How do you value a water right?

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WestWater Research LLC

Brett Bovee
Brett Bovee
Regional director, WestWater Research LLC, Fort Collins

A water right can be an important and valuable piece of a real estate portfolio. In some locations along the Colorado Front Range, the water rights can be worth more than the underlying land. But just like other types of real estate, water rights are quite varied and can carry a wide range of values. So how do you value a particular water right?

First, a brief review of what a water right is and is not. A water right is a usafunctory right (legal term) that provides the right to use the state’s public water resources for a defined purpose under specific terms and conditions. It is regarded as a property right because it can be separated from the land and conveyed to someone else. A water right is not the legal right to own and use a particular set of water molecules. A water right is not a guarantee to water.

Our water resources are administered under a prior-appropriation system, which means that the earliest (most senior) water-right holders get to use water first. In some cases, a water right may not provide a reliable water supply because it was established late in the game.

Water rights tied to properties can come in all sorts of flavors, but some of the most common are mutual ditch company shares, nontributary groundwater rights (sometimes referred to as Denver Basin rights) and units in a regional water storage project (such as Colorado-Big Thompson units). All of these types of water rights have different characteristics and associated value.

The most common way to value a water right is to document comparable sales. This is similar to methods employed in other real estate sectors. The difficulty with water rights is finding other sales, which transferred water rights that were indeed comparable to the subject water right of interest. You wouldn’t call a two-bedroom bungalow and a seven-bedroom estate comparable just because they are both houses in close proximity.

The same type of attribute information is important in valuing water rights. Aspects such as reliability, transferability and location (buyers) all factor into a water right’s value. When accurately comparable sales can be found, they provide the best indication of value. This is the most common valuation technique employed in areas with active water rights trading such as the Front Range.

Another method is looking at the potential income that could be generated from having the water supply that a water right provides. This often is applied to agricultural lands, by comparing the added value of being able to irrigate and grow higher-value crops, instead of dryland farming. For most other water uses, the analysis of income is complicated by other business, resource and manufacturing inputs.

A third method is looking at a replacement cost if the water right and the associated water supply were not available. For example, if a water user did not have ownership of a mutual ditch company share, what would the cost be to develop and utilize a new groundwater well? Another example is to consider the costs associated with a municipality acquiring and developing alternate water sources. The replacement-cost approach basically informs what the value of a water right might be by looking at the additional costs incurred by a buyer if they chose a different water right or source. In the residential real estate world, it would be like valuing a newly constructed house by looking at the cost of an old house plus the cost of the remodel and repairs.

Since comparable sales often are the method of choice for valuing water rights, some perspective on the Front Range water rights market is helpful. In 2016, we completed a review of water right trades in the South Platte Basin, which stretches from north Denver up to Fort Collins. In 2015, there were approximately 90 known sales of water rights separate from land, which transferred approximately 4,500 acre-feet of water and had a corresponding value of about $57 million. The majority of these sales involved Colorado-Big Thompson units, which are selling at record prices.

The water lease market in Northern Colorado has risen steadily over the past decade, with demand from the oil-and-gas industry and groundwater wells needing to mitigate their impact on river systems. In recent years, water leases have made up around 80 percent of the total volume traded annually.

The Colorado Front Range continues to have an active water rights transaction market. As a result of land development and economic growth, the value of a water right is fairly high when compared to other Western locations. But not all water rights were created equal, and the value of a water right is specific to the type and characteristics of the right. Therefore, it is important to consider an accurate value for a water right as part of real estate planning and transactions.

For more information, visit www.waterexchange.com/market-insight.

Featured in CREJ’s March 1-14, 2017, issue.

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