Fractional Interest / Partial Interest Appraisals

Appraisers always come back to valuing partial interests or fractal interests in real property because there are so many properties that end up having a number of undivided interests (tenancy in common).  So appraisers end up asking the same question, what is a fractional interest in the property that I am appraising worth?

Like most appraisers I have read and collected many of the fractional interest valuation articles published over the years.  Many relate to specific studies that deal with partnership sales, business interests and partial stock conveyances and not with real estate interests.

Some articles do an excellent job of explaining the fact that you have to value the fee interest first and then analyze the fractional interest.  Many discuss a 20% to 40% discount as if it’s a “rule of thumb.”       

While there are some good fractional real property valuation articles, if you have read them you know that the best ones are based on old studies that are specific to one area or one property type.  Most studies conclude that it's not really possible to separate the loss of control issue from the minority ownership issue. 

Researchers and the courts have both concluded that the ownership of a fractional interest reduces the market value of a real property beyond it fractional percentage.  A 25% interest in a property is thus not worth 25% of the entirety.  In fact if the 75% interest owner or owners spend their lives thwarting every attempt to partition the property or sell the entire property the 25% interest may have little value.

Yes the other owners can’t stop you from selling your undivided interest, but who will want to buy it knowing that they are buying an interest that may have no practical value during their lifetime.  While there are investors who will buy interests like that they are relatively few.

The problem with making sales comparisons as an appraiser is that a 25% interest in Property A may have sold with a 50% discount because the buyer knew that the 75% interest owner would pay more if they own it, or because they have some information that the general public does not.  Property B however may have a 75% interest owner with absolutely no motivation to sell in which case you have to wait many years for something to change.

I have personally followed an owner with a 25% fractional interest in a large vacant land parcel that was worth over time between $ 10,000,000 and $ 3,000,000.  So the 25% interest owner’s potential value if the property would have been sold was reduced by 70% over time because the 75% interest owner would not sell.  So I ask myself “is a 20% to 40% reduction in value appropriate when the majority undivided interest holder or holders are simply not motivated to sell?”

It is my opinion that an undivided interest ownership should be valued using a comparable 25% interest sale if you know the underlying circumstances.  Most buyers would pay considerably more for a 25% interest in real estate if they know that there is some reasonable expectation that they can join with the majority owner and make a sale.  If there was no reasonable expectation that this would happen for many years a larger discount is appropriate.

As discussed there are many studies, especially those associated with stock transactions and limited partnership interests that proved a relatively wide range of price discounts that can be included in an appraisal analysis.  They are usually used to “narrow the conclusions” in a fractional interest analysis.

When there is a cash flow associated with a fractional or partial interest it is relatively easy for the appraiser to analyze the discounted future cash flow and provide a value based on the anticipated income stream.  Even though IRS Revenue Ruling 59-60 does not indicate that this method is acceptable it remains a reasonable appraisal practice.

Thus an appraiser must consider the “unique set of facts” related to the subject real property interest to quantify a reasonable value discount, and discuss the fact that the appraiser has concluded a value based on an “extraordinary assumption” that the facts that were used to conclude a value do not change.  If your 75% interest owner, who had no interest in selling, passes away after you complete your report after being a hold out for 30 years all bets are off.

For more appraisal information contact Glenn Rigdon, MA, MRICS, ASA a Las Vegas / Henderson Nevada appraiser via email or via his business website Horizon Village Appraisal (http://www.horizonvillageappraisal.com), or you can send email to grigdon@cox.net .

Article source: http://www.appraisalarticles.com/Real-Property-Appraisal/Fractional-Interest-Appraisals/4517-Fractional-Interest-Partial-Interest-Appraisals.html