There are many different types of regulatory takings, each with their own unique rules and body of Supreme Court jurisprudence. Although the Supreme Court has articulated different inquiries based on the type of taking, each of the tests “aims to identify regulatory actions that are functionally equivalent to the classic taking in which government directly appropriates private property or ousts the owner from his domain. Accordingly, each of these tests focuses directly upon the severity of the burden that government imposes upon private property rights.”¹

In Penn Cent. Transp. Co. v. City of New York, the Court acknowledged it had been “unable to develop any ‘set formula’ for determining when ‘justice and fairness’ require” compensation for a taking and instead created a flexible standard of review.² The Penn Central test is an ad hoc determination based upon all facts and circumstances but with particular attention paid to a set of three factors: (i) “economic impact of the regulation on the claimant”; (ii) the extent to which the regulation interferes with “distinct investment-backed expectations”; and (iii) the character of the government action.³ Since then, the Court has provided little guidance on the application of these factors.

Economic impact
Economic impact is a factual determination that is relatively simple to measure: an expert appraiser determines the fair market value of the property at its highest and best use before the regulation was enacted, as compared to the fair market value at its highest and best use after the regulation was enacted.

There is, however, an argument to be made that the extent of the economic impact should not be as important. Property rights are defined by state law, not the economic value attached to them. And although property rights do not magically vest at certain price points or certain percentage losses, courts require a significant diminution in value to constitute a taking. For example, in New York, 82 percent is enough of a loss to constitute a taking,⁴ but 64 percent is not enough.⁵ How does constitutionality turn on 18 percentage points of value? The answer is that it doesn’t. The difference between those two cases was whether the owner could still use the property for economic benefit.

The reality is that constitutional regulations can sometimes cause large degrees of economic suffering and unconstitutional regulations can sometimes cause very little. The Constitution is about rights; economics are about damages. And thus, what a market buyer will pay for a property that is restricted by a regulation reflects the extent of the regulation (i.e., damages), not whether there was a vesting of a property right.

Reasonable investment-backed expectations

Reasonable investment-backed expectations are an objective determination, not a subjective one. It is not about the impact to a specific person, disconnected from market realities. Rather, it is about the regulation’s impact upon the property, regardless of individual preferences, and grounded in what a reasonable market participant would have expected.⁶

The determination of reasonable investment-backed expectations is also a before-and-after comparison. The court evaluates the investment-backed expectations of market participants before the regulation was enacted as compared to those same expectations after the regulation was enacted. Thus, reasonable market participants have investment-backed expectations of utilizing a property to its maximum economic potential at its maximum permitted use. Any use other than that is not objectively reasonable. For example, if a regulation precluded all development on a valuable piece of land, the fact that the owner only intended to use it to tend sheep and grow grass does not make that regulation constitutional.

Prior to Palazzolo v. Rhode Island, owners that took title after a regulation was passed often had difficulty in claiming that the regulation was a taking since they had notice of the limitation before the purchase. Courts often found that they had notice of the regulation at the time of purchase.⁷ However, Palazzolo held that the potential regulatory takings claim runs with the land and is transferable from owner to owner:

Were we to accept the State’s rule, the post enactment transfer of title would absolve the State of its obligation to defend any action restricting land use, no matter how extreme or unreasonable. A State would be allowed, in effect, to put an expiration date on the Takings Clause. This ought not to be the rule. Future generations, too, have a right to challenge unreasonable limitations on the use and value of land.

Nor does the justification of notice take into account the effect on owners at the time of enactment, who are prejudiced as well. Should an owner attempt to challenge a new regulation, but not survive the process of ripening his or her claim (which, as this case demonstrates, will often take years), under the proposed rule the right to compensation may not be asserted by an heir or successor, and so may not be asserted at all. The State’s rule would work a critical alteration to the nature of property, as the newly regulated landowner is stripped of the ability to transfer the interest which was possessed prior to the regulation.⁸

However, Justice O’Connor’s concurrence differentiated between the right to bring a regulatory takings claim and the ability to win that claim. In accord with the majority opinion, she confirmed that a post-enactment purchaser can bring a takings claim,⁹ but suggested that with notice of the regulation, a claimant’s reasonable investment-backed expectations may not have been negatively impacted.

Today’s holding does not mean that the timing of the regulation’s enactment relative to the acquisition of title is immaterial to the Penn Central analysis. Indeed, it would be just as much error to expungåe this consideration from the takings inquiry as it would be to accord it exclusive significance. If existing regulations do nothing to inform the analysis, then some property owners may reap windfalls and an important indicium of fairness is lost.¹⁰

While Justice O’Conner also stated that investment backed expectations are “not talismanic,”¹¹ and are not to be given exclusive significance,¹² the damage was done.

Justice O’Connor’s interpretation is both contrary to the majority opinion in Palazzolo and unworkable in practice. If someone buys property with notice of a pre-existing unconstitutional regulation, either the owner can bring a claim, or he can’t. Notice cannot be both a non-factor and a penalizing factor at the same time. Yet, that would seem to be the end result of Justice O’Connor’s concurrence.

CLICK HERE to read the full article, which was originally published in ALI CLE’s The Practical Real Estate Lawyer.

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