1.10.3. Special Considerations for Minerals Properties.

Property Rights and Interests. It is fundamental that the property rights and interests in minerals properties are identified as part of the problem identification process. The client agency must identify the property rights and interests that are to be acquired and valued. A comprehensive understanding of the rights and interests to be appraised is critical to the proper development of both the sales comparison and income capitalization approaches to value. 

In the oil and gas industry there is a distinction between the working interest and the royalty interest. For example, in a federal lease sale the successful bidder acquires a working interest through payment of a bonus bid while the United States retains the royalty interest. In hard rock mining, these two interests are sometimes referred to as the contributing and noncontributing interests. The contributing interest is controlled by the mining company, which contributes the capital required for exploration, ore definition, and mining of a property. The noncontributing interest is a passive interest in the land and is essentially a nonparticipating royalty interest. Both contributing and noncontributing interests can be present in leased fee and fee simple estates. In the case of fee ownership, the contributing and noncontributing interests may be held by the same party. 

The selection and evaluation of comparable sales in the sales comparison approach and the methodology selected for the income capitalization approach are both driven by the interests being acquired and valued. For example, when valuing a noncontributing interest, the sales selected for analysis should be transfers of property with the same interest. The income analyzed would be the present worth of the anticipated future royalty income. 

Appraisers valuing mineral properties impacted by the 1872 Mining Law are advised to coordinate with client agency staff to clarify the approaches to valuing those interests. 

Sales Comparison Approach to Value.Despite the common use of the income capitalization approach for industry purposes, in federal acquisitions the sales comparison approach is normally considered the most reliable approach for minerals as for other property types.82 As a result, the appraiser cannot default to using an income approach or other valuation method that may be acceptable for typical industry or other purposes. It is unacceptable for an appraiser to simply state that there are no comparable sales transactions without providing adequate support for the conclusion. 

To properly develop a sales comparison approach to value for a mineral-bearing property, the appraiser must understand the level of information available concerning the mineralization found on the subject property. It is then important to identify comparable sales that had similar levels of information about mineralization available at the time of sale. Significant variables typically include rights conveyed, conditions of sale, the presence of multiple ores on the same property, access for extraction purposes, topography and cover (stripping ratios), transportation availability and cost, and distance to smelters or refineries. All of these factors may require adjustment.83 

In analyzing a sale of a mining property as a comparable sale, the sale may include the mine, mill, extraction plant, offices, and various other support facilities. These capital improvements are part of the real property and are also components of the business of mining and selling the mineral. The appraiser must understand the complex interplay of the real property components and identify where the real property ends and the business interests begin. 

The verification of comparable sales data is a critical component of this analysis, and the assistance of experts in identifying all necessary areas of inquiry during the verification process may be required. The appraiser may need to consult geologists, engineers, and other experts for producing or nonproducing oil and gas, fissionable and hard rock, or other locatable minerals.

In valuing mineral properties using the income capitalization approach, “[g]reat care must be taken, or such valuations can reach wonderland proportions.” — United States v. 47.14 Acres of Land in Polk Cty., 674 F.2d 722, 726 (8th Cir. 1982).

Also important in the sales comparison approach is the selection of the appropriate unit of comparison. Such selection should generally mirror that unit of comparison used by participants in the market and, as such, will generally result in the tightest bracket of value for the subject property.84 

Income Capitalization Approach to Value.The income capitalization approach to value is also a valid means for developing an opinion of the market value of mineral properties, but should never be used exclusively if comparable sales are available for use in the sales comparison approach. The income capitalization approach can be especially applicable when the subject property is already being mined, and thus the historical income stream from the property is available for analysis. In applying the income capitalization approach, appraisers must take care to consider only the income that the property itself will produce—not income produced from the business enterprise conducted on the property (i.e., the business of mining).85 An appraiser who is not thoroughly experienced in the appraisal of mineral properties should not attempt to employ the income capitalization approach. Even when used by an appraiser experienced in this field, this appraisal approach can be highly speculative, and great care must be exercised in its use. 

In developing an opinion of value by the income capitalization approach for a mineral property, it is generally recognized that the most appropriate method of capitalization is yield capitalization, most notably discounted cash flow (DCF) analysis. The income that may be capitalized is the royalty income, and not the income or profit generated by the business of mining and selling the mineral. For this reason, the income capitalization approach, when applied to mineral properties, is sometimes referred to as the royalty income approach. 

In conducting a DCF analysis, the appraiser must avoid estimating a property-specific investment value to a particular owner instead of developing an opinion of the market value of the property if it were placed for sale on the open market. Like application of the subdivision development method to value, DCF analysis in the valuation of mineral properties can be highly complex.86 Creation of a detailed mining plan for the property is often required. The essential components of this approach are: (1) the royalty rate; (2) the unit sale price of the mineral to which the royalty rate is applied (e.g., $20 per ton); (3) the projected annual amount of mineral production (e.g., 100,000 tons per year)—with the product of this ingredient and the prior two ingredients yielding the annual income; (4) the projected number of years of production and the year when the production will begin; and (5) the proper capitalization or discount rate. 

In developing an estimated income stream, the proper royalty rate can be derived from comparable mineral lease transactions, and the mineral unit price to which the royalty rate is applied may be derived from appropriate market transactions. The annual amount of production and the number of years of production are more difficult (and speculative) to estimate, and at a minimum require not only physical tests of the property to determine the quantity and quality of the mineral present, but also market studies to determine the volume and duration of the demand for the mineral in the subject property. Production level estimates should be supported by documentation regarding production levels achieved in similar operations. Production levels should also be consistent with the mining plan’s labor and equipment estimates. Numerous other factors may have to be considered, such as the amount of overburden, the method of mining (e.g., surface or deep mining), the requirements of permitting and applicable reclamation laws, the hauling distance to market, competition from other sites, the size and timing of the investment needed to construct any necessary access or processing plant, and so on. 

When the interest to be acquired and appraised includes the working or contributing interest, the income analysis should also consider the size and timing of the investment needed. Capital costs will include expenditures for services, construction, and equipment related to mine development, preproduction, and production. Among the factors to be considered in this portion of the analysis are preliminary studies such as exploration and environmental and engineering studies required to define the location and nature of the resource sufficiently to support the mining plan and ensure compliance with all applicable governmental permitting and land use regulations. The engineering costs related to the mining operation design must include contractors’ fees and management. Other elements to be considered include the costs of site preparation, facilities and improvements (including off-site improvements, such as rail or road facilities), mining equipment, and preproduction (including all of the costs required to bring the extraction process to full production, including the costs of time lag and permitting).87 

Operating costs are the expenditures incurred during the ongoing extraction process. These cost elements include labor, materials, supplies, utility costs, payroll overhead, management, indirect costs, and contingencies. Also, appropriate deductions for all relevant taxes associated with the operation must be made. As in the subdivision development approach, the estimation of an appropriate level of entrepreneurial profit is a critical element in the DCF analysis of any mineral property and is a factor that should be supported by direct market data whenever possible. 

One of the most critical factors in the application of DCF analysis is the selection of the discount rate. Attempts have been made to apply various statistical techniques (such as probability weighted scenarios, Monte Carlo analysis, marketing uncertainty analysis, and timing of development analysis) to mineral valuations to account for the extraordinary high risks associated with such operations. However, the application of various statistical techniques is not a substitute for discount rate selection derived from and supported by direct market data,88 which is the preferred and most widely accepted approach.89

82 See Section 4.8.
83 For a general discussion of the application of the sales comparison approach, see Sections 1.5.2 and 4.4.2.
84 See Section 4.8.

85 See Sections 4.4.4 and 4.8.
86 See Sections 1.5.1.2 for discussion of the subdivision development method.

87 This factor can have a significant impact on the value of mineral property because the time lag between the effective date of an appraisal and the projected date upon which all studies have been completed, all permits issued, all construction completed, and an actual income stream can be generated may be extended.
88 For a discussion of market extraction of discount rates, see the American Society of Farm Managers and Rural Appraisers’ 2012 course,
“Appraising Natural Resources,” 18-19.
89 See Section 1.5.1.2.