Federal Land Management: Appraisals of Headwaters Forest Properties
(Letter Report, 12/24/98, GAO/RCED-99-52).

Pursuant to a legislative requirement, GAO reviewed the appraisals of
Headwaters Forest, focusing on: (1) whether they complied with federal
appraisal standards and how the values of the appraisals were derived;
and (2) key assumptions used in the appraisals.

GAO noted that: (1) it did not identify any areas in which the
appraisals of the Headwaters and Elk River properties deviated from
Federal appraisal standards; (2) federal appraisal standards state that
the government should appraise a property to be acquired at its fair
market value; (3) the appraiser of the Headwaters property produced a
limited appraisal with four market values--one value for each of four
timber harvest assumptions provided by the Bureau of Land Management
(BLM); (4) in calculating these four values, the appraiser relied on two
approaches: (a) estimating the current cost of the land and the timber
from revenue and logging-cost estimates; and (b) estimating the total
net income from future timber operations and adjusting this amount to
the present value of the standing trees; (5) the appraiser of the Elk
River property relied on one approach to derive fair market value, the
use of comparable sale information to estimate value, and verified the
result using a second approach, estimating the total net income from
future timber operations and adjusting this amount to the present value
of the standing trees; (6) following these standards led the appraiser
to estimate the value of the Headwaters property at $135 million, $250
million, $350 million or $405 million, depending on the assumed harvest
level; (7) the Elk River property was appraised at $78.4 million; (8)
the Secretary of the Interior, in his opinion of value, determined that
the $380 million authorized for the combined properties falls within
these appraised values; (9) the Secretary's opinion of value also found
the acquisition to be in the best interests of the United States because
it represents an opportunity to set aside an irreplaceable resource for
the public; (10) GAO's work found that in both appraisals, the need to
make key assumptions during the appraisal process tended to increase
uncertainty about the appraised values; (11) GAO did not estimate the
specific monetary impact of these assumptions; (12) however, using
different assumptions would have changed the appraised values; (13) the
Department of Justice and BLM officials noted that the appraisals could
not have been completed by statutory deadlines without making
assumptions to address these issues; and (14) although GAO notes that
using different assumptions would have changed the appraisal values, GAO
does not find the use of the assumptions unreasonable.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  RCED-99-52
     TITLE:  Federal Land Management: Appraisals of Headwaters Forest 
             Properties
      DATE:  12/24/98
   SUBJECT:  Forest management
             Appraisals
             Fair market value
             Timber sales
             National forests
             Real estate sales
IDENTIFIER:  Headwaters Forest (CA)
             Elk River Forest (CA)
             California
             
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Cover
================================================================ COVER


Report to Congressional Committees

December 1998

FEDERAL LAND MANAGEMENT -
APPRAISALS OF HEADWATERS FOREST
PROPERTIES

GAO/RCED-99-52

Appraisals of Headwaters Forest Properties

(141272)


Abbreviations
=============================================================== ABBREV

  BLM - Bureau of Land Management
  ESA - Endangered Species Act

Letter
=============================================================== LETTER


B-281704

December 24, 1998

Congressional Committees

In Public Law 105-83, passed on November 14, 1997, the Congress
authorized and appropriated up to $250 million to preserve and
protect the Headwaters Forest in Humboldt County, California, by
acquiring the approximately 4,500-acre Headwaters Forest and about
3,000 acres of adjoining timberland.  The 7,500 acres to be acquired
include the Headwaters Forest, owned by the Pacific Lumber Company
(Pacific Lumber),\1 and two adjoining properties:  the Elk Head
Springs Forest, also owned by Pacific Lumber, and a portion of the
Elk River property owned by the Elk River Timber Company.  After
acquisition, these properties will be combined as the Headwaters
Forest.  In September 1996, the federal government, the state of
California, MAXXAM, Inc.  (Pacific Lumber's parent company), and
Pacific Lumber signed an agreement for the federal and California
governments to acquire the properties in exchange for $380 million in
cash and assets from the United States and California.  As part of
the acquisition agreement, California will contribute $130 million to
purchase the properties. 

The law requires that the properties be purchased within
approximately 16 months of the law's passage, which would be by March
1, 1999.  Before the acquisition can occur, a number of statutory
conditions must be met, including the completion of an appraisal of
the properties and a review by the Comptroller General of the
appraisal within 30 days of his receiving it.  Furthermore, the law
requires the Secretary of the Interior to provide an opinion of the
value of the land to be acquired, which is to include the total value
of all compensation to be provided for the acquisition.\2 The new
Headwaters Forest will be managed by the Department of the Interior's
Bureau of Land Management (BLM).\3 For this reason, BLM arranged for
and reviewed two appraisals of the properties involved in the
acquisition:  one appraisal of the combined Headwaters Forest and Elk
Head Springs Forest properties (from here on referred to as the
Headwaters property) and a second appraisal of the Elk River
property. 

We received the completed appraisals on November 25, 1998; this
report presents the results of our review.  Specifically, we reviewed
the appraisals (1) to determine whether they complied with federal
appraisal standards and how the values of the appraisals were derived
and (2) to assess key assumptions used in the appraisals.  To do this
work, we reviewed federal appraisal standards and instructions, peer
reviews of the appraisals, and the appraisals themselves.  We
discussed the key assumptions with the appraisers, BLM officials, a
Department of Justice official, officials from the Department of the
Interior's Office of Solicitor, forestry and acquisition officials
from the state of California, and outside experts in government land
acquisition.  In the limited time available to us, we reviewed only
the appraisal reports and the reports' appendixes related to timber
inventories.  We reviewed timber inventory data for the properties
and interviewed the timber experts who established the inventory
levels used in the appraisals.  We did not review other technical
appendixes, proprietary data, or supporting analyses used in
developing the appraisals. 


--------------------
\1 As appropriate, we use the name Pacific Lumber to refer to the
company and any of its wholly owned subsidiaries. 

\2 Total compensation is to include tax benefits.  The Secretary
deferred to the Internal Revenue Service and the California Franchise
Tax Board as to the final amount of tax benefits. 

\3 A final decision on the coordination of federal and state
management of the Headwaters Forest, once it has been acquired, has
not been made. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

We did not identify any areas in which the appraisals of the
Headwaters and Elk River properties deviated from federal appraisal
standards.  Federal appraisal standards state that the government
should appraise a property to be acquired at its fair market value. 
The appraiser of the Headwaters property produced a limited
appraisal\4 with four market values--one value for each of four
timber harvest assumptions provided by BLM.  In calculating these
four values, the appraiser relied on two approaches:  (1) estimating
the current cost of the land and the timber from revenue and
logging-cost estimates and (2) estimating the total net income from
future timber operations and adjusting this amount to the present
value of the standing trees.  The appraiser of the Elk River property
relied on one approach to derive fair market value, the use of
comparable sale information to estimate value, and verified the
result using a second approach, estimating the total net income from
future timber operations and adjusting this amount to the present
value of the standing trees.  Following these standards led the
appraiser to estimate the value of the Headwaters property at $135
million, $250 million, $350 million, or $405 million, depending on
the assumed harvest level.  The Elk River property was appraised at
$78.4 million.  The Secretary, in his opinion of value, determined
that the $380 million authorized for the combined properties falls
within these appraised values.\5 The Secretary's opinion of value
also found the acquisition to be in the best interests of the United
States because it represents an opportunity to set aside an
irreplaceable resource for the public. 

Our work found that in both appraisals, the need to make key
assumptions during the appraisal process tended to increase
uncertainty about the appraised values.  For the Headwaters property
appraisal, these assumptions are that (1) a past timber inventory was
reliable, (2) certain levels of harvest could be achieved, (3) the
proper land use and environmental permits would be in place and
harvesting could begin after 1 year, and (4) the acquisition of the
parcel had no effect on the value of Pacific Lumber's remaining
holdings.  The Elk River appraisal used an increased timber harvest
volume that was based on the assumption that the timber volume should
include anticipated timber growth through the date of the expected
acquisition.  We did not estimate the specific monetary impact of
these assumptions.  However, using different assumptions would have
changed the appraised values.  For example, if timber harvest permits
had been delayed for a year, the present appraised value of the
Headwaters property would have been lower.  On the other hand, if for
the lower harvest premises, the harvest levels had been more heavily
weighted toward the higher-value timber, then the appraisal values
would have been higher.  Justice and BLM officials noted that the
appraisals could not have been completed by statutory deadlines
without making assumptions to address these issues.  Although we note
that using different assumptions would have changed the appraisal
values, we do not find the use of the assumptions unreasonable. 


--------------------
\4 Under some circumstances, a limited appraisal can be performed,
which means an appraiser can perform an assignment that calls for
something less than or different from work that would otherwise be
required by the guidelines. 

\5 In his opinion of value, the Secretary discusses several
appraisals, completed in 1991 and 1993, which indicate a range of
values for portions of the Headwaters tract of $375 million to $705
million. 


   BACKGROUND
------------------------------------------------------------ Letter :2

The Headwaters Forest in Humboldt County, California, includes the
largest grove of virgin old-growth redwood timber in private U.S. 
ownership.  It is currently owned by Pacific Lumber, but has been the
focus of preservation efforts by the public for at least 10 years. 
Most recently, it has been identified as habitat for the marbled
murrelet--a robin-sized seabird--which is listed as endangered under
California law and as threatened under the Endangered Species Act
(ESA).  Both California and the United States provide protection for
threatened and endangered species, as well as provide for the
protection of habitat for listed species.  Under ESA, it is unlawful
for any person or entity to take any threatened or endangered
species.  The term "take" includes actions that harm, kill, capture,
or collect such species.  Furthermore, under Interior's regulations,
the term ï¿½harmï¿½ is defined to include significant habitat
modification and degradation that kills or injures wildlife by
impairing essential behavior, such as breeding and sheltering.  The
Secretary of the Interior may, under ESA, issue an incidental take
permit for a threatened or endangered species in line with a habitat
conservation plan, which, among other things, specifies the impacts
that are likely to result from the taking and measures to mitigate
these impacts. 

Additional protections of timberland exist under California law. 
Under the California Forest Practice Rules, timber harvesters must
operate under approved timber harvest plans and be licensed. 
Additionally, large harvesters may submit a sustained yield plan for
long-term harvesting.  In 1995 and 1996, when Pacific Lumber applied
for a permit to conduct a timber harvest operation on the Headwaters
property, its application was denied by the state.  The state
determined that Pacific Lumber cannot harvest its timber without a
habitat conservation plan and an incidental take permit.  The company
has filed two takings lawsuits against the state and federal
governments claiming that the endangered species regulations for the
marbled murrelet do not allow it to harvest the timber.\6

As a result of negotiation efforts to preserve the redwood trees, in
September 1996, Pacific Lumber, MAXXAM, Inc., the state of
California, and the federal government agreed to exchange the
Headwaters property for up to $380 million in state and federal
assets.  As part of the agreement, the federal and state governments
will acquire almost 7,500 acres, including the Headwaters property,
the Elk Head Springs property, and a portion of the Elk River
property.  The portion of the Elk River property that will remain
with the Headwaters property is a wishbone-shaped parcel of about
1,700 acres; it includes a buffer for the old-growth trees and a
150-foot buffer on either side of the Elk River to protect the
riparian habitat.  Pacific Lumber will receive about $300 million and
the remaining 7,704 acres of the Elk River property, including an
island of land--essentially, an inholding \7 --within the newly
acquired Headwaters property and buffer zone.  To this exchange, the
federal government will contribute $250 million in funding and the
state will contribute $130 million.  One of the conditions of the
acquisition agreement is that Pacific Lumber will develop, for the
rest of its land, a habitat conservation plan for the purposes of
receiving an incidental take permit for the marbled murrelet and
other species.  At the same time, Pacific Lumber will submit a
sustained yield plan for timber harvesting to the state of
California.  Yet another condition of the agreement is that Pacific
Lumber will dismiss its takings lawsuits filed in 1996 against the
state and federal governments.  The acquisition will not proceed if
any of these conditions are not met.  BLM and Justice officials
stated that negotiations on these issues have been difficult and have
threatened the completion of the agreement, which, if it falls
through, could cause Pacific Lumber to continue its takings suits. 

The Congress, in its fiscal year 1998 appropriation for the
Department of the Interior and related agencies, authorized and
appropriated up to $250 million for Pacific Lumber's Headwaters
Forest.  We noted in a report last year that there was uncertainty
about the property's fair market value, and the Congress subsequently
required that the property be appraised before being acquired.  \8
According to the law's conference report, the appraisal had to be
done in compliance with federal appraisal standards and other
applicable laws and regulations governing federal land acquisitions. 
Furthermore, according to the legislation, the appraisal had to be
reviewed by the Comptroller General within 30 days of his receiving
the appraisal and had to be provided to the House Committees on
Resources and Appropriations and the Senate Committees on Energy and
Natural Resources and Appropriations.  The Chairmen of the House and
Senate Appropriations Subcommittees on Interior and Related Agencies
also requested that we do this work.  Further legislative conditions
for the use of federal funds to acquire the properties include the
issuance to Pacific Lumber of an incidental take permit based on a
habitat conservation plan for the remaining Pacific Lumber land, and
approval by the state of California of a sustained yield plan for the
remaining Pacific Lumber property. 

Originally, the federal side of the acquisition was being managed
jointly by BLM and the Department of Agriculture's Forest Service. 
In 1997, the Forest Service entered into a contract with an appraiser
to determine the value of the Elk River property.  BLM entered into a
contract in 1997 with an appraiser to determine the value of the
combined Headwaters and Elk Head Springs properties.  Subsequently,
in late 1997, BLM was made responsible for managing the entire
Headwaters acquisition, including the Elk River appraisal process. 
The appraisals were to be completed in mid-March 1998; however, they
were not completed until September 1998.  During the summer of 1998,
BLM contracted for peer reviews of the appraisals.  After the peer
reviews were completed, BLM reviewed and approved the appraisals,
determined that they met federal appraisal standards, accepted the
appraised values, and forwarded them to the Secretary of the
Interior.  The appraisals and the Secretary's opinion of value were
made available for our review on November 25, 1998. 


--------------------
\6 A taking may occur when government regulation of land prevents the
landowner from having any beneficial use of his or her land. 

\7 An inholding is private property completely within the boundaries
of public land. 

\8 Federal Land Management:  Estimates of Timber Value and Economic
Effects of Harvesting the Headwaters Forest (GAO/RCED-97-241R, Sept. 
24, 1997). 


   APPRAISAL STANDARDS AND RESULTS
   OF THE HEADWATERS AND ELK RIVER
   PROPERTY APPRAISALS
------------------------------------------------------------ Letter :3

In its instructions for the Headwaters and the Elk River property
appraisals, BLM instructed the appraisers to follow federal appraisal
standards in valuing the properties.  These standards state that the
government should appraise a property to be acquired at the fair
market value.  According to the standards, fair market value is the
amount for which a property would be sold--for cash or its
equivalent--by a willing and knowledgeable seller who is not
obligated to sell to a willing and knowledgeable buyer with no
obligation to buy. 

Federal appraisal standards provide for several methods of
determining fair market value, including analyzing prior sales of
comparable properties or of the identical property.  While the
standards indicate that the use of a sales comparison approach is
normally the most accurate method, other methods, such as the income
approach or cost approach, may be used when comparable sales data are
not available.  The income approach involves estimating the value of
a resource on the basis of the present value of the anticipated
future income from production.  Generally, the income method values
the estimated future income stream from a project and adjusts the
value of this income stream to its value today by using a discount
rate.\9 The cost approach also involves estimating the value of a
resource but is based on the current costs to reproduce or replace
the existing resource in addition to the value of the bare land. 

In cases where existing land use regulations could affect the value
of an appraised property, professional standards require the
appraiser to consider the effect of regulations on the use and value
of the property.  The harvesting of timber on the Headwaters property
has been affected because the property contains habitat for the
threatened marbled murrelet, as well as other species; harvesting has
also been affected by state forest practice statutes and regulations. 
For the purposes of appraising the Headwaters property, BLM
instructed the appraiser to assume that all land use plans and
permits were in place to allow for the harvesting of the property. 
Although the Elk River property has identified threatened and
endangered species, it does not have old-growth redwood stands, which
provide a unique habitat for some threatened and endangered species. 

Professional appraisal standards permit limited departures from
certain guidelines, but only if an appraiser determines that the
appraisal results will not be confusing or misleading and if the
report is clearly identified as a limited appraisal.  For the
appraisal of the Headwaters property, because it has been identified
as threatened and endangered species habitat and no comparable
habitat conservation plans for the species exist, the amount of
timber harvest allowed is uncertain.  Therefore, BLM instructed the
appraiser to assume specific timber harvest levels to avoid
speculation on the amount of timber that could be harvested.  The
appraiser was instructed to assume that the owner could harvest 25
percent, 50 percent, 75 percent, and 95 percent of the merchantable
timber on the property.\10 The appraiser determined that relying on
this set of critical assumptions would result in a limited appraisal
but would not confuse or mislead.  BLM did not include specific
instructions on the levels of harvest to be used in the Elk River
appraisal. 

In cases in which the government does not acquire an entire property,
but acquires only a piece of it, federal appraisal standards state
that the preferred way to value the partial property is to use a
"before and after" method.  This method occurs when the government
acquires property by condemnation or negotiated settlement.\11 In the
before and after method, the appraiser estimates the value of the
whole property before the transaction and reduces it by the value of
the property remaining in private ownership after the transaction is
completed.  Although Pacific Lumber owns approximately 200,000 acres
of timberland in northern California, BLM's instructions directed the
appraiser to estimate the value of the Headwaters property as if it
were not part of the larger Pacific Lumber holdings (i.e., a
stand-alone property).  The appraisal instructions included this
direction because, according to a Justice official, the Headwaters
agreement is not a negotiated settlement of the company's lawsuits,
but is an agreement to acquire land for which discussions have been
ongoing for almost a decade.  According to this official, if the
property is acquired, an additional provision of the agreement is for
the dismissal of the company's two takings lawsuits against the state
and federal governments.  The Elk River property was also appraised
as a stand-alone property. 


--------------------
\9 A discount rate reflects the earning power of money over time and
the risk associated with this earning power.  The choice of a
discount rate is a key factor in determining the net present value;
in effect, the lower the discount rate, the higher the net present
value of an asset. 

\10 Merchantable timber refers to trees with a minimum diameter,
measured at breast height, of 10 inches. 

\11 Under condemnation, a government acquires property in the public
interest and pays just compensation to the property owner. 


      ESTIMATE OF HEADWATERS
      PROPERTY'S VALUE
---------------------------------------------------------- Letter :3.1

The Headwaters property appraisal covers the 4,500-acre Headwaters
Forest and the 1,125-acre Elk Head Springs Forest, both of which are
old-growth forests owned by Pacific Lumber.  The appraiser estimated
four values for the Headwaters property--one for each harvest premise
provided by BLM in its instructions.  In establishing these values,
the appraiser used two approaches--the cost approach and a discounted
cash flow approach, which is an income method.  According to the
appraiser, there are no timber properties or sales of properties like
the Headwaters property--that is, large properties with both
old-growth trees and marbled murrelet populations--which makes the
sales comparison approach impossible. 

For both methods, the appraiser estimated the total amount of timber
available for harvest, the time needed to harvest the timber under
each premise, and the costs of logging the timber, which include the
costs for transportation.  Using timber inventory data provided by an
outside consultant, the appraiser estimated that the property
contains about 670 million board feet (mmbf) of timber.\12 He then
estimated that it would take 5 years to harvest 25 percent of the
timber, 8 years to harvest 50 percent of the timber, 11 years to
harvest 75 percent of the timber, and 15 years to harvest 95 percent
of the timber on the property.  The appraiser estimated that logging
costs would be the same under each premise, about $90 per thousand
board feet (mbf).\13

The appraiser relied on the discounted cash flow analysis to
establish the four premise values and used four values established
using the cost approach to verify the discounted cash flow values. 
He then reconciled the two sets of values.  In the discounted cash
flow method, the appraiser estimated the net annual income under each
harvest premise--for example, 25 percent over 5 years--and calculated
the present value of the total net income stream.  To this, he added
the present value of the remaining land and trees as if they were
sold at the end of the harvest period.  For each premise, the
appraiser used a discount rate of 9 percent and used appreciation
rates for timber values of 1 to 4 percent, depending on the type of
tree.  In the cost approach, the appraiser estimated that the
immediate harvest value of the land and timber would be $590 million;
he then multiplied the four premise percentages--for example, 25
percent--to get the value of the timber harvested under each premise. 
Because the timber on the property could not be harvested in 1 year,
the appraiser discounted the values using a rate of 8 percent.  For
the cost approach, the appraiser used a 3.5-percent appreciation
rate. 

The Headwaters property appraisal established four values based on
four separate harvest premises.  These four values are displayed in
table 1. 



                                Table 1
                
                  Headwaters Property Appraised Values

                         (Dollars in millions)

Assumption about                                            Conclusion
future timber                                                    about
harvest amount                                          property value
----------------------------------------  ----------------------------
25-percent harvest                                                $135
50-percent harvest                                                 250
75-percent harvest                                                 350
95-percent harvest                                                 405
----------------------------------------------------------------------

--------------------
\12 One million board feet (mmbf) is a measure of timber volume equal
to 1 million boards measuring 1 foot wide by 1 foot long by 1 inch
thick. 

\13 One thousand board feet (mbf) refers to a measure of timber
volume equal to 1,000 boards measuring 1 foot wide by 1 foot long by
1 inch thick. 


      ESTIMATE OF ELK RIVER
      PROPERTY'S VALUE
---------------------------------------------------------- Letter :3.2

The Elk River property appraisal covers the 9,468 acres of
second-growth timber commonly referred to as the Elk River Timber
Company property, even though the owner of record is L.E.T., a joint
venture.\14 Over 1,700 acres of this property, which adjoins the
north side of the Headwaters property, will be retained by the
government to act as a buffer for the old-growth forest.  The
remaining acreage will be part of the exchange with Pacific Lumber
for its Headwaters properties. 

The appraiser responsible for the Elk River property appraisal relied
on a sales comparison approach and verified the value using a
discounted cash flow approach.\15 For both approaches, the appraiser
estimated the total amount of timber available for harvest and the
costs of logging the timber, which include the costs for
transportation.  Using timber inventory data provided by an outside
consultant, the appraiser estimated that the property contains about
207 mmbf of timber.  The appraiser estimated that logging costs would
be the same under each approach, about $132 per mbf. 

Using the sales comparison approach, the appraiser gathered data on
the price of logs delivered to mills and the sale price of standing
timber.  He calculated a price per thousand board feet for each type
of timber--for example, redwood--and multiplied these prices by the
amount of timber, according to type, that could immediately be
logged.  The appraiser estimated that about 109 mmbf of the timber on
the property could be logged immediately.  To this value, the
appraiser added the present value for the remaining land and trees. 

The appraiser used a discounted cash flow analysis to verify the
value established by the sales comparison approach.  In the
discounted cash flow analysis, the appraiser assumed that 12.5 mmbf
of timber would be cut each year for 10 years and calculated the
discounted value of the related net income stream.  To do this, he
used an 11-percent discount rate and an annual price appreciation
rate of 3.5 percent.\16 Finally, he added the net present value of
the property as if sold at the end of the 10-year harvest. 

In an addendum to the appraisal, the appraiser allocated the timber
assets and the associated value between the government's and Pacific
Lumber's parcels.  To do this, he estimated the volume of loggable
timber on each parcel and multiplied this volume by the estimated
price paid by lumber mills, adjusted for logging costs.  The
appraisal established a value of $78.4 million for the property.  The
appraiser then allocated $51.8 million of this value to the portion
of the property to be given to Pacific Lumber and $26.6 million to
the portion of the property to be retained by the government. 


--------------------
\14 A memorandum of agreement signed by the Elk River Timber Company
indicates it will acquire title to the Elk River property. 

\15 The appraisers for these two properties each used data based on
other timber sales.  Each appraiser used a hybrid of the sales
comparison and cost approaches that utilizes practices from both
approaches. 

\16 The discount rates used in the two appraisals are different
because they are based on the independent judgments of the two
appraisers.  According to BLM officials, the market for old-growth
redwood is less risky than the market for young-growth timber. 


      SECRETARY OF THE INTERIOR'S
      OPINION OF VALUE
---------------------------------------------------------- Letter :3.3

The Secretary wrote an opinion of value that summarized the purpose
of the Headwaters agreement and acquisition.  This document also
summarized the results of the two appraisals and concluded that the
authorized public expenditure of $380 million is within the range of
appraised values; the values range from $135 million to $405 million
for the Headwaters property and include an additional $26.6 million
for the portion of the Elk River property to be retained by the
government.  The opinion also found the acquisition to be in the best
interests of the United States because it represents an opportunity
to set aside an irreplaceable resource for the public. 


   KEY ASSUMPTIONS USED IN THE
   HEADWATERS AND ELK RIVER
   APPRAISALS
------------------------------------------------------------ Letter :4

The Headwaters and Elk River property appraisals relied on several
key assumptions.  The need to make key assumptions during the
appraisal process tended to increase uncertainty about the appraised
values.  In general, the need to make assumptions about key unknown
factors increases the uncertainty associated with any estimate of
appraised value.  Although we have not determined the cumulative
effect of relying on these assumptions, it appears that some of these
assumptions tended to increase the appraised value of the property
while others tended to decrease the appraised value.  Although we
note that using different assumptions would have resulted in
different appraised values, we do not find the use of the assumptions
unreasonable. 


      HEADWATERS APPRAISAL
---------------------------------------------------------- Letter :4.1

In estimating the four fair market values of the Headwaters property,
the appraisal relied on several key assumptions.  The key assumptions
made in the appraisal that we address are that (1) a past timber
inventory was reliable for the purposes of the appraisal, (2) certain
levels of harvest could be achieved, (3) the proper land use and
environmental permits would be in place and harvesting could begin
after 1 year, and (4) the acquisition of the parcel had no effect on
the value of Pacific Lumber's remaining holdings.  According to
Justice and BLM officials, with more time to do the appraisals, some
of the assumptions might not have been necessary because more
information might have been available.  Under such circumstances, the
habitat conservation plan, the sustained yield plan, and the
incidental take permit for the remaining Pacific Lumber property
could have been nearer completion, if not completed, before the
appraisal occurred.  These documents could have served as guidance to
make some of the appraisal assumptions more precise.  Although we
note that using different assumptions in each of these four cases
would have resulted in different appraised values, we do not find the
use of the assumptions unreasonable. 


         GOVERNMENT ASSUMED THE
         1992 TIMBER INVENTORY TO
         BE ACCEPTABLE FOR
         APPRAISAL PURPOSES
-------------------------------------------------------- Letter :4.1.1

The Headwaters appraisal relied on a timber inventory for the
Headwaters property (not including the Elk Head Springs property)
performed in 1992.  The 1992 inventory involved measuring trees in
specific plots on the property; as a result of this sampling, the
timber was categorized into seven types, or strata.  In 1997, BLM
hired a consulting firm to perform a verification sample of the
property to determine whether the 1992 timber inventory would still
be a reliable estimate of timber volume.  The consultants sampled the
four main old-growth timber types, and that sample yielded a timber
volume estimate that was 9 percent less than the 1992 estimate. 
Statistical tests of the samples showed that the 9-percent difference
was within the sampling error acceptable to BLM and that the two
volume estimates were not significantly different.\17 As a result,
BLM used the 1992 timber inventory as the basis for determining
volume in the appraisal.  According to BLM officials and the forestry
consultants who performed the work, the old-growth timber would not
be expected to have much net growth, and for this reason, it would be
appropriate to use the 1992 volume.  However, in the young-growth
strata of timber, which was not included in the sample, growth would
occur.  A new inventory might have led to a different estimate of
timber volume, which, in turn, could have affected the appraised
value. 


--------------------
\17 The statistical tests used confidence levels of 95 percent. 


         GOVERNMENT ASSUMED LEVELS
         OF HARVEST
-------------------------------------------------------- Letter :4.1.2

Because of marbled murrelet and forestry restrictions on the
Headwaters property and the lack of comparable habitat conservation
plans on other properties, the government instructed the appraiser to
assume four levels of harvestability for the appraisal:  25 percent,
50 percent, 75 percent, and 95 percent.  While the appraiser
developed different time lines for each harvest premise, he used the
same harvest scenario for each premise.  This scenario included
estimated discount rates, logging costs per thousand board feet, and
price appreciation.  However, a larger harvest--under the 95-percent
premise, for example--might be delayed because of longer time frames
for cutting and the possibility that harvest plans might be delayed
or disapproved.  Consequently, there is greater risk associated with
a larger harvest.  The appraiser did a sensitivity analysis for each
harvest premise; however, he used the same range of discount values
for both the large and small harvest levels.  Given the higher risks
that may be associated with larger harvest premises, a higher range
of discount rates might be applied, resulting in lower appraised
values for these premises. 

Furthermore, the appraiser assumed, on the basis of his
interpretation of BLM's instructions, that an even mix of timber
types would be cut under each premise, regardless of the type or
value of the timber.  For example, under the 25-percent premise, 25
percent of each timber type would be cut, as opposed to cutting an
equivalent volume consisting solely of old-growth redwood, the most
valuable type.  In reality, a purchaser interested in maximizing the
profit of the property would likely harvest the most valuable timber
first.  As a result of this assumption, the lower harvest premises
may be undervalued.  The effect on the higher harvest premises would
be less severe because more timber would be cut under these premises. 


         GOVERNMENT AND APPRAISER
         ASSUMED THAT PERMITS
         WOULD BE ISSUED
-------------------------------------------------------- Letter :4.1.3

The appraisal relied on the assumption that a harvester would have
received the required governmental permits and would have been able
to commence harvesting in a timely manner.  For each premise, the
appraiser assumed harvesting would begin after 1 year, during which
all harvest plans and permits would be finalized.  Prior to
harvesting, timber operators are required to be licensed, and in
addition, operators must submit timber harvest plans for the state's
approval.  Furthermore, when threatened and endangered species
habitat is involved, a habitat conservation plan may need to be
approved before timber harvest plans can be approved.  At the time of
the agreement for the acquisition of Headwaters, the company had
submitted at least one timber harvest plan for this area but had not
developed a habitat conservation plan.  According to both state and
BLM officials, although a timber harvest plan can be approved in
about 10 weeks, there is less experience with processing a habitat
conservation plan and this could take years to finalize.  We believe
the net present value of future income from the timber would have
been lower if delays had occurred.  \18 If the appraiser had assumed,
for example, a 2- to 3-year delay in obtaining permits, he would have
obtained a lower appraised value under each premise. 


--------------------
\18 Although there would be real appreciation in the timber value
during the delay, the delay would cause future income to be more
heavily discounted.  Because the discount rate exceeds the
appreciation rate, the net effect of the delay would be to reduce the
net present value. 


         GOVERNMENT ASSUMED NO
         VALUE ADDED TO REMAINING
         PACIFIC LUMBER HOLDINGS
-------------------------------------------------------- Letter :4.1.4

The Headwaters property makes up about 5,600 acres of the 200,000
acres owned by Pacific Lumber in Humboldt County.  Because the
government is acquiring only part of the property, BLM instructed the
appraiser to estimate the value of the 5,600 acres without
considering the fact that the property is part of a larger ownership. 
Justice officials and officials from Interior's Office of the
Solicitor believe the Headwaters acquisition is an independent
transaction begun before the lawsuits and the negotiated agreement to
dismiss the company's takings lawsuits.  Because of this view, BLM,
Justice, and Interior's Office of Solicitor officials instructed the
appraiser to value the Headwaters property as if it were a
stand-alone property and as if it were sold voluntarily. 

However, the company views the acquisition as part of a negotiated
settlement of the company's lawsuits.  When the government acquires
property through a negotiated settlement, the rules of appraisal are
generally structured to measure what the property owner will lose. 
If only a portion of the property is acquired by a negotiated
settlement, consideration is given to the damages and/or benefits
that may accrue to the property owner's remaining property.  This is
accomplished by estimating the market value of the entire ownership
(larger parcel) before the government's acquisition and then
estimating the market value of the property remaining after the
acquisition.  The difference between the two values is the value the
owner has lost, which is equal to the value of the acquired property. 

According to BLM officials, it would have been difficult to value the
200,000 acres owned by Pacific Lumber, because of both the time and
work involved.  Nevertheless, Pacific Lumber may benefit from the
sale of the Headwaters property because the company may be able to
harvest a significant portion of its remaining property under the
habitat conservation plan developed as part of the Headwaters
agreement.  Because the appraisal instructions reflected the view
that the company's sale of the property was voluntary, the appraiser
did not make an adjustment to the appraised value to account for
possible increases in the value to the remaining property.  As a
result, each of the four values may be overstated. 


      ELK RIVER APPRAISAL
---------------------------------------------------------- Letter :4.2

In estimating the fair market value of the Elk River property, the
appraisal relied on one key assumption.  The appraisal assumed that
the property to be valued includes the anticipated net timber growth
occurring between the date of value and the date of the acquisition. 
As stated earlier, in general, the need to make assumptions about key
unknown factors increases the uncertainty associated with any
estimate of appraised value.  Reliance on this assumption increased
the appraised value of the property, although we have not determined
the specific amount of increase.  While we note that using different
assumptions would have resulted in different appraised values, we do
not find the use of the assumption unreasonable. 


         GOVERNMENT AGREED TO A
         PROJECTED INCREASE IN
         TIMBER VOLUME
-------------------------------------------------------- Letter :4.2.1

The timber volume upon which the Elk River property appraisal is
based includes anticipated timber growth through the date of the
expected acquisition.  BLM instructed the appraiser to include the
estimated growth on the basis of a memorandum of agreement among the
state of California, the United States, Pacific Lumber, and the Elk
River Timber Company.  This memorandum stipulated that in exchange
for including an estimate of timber growth, the Elk River Timber
Company would forgo any timber harvests or other economic use of the
property until the acquisition.  Elk River had an approved timber
harvest plan for portions of the property and could have harvested
timber in those areas. 

The date of value for the appraisal is June 15, 1998, yet the timber
volume used in the appraisal is projected to February 28, 1999-ï¿½more
than 8 months later.  This projection, which was calculated by
forestry services consultants for BLM, relied on a 7-percent annual
growth estimate.  The consultants based the growth estimate on data
from the Elk River Timber Company, tree core samples they took from
the property, and historical growth data for the site.  While the
estimate is statistically based and BLM accepted the estimated
increase in volume, the amount of growth is a projection and could be
more or less than estimated.  As a result, the appraised value
reflects additional value based on projected growth. 


   OBSERVATIONS
------------------------------------------------------------ Letter :5

In our review of the Headwaters and the Elk River property
appraisals, we did not identify areas in which the appraisals
deviated from federal appraisal standards.  We also did not find that
the use of assumptions in the appraisal was unreasonable given the
imprecision involved in appraising timber properties and the unique
circumstances of this property. 

The Secretary of the Interior recognized, in his opinion of value,
the intrinsic worth of the irreplaceable natural resources of the
Headwaters property, whereas the appraisals simply estimated the
value of the properties on the basis of their use as timberlands.  In
the event that the Headwaters acquisition is not completed by March
1999, Pacific Lumber will have various alternatives for dealing with
the limitations placed on harvesting timber on this property.  One of
these alternatives is the revival of its takings lawsuits. 
Alternatively, Pacific Lumber might seek to negotiate a habitat
conservation plan, an incidental take permit, and state timber
harvest plans for the Headwaters property in order to harvest timber. 


   AGENCY COMMENTS
------------------------------------------------------------ Letter :6

We provided the Department of the Interior with a draft of this
report for review and comment.  In its comments, Interior generally
agreed with the information in the report.  The Department also
provided technical comments about the Secretary's opinion of value,
the requirements and application of the Endangered Species Act, and
the memorandum of agreement among Pacific Lumber, the state of
California, the United States, and the Elk River Timber Company,
among other things.  We incorporated Interior's recommended changes
or clarified the report's language as appropriate.  (Interior's
comments are reproduced in app.  I.)


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :7

We reviewed the Uniform Appraisal Standards for Federal Land
Acquisitions, issued in 1992 by the Interagency Land Acquisition
Conference, as well as the Uniform Standards of Professional
Appraisal Practice issued in 1998, to become familiar with federal
appraisal standards.  We reviewed the appraisals themselves,
Appraisal of Headwaters and Elk Head Springs, signed September 28,
1998, and Appraisal Report:  The Elk River Timber Company, signed
September 28, 1998, to become familiar with their methodology and
data.  We discussed both the standards and the appraisals with the
Chief Appraiser and State Forester for BLM's California State Office
and the contract appraisers who conducted the appraisals.  We
interviewed an outside appraisal expert, officials with the state of
California, and other experts in government land acquisition.  We
also met with officials from Justice and Interior's Office of the
Solicitor.  Both these agencies provided BLM with legal advice on the
appraisal process. 

In a December 1997 letter to the Secretary of the Interior, the
Committee and Subcommittee Chairmen who requested our work
recommended that the Interior coordinate the appraisal process with
us before we received the final appraisal.  While BLM officials did
apprise us of the status of the appraisal process before we received
the final appraisal on November 25, 1998, they declined to provide us
with any analyses or drafts of the appraisal before that date because
this information was subject to review and change. 

After doing some preliminary work in January and February 1998, we
performed the bulk of our review in November and December 1998.  Our
work was conducted in accordance with generally accepted government
auditing standards. 


---------------------------------------------------------- Letter :7.1

We are sending copies of this report to the appropriate congressional
committees and will make copies available to the Secretary of the
Interior and other interested parties.  We will make copies available
to others upon request. 

If you or your staff have any questions, please call me on (202)
512-3841.  Major contributors to this report were Jay Cherlow, Tim
Guinane, Susan Iott, Diane Lund, Dick Kasdan, Sue Naiberk, and Victor
Rezendes. 

Barry T.  Hill
Associate Director, Energy,
 Resources, and Science Issues


List of Congressional Committees

The Honorable Ted Stevens
Chairman
The Honorable Robert Byrd
Ranking Minority Member
Committee on Appropriations
United States Senate

The Honorable Frank H.  Murkowski
Chairman
The Honorable Dale Bumpers
Ranking Minority Member
Committee on Energy
 and Natural Resources
United States Senate

The Honorable Slade Gorton
Chairman
The Honorable Robert Byrd
Ranking Minority Member
Subcommittee on Interior
 and Related Agencies
Committee on Appropriations
United States Senate

The Honorable Bob Livingston
Chairman
The Honorable David Obey
Ranking Minority Member
Committee on Appropriations
House of Representatives

The Honorable Don Young
Chairman
The Honorable George Miller
Ranking Minority Member
Committee on Resources
House of Representatives

The Honorable Ralph Regula
Chairman
The Honorable Sidney R.  Yates
Ranking Minority Member
Subcommittee on Interior
 and Related Agencies
Committee on Appropriations
House of Representatives




(See figure in printed edition.)Appendix I
COMMENTS FROM THE DEPARTMENT OF
INTERIOR
============================================================== Letter 



(See figure in printed edition.)



(See figure in printed edition.)


*** End of document. ***