Water Rights as Collateral – Challenges and Considerations in Protecting and Assigning Value
In New Mexico, agricultural land is often used as collateral for financing. Due to water scarcity, growing populations and competing needs for water, the value of water rights independent of the land itself is increasing and very likely will continue to increase, leading to a more frequent use of the water rights themselves as financial collateral. Lenders and creditors who understand state water law are better able to protect themselves against the risks in collateralizing water rights as they will be able to identify areas of concern and hire the proper experts to assist them in a more detailed risk analysis. This article will provide a brief overview of necessary considerations and some of the challenges and risks to assigning value to water rights.
Determine Whether the Borrow has Proper Title to the Water Rights
Who has title to water rights is a separate question from whether those water rights are valid. In New Mexico, water rights are considered real property and a change in title to water rights must be recorded with the county clerk’s office. Irrigation rights are considered appurtenant to the land and will be transferred with the land even if not explicitly mentioned in the deed. Water rights designated for uses other than irrigation are not appurtenant to the land and must be explicitly deeded in order to transfer the title. Many times water rights are ignored or simply mentioned as an appurtenance to real property in transactional documents. This makes a traditional title search difficult. The New Mexico Office of the State Engineer (OSE) also maintains ownership records, although such files will not always have accurate or up-to-date title documents. Thus, a search of both county clerk and OSE records is a prudent step to determine whether there may be any recorded title defects related to water rights such as options, rights of first refusal, licenses, covenants, and prohibitions against sale or transfer. A title search may also uncover liens or encumbrances against the water rights. In New Mexico, title companies do not write title insurance on water rights. This is because of the high level of risk in insuring that a seller has proper title to valid water rights.
An important aspect of determining whether a borrower pledging agricultural land as collateral has title to water rights is to determine whether the water rights have been severed from the real property. Notably, after a loan is approved, water rights can be severed from the property without notice to the lender. The best way to determine whether water rights have been severed from agricultural land is to look at the OSE file. The OSE file will contain any applications to change place of use or change of ownership forms, which should have title instruments attached.
Determine the Validity of the Water Rights
Beneficial use is the basis, the measure and the limit of water rights in New Mexico. The doctrines of forfeiture and abandonment can extinguish an otherwise valid water right following an extended period of non-use. When water rights are extinguished through forfeiture or abandonment, they revert back to state ownership. Therefore, it is critical that lenders conduct an historic use analysis to verify such nonuse periods have not occurred. An historic use analysis involves comparing the paper right with the actual use of water on the ground. The scope of the historic use analysis will likely depend on the value of the loan. However, the analysis should at least include an evaluation of all readily available evidence of water use such as ground photos, aerial photos, diversion records, and pump logs. Other information that can be gathered includes interviews of neighboring landowners, soil composition analyses, review of production records, electrical records for irrigation pumps, and similar circumstantial evidence of water use. It is also advisable to obtain a declaration or affidavit from the water right holder that the water has not gone unused for the statutory forfeiture or abandonment period. A lender should require periodic proof from land owners that they are continuously putting their water rights to beneficial use so as not to lose them to forfeiture or abandonment.
Assigning Value to Irrigated Land and Water Rights
When attempting to appraise irrigated agricultural lands, water rights are a fundamental component of the analysis. Water rights add value to the real estate. They are also crucial to the revenue stream in agricultural enterprises. When determining the value of water rights, one must include an appraisal of the availability and reliability of the water right for the intended use of the property. This produces a risk factor that can be used to discount the underlying property value in proportion to the level of concern regarding the future availability of water. Additionally, the water rights may have independent value apart from their use on the agricultural land. This type of analysis must include an evaluation of whether the water rights are inchoate (not vested or transferrable), vested (put to beneficial use and transferrable), declared, permitted, licensed or adjudicated, how much water will be available to satisfy the rights, as well as an analysis of the financial and engineering feasibility of conveying water from the source to new locations.
The best appraisal methods depend on the circumstances. Traditional appraisal methods used for real property may produce inaccurate results, especially where an appraiser is attempting to value the water rights apart from the land. This difficulty is only magnified by the typical lack of market information for water rights. Below are some recommendations for minimizing risk:
- Hire a Water Rights Attorney/Expert. A lender must know when to hire an attorney or water rights expert who understands New Mexico water law, environmental laws, and current legislative and public policy developments likely to affect water rights, and who can evaluate the risks associated with these issues. Some water rights experts do not review title, so an attorney is often preferable.
- Review All Available Water Rights Information. Information about an applicant’s water rights title and validity should be available at the OSE and county clerk’s office (deeds). Additionally, OSE personnel and surrounding landowners are a valuable source of background information. Compare this information to the loan application for consistency; it may be that an applicant only holds water rights for part of the irrigated acreage being pledged as collateral. Determine whether there are other water rights in the area that may affect the borrower’s ability to access water. Nearby wells and undeveloped inchoate rights have the potential to impact water availability. Loan applicants should provide such information as part of a loan application packet.
- Take Necessary Steps to Protect the Collateral. When a lender forecloses on any property with appurtenant water rights, it steps into the shoes of the landowner, subjecting it to any deadlines with regard to water rights on the property. These deadlines, which can usually be found in the conditions on an OSE permit, include the period allowed for perfection of an inchoate right or transferred right. The potential of losing the water right to forfeiture or abandonment for nonuse must also be evaluated.
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