and dock properties. It will be of great interest to
learn his reasons for making such exceptions in the case of the most
costly lands, and whether the valuation of such lands should be more or
less than that of similar adjacent lands used for other purposes. From
the context the inference may be drawn that the valuation should be
somewhat higher than that of adjacent similar land in the case of a
steam or interurban railroad, because its holdings form a continuous
strip; but to the writer this reasoning does not appear satisfactory.
The statement of the Court, that "the value of land depends largely upon
the use to which it is put and the character of the improvements upon
it," does not necessarily involve a higher valuation of the property
than its cost, and it is quite conceivable that the actual value of the
property after being taken by a railroad may be much less than it was
before. The only reason in such a case for maintaining the purchase
price is to conserve the general valuation of the adjacent similar real
estate.
In dealing with the subject of depreciation, the author has been very
brief, as he did not consider it essential for the purposes of the
paper. This is to be regretted, as depreciation is an important feature
in every valuation, and so few trustworthy data concerning it are
available. The value of the paper would be greatly enhanced if the
author would give the assumed average life of the principal components
of a railroad, based on some definite traffic, and normal grades and
curves. Much diversity of practice in this respect prevails, and the
final judgment of the numerous experts who were engaged in the Michigan
valuations cannot fail to be of great interest. The same remarks are
also applicable to the unit prices adopted for construction and
equipment.
The subjects of expenses for organization, engineering, administration,
contingencies, and non-physical values are treated very thoroughly by
the author, and particularly interesting is his discussion of the
complex question of franchise value. After quoting from numerous
judicial opinions, he reaches the conclusion that the franchise simply
protects the owners of the property in their enjoyment of the earnings,
and that its value merges into the "fair value" of the property and
becomes inseparable from the other non-physical elements of value; also,
that the aggregate non-physical value of the property depends only on
the net income for a period of years. This method of estimation
certainly has the merit of being simple, rational, and free from all
hypothetical considerations. It is, however, obviously governed by the
rates charged for the services rendered, and if these are likely to be
altered at any time by governmental action, a corresponding alteration
in the "fair value" of the property will take place.
This consideration brings us at once to the intricate question of
reasonable rates, which involves the matter of reasonable design and
construction of the property. In most cases the working capacity of the
plant must be much greater than the average annual demand for the
service performed, as so-called "peak loads" of relatively short
duration must be provided for. The magnitude of these peak loads,
however, varies with the subsequent development of the territory, which
is necessarily conjectural; hence it follows that a comparatively large
amount of capital is often invested in an enterprise for the purpose of
taking care of such anticipated temporary demands, and on this
investment a "fair return" should be granted. This condition is
particularly noticeable in municipal water-works plants, where provision
must be made for supplying water for fire service to an extent which may
be several times greater than the normal hourly rate of consumption. In
the case of railroads, such demands can usually be met by adding to the
rolling stock at moderate expense, while in a water-works the outlay is
relatively greater because the entire plant must be adapted in the
outset to the anticipated maximum delivery in the course of a
comparatively long period of time.
The problem of rate-making has been excluded by the author from his
present paper on valuation; but, inasmuch as he is so well qualified for
the task, and also because the non-physical value of the property
depends mainly on the rates obtained for the service rendered, it is
hoped that he will deal with this feature in a subsequent paper, thereby
bringing out a discussion on the obscure subject of "fair return." It is
noticeable that these phrases occur frequently in judicial opinions, but
the fundamental principles on which a definite conclusion should be
reached are seldom set forth clearly.
RICHARD T. DANA, M. AM. SOC. C. E. (by letter).—The solution of this
problem includes practically all the factors in the general subject of
economics, in which engineering occupies a large but by no means
preponderant part. Mr. Riggs has done some very valuable and pioneer
work in contributing this paper at this time; and the writer, in calling
attention to what appears to be a radical error in it, does not wish to
be taken as attempting to detract in any way from its great value as a
whole. It is most important, in the inception of such an investigation,
on the part of the members of this Society, to remove from the subject
the stumbling blocks as they appear.
The author makes the following statement:
"It is true that the 'value' of a property is an unstable figure,
subject to fluctuations due to natural or artificial causes, and
that a material change in value may occur suddenly, but the 'value'
of any given property on any given date is, or should be, from an
engineering standpoint, a definite sum which may not be varied or
changed to suit the whim or will of the people for whom the work is
done."
The fundamental conception of a value is so important in an
investigation of this kind that it is worthy of careful and thorough
discussion.
The appraisals which the writer has had occasion to make have generally
been for one or other of the following purposes, namely:
(I) Taxation, in the interest of the community or corporation
taxed;
(II) Bonding, in the interest of the banker or representative of
persons who contemplated lending money on the property;
(III) Rate-making, in order to determine what was a fair amount
of money that the property should be allowed to earn for the
owners.
Now, in general, a proper value for any property for any one of these
purposes is different from its proper value for any of the others. This
proposition is of immense significance, for the reason that, if the
value for the property arrived at, on one basis, be accepted and applied
for one of the other purposes, it will inevitably result in gross injury
and financial loss to some one.
In attacking this problem, one must be careful to take the correct
standpoint, which is not necessarily that of engineering. Engineering
science is indispensable for a large part of the work, but there are
other indispensables, which would not ordinarily be recognized as
engineering. The writer takes the view that engineering is a part of
economics, rather than economics being a part of engineering.
To illustrate this point, consider two objects, one of which is concrete
and simple and the other more complex.
(1) A steam shovel belonging to a railroad, costing $10,000, new;
(2) The entire railroad as an operating entity.
Assume for (1) that the shovel has been purchased recently, is in
perfect condition, and that the railroad has some work for it to
commence on as soon as it can be properly installed. What is its:
(I) Taxable value,
(II) Bonding value, and
(III) Rate-making value?
(I) The tax assessor cannot properly appraise it at $10,000, because it
certainly would not sell for that sum, and if the community should have
to sell it for taxes the actual return minus the charges would be so
much less than the $10,000 that the community's books would show a heavy
loss; and this practice, if largely indulged in, would bring the
community into financial straits. The community must be exceedingly
conservative in its estimate, for this very reason; and, therefore, it
has been customary, almost universally, to tax such articles practically
on their sale value at what might be called panic prices. The company
which sold the shovel to the railroad would not buy it back two days
after the sale for more than the original price minus what that company
considers its selling charges, say 20%; so that, in this case, even if a
customer were at the door, the shovel would not be worth more than
$8,000, and a fair tax appraisal could not consistently be more than
$8,000 minus charges of, say, $250, or $7,750.
(II) Assuming that the railroad is a very small one, that it wants to
borrow money, and desires to put up the shovel as collateral for the
loan. What would be its loan value to the lender? In considering this
point, it is necessary to assume that no aid is rendered by the credit
of the railroad itself, but that the protection for the loan is to be
furnished by the shovel only. Now, the banker will reason that, in the
event of the note remaining unpaid, he will have to sell the shovel to
reimburse the bank for its loan, and he will be required to consider the
matter on a conservative basis. He cannot lend on the shovel up to its
full value, for in the first place it is not a "negotiable security." If
it were a security, with a free market on some stock exchange, he would
probably lend to the amount of 80% of its value, but a steam shovel in a
sand bank on a railroad is by no means as convenient of exchange, nor as
easy to foreclose on as a stock certificate in a banker's box; therefore
he will lend, or he ought to lend, less than 80% of its sale value,
minus the selling charges. If he lends more than this, he is lending on
the credit of the owner of the shovel rather than on the shovel itself.
Granted that the maker of the shovel is willing to buy it back at its
full selling price less the selling cost, the maximum loan value of the
shovel would be a little less than 64% of its purchase price, or $6,400.
To lend more than this on the shovel would not be conservative banking.
There is another bonding or loan value to this shovel, when it is
considered as part of the assets of the railroad, the bonds of which are
to be held by the banker, under which circumstances a higher value than
$6,400 would be admissible.
(III) If the value is to be determined with a view of ascertaining what
is a reasonable figure that the owner of the shovel ought to be allowed
to earn as a public utility organization, the problem is entirely
distinct from the foregoing two cases. Assume that the railroad is
entitled to earn at least 6% on its investment in the shovel. Now, its
investment is $10,000, because that is the money that it cost; and
nothing had been credited to its account, since the shovel had just been
purchased and had not yet done any work. The shovel cannot be considered
as being worth more than its cost, and it can easily be shown it is not
worth less for rate-making purposes.
These three illustrations, which are very briefly outlined, should
demonstrate the fact that there is almost no relationship between any
two of the different kinds of value which are being considered.
Now, from the standpoint of the railroad as a whole:
(I) Should railroad property be taxed on the basis of what the entire
railroad would bring on a foreclosure procedure? Obviously not, because
the railroad is taxed in sections. The Town of Squedunk will tax the
portion of the railroad that lies within that town, and will have
considerable difficulty in putting down as security for its own bonds
the locomotives and cars which go through once a week or twice a day at
40 miles per hour. To cover partly the flitting assets, it taxes the
railroad on a franchise value. It may tax a railroad's land on the same
basis that it taxes land owned by private individuals, notwithstanding
the fact that when the railroad buys the right of way it generally has
to pay more money per acre than the householder or the farmer. This unit
cost to the railroad may be two or three times that to the farmer, yet
the writer has never heard of a community attempting to tax railroad
property two or three times as heavily as adjoining property used for
private or commercial purposes.
(II) On the other hand, this same property is an absolutely sound asset
for the railroad, and the railroad probably bought the property from the
proceeds of the sale of bonds. If the public service commissions were to
rule that the railroad may be allowed to issue bonds only to the amount
of the taxable value of the property which is to be held as security for
the bonds, the result would be an absolute paralysis of railroad
construction. A bond is an obligation to pay so much interest for so
many years, and to pay back the principal at the end of its term. The
bondholder is interested in the absolute regularity of his interest, and
in the security that lies behind the principal, and it is to-day the
custom of banking houses to consider a bond well secured when, in a
territory of reasonably rapid growth, the principal is earning say twice
the interest on its bonds, and when the cost of reproduction is in
excess of the amount of the bonds, provided that the property is in good
physical condition. If it should be necessary to foreclose on the bonds,
it is then reasonable to suppose that some one else will buy it in for
at least the amount of its bonded indebtedness. What can this possibly
have to do with the taxable value of the track in the Town of Squedunk?
One may be 1.5 times the other, or three times the other, depending on a
multitude of circumstances.
(III) The value of the property for rate-making is a complex one to
determine, and, of course, there is no opportunity for a full discussion
of it here. One point, however, will serve to establish thoroughly the
difference between this and taxable or bonding value. If the community
is prosperous and the business is a good one and honestly managed, the
railroad ought to be allowed to earn a reasonable percentage, say, at
least 6%, on what has been put into it. If the community should decree
otherwise, then people will not build railroads for investment purposes,
and all will lose money. Now, it is a well-known fact that a new
railroad's earnings have to grow for several years before they are on a
normal basis, and part of what the owners of the property have put into
it is, for example, the interest on its cost before its earnings are on
a normal basis. This may amount to a considerable percentage of the
original construction cost of the property, if the business is several
years in developing. Granted that the community ought to allow the
property to earn a reasonable interest on what has been put into it,
then the rate-making value will be very much larger than the sum of the
taxable valuation of all its different parts. It will also be much
greater than its bonding value, because, as a bond proposition, it can
borrow money up to a limited percentage of what it is actually worth.
GEORGE T. HAMMOND, M. AM. SOC. C. E. (by letter).—The engineer called on
to fix the valuation of public service corporation property has so
little engineering literature on this special subject to guide him that
he must feel grateful to the author of this excellent paper for adding
so much of a kind that is very desirable.
Estimating the cost of an engineering structure in advance of its
construction is one of the most ordinary professional duties, but how
difficult it actually is, and how much engineers differ with one another
in their estimates on the same structure! Perhaps there is no
professional duty which calls for so much study and so much experience,
or which tests so closely the ability and capacity of the engineer. How
seldom professional estimators agree with each other; or designing
engineers with contracting engineers; as witness the bids received at
the public lettings of contracts when compared with the engineers'
estimates of cost; and, if this is true, which no one will attempt to
deny, how much more so is it probable that estimators will disagree when
they attempt to place a value on works already completed, and in
service, perhaps, for many years, in which various changes in value have
occurred, and in which questions of fact are mixed with legal questions
involving legal rights, as well as financial questions.
The tendency in all such valuations appears to be a mixing up of things
in general—like the witches' stew. Everything goes into the pot and is
boiled together until all becomes soup, at least until the official
commission, like the witches, considers it done and ready to be served
up in the form of a report. It is then observed that the substance
served out is of a complex nature; that the valuation of engineering
structures has become mixed with other and uncertain values; that the
whole value, as stated, is, after all, little better than the
commission's opinion of the value; and that another commission would
reach a different conclusion.
The author states that the valuation of corporation property:
"Should be the honest judgment of the men composing the commission,
as to the actual cost of reproduction, present physical value, or
'fair value,' and should be ascertained by a systematic and
scientific method which takes into account all the facts concerning
the property, its physical value, its strategic location, its
operating revenues and expenses, and its franchises, rights,
competition, opposition, and all other tangible or intangible
elements, which would affect values. The method of valuation should
be such as to minimize or entirely eliminate all differences due to
errors of personal judgment."
This, it seems, complicates actual present values with conditions which
might, or might not, continue. Outside of the physical valuation of the
plant, which offers the easiest problem presented, how can one fairly
put a value on operating expenses and revenues, which might be affected
favorably or advisedly by good or bad management, and by numerous other
complex and almost incomprehensible circumstances.
The tendency of all such commissions seems to be to confuse together and
mix up some things which are logically separate. Thus, the value of the
plant and franchise, good will, and present investment or income value,
etc., are too often taken together. The value of the plant is dependent
on the cost of reproduction, and also the depreciation of the
structures, as engineering structures, and should be based on present
prices for which the work could be replaced, minus the depreciation,
which is a question of engineering judgment and experience. The other
items of value are largely dependent on the situation of the plant and
its prospects as an income-producing property, and this again is a
matter of opinion, in which the opinions of financiers and investors are
sometimes of more moment than those of engineers. The opinion of lawyers
as to the value of the franchises and the cost of the legal
complications possible or probable must also enter into any seriously
worthy opinion as to value.
The few salient lights in the picture of valuation, presented by the
author, serve especially to reveal the darkness which involves the whole
subject of valuation, estimating, and the use of cost data for such
purposes, and to suggest that, with all the wonderful progress on the
theoretical side of the profession, engineers have as yet advanced but
little in this division of the practical side—cost data, valuation, and
estimating. Engineers cannot compare the results of different estimators
and appraisers without sorrow and even shame for their ignorance, or
their incapacity to agree in the application of scientific principles
and the results of practical experience to this branch of their work.
At present we would seem to be a long way from a method of valuation,
"such as to minimize or entirely eliminate all differences due to errors
of personal judgment."