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Partial and Fractional Interests
There are occasions when an appraiser is asked to appraise less than the entire interest in a property. The first is when there is a need for ‘a less than the whole’ to be appraised in real property. This is referred to as a “Partial Interest” estimate. The second is when an ownership position is being appraised, such as a 35% undivided interest in a property. This is referred to as a “Fractional Interest” estimate. Some people use the terms partial and fractional interests interchangeably, but in the classic literature of real estate, there is a distinction with partial interests (as differentiated from fractional interests) referring to such portions of the division of the bundle of rights.
These types of valuation are typically the most complex assignment that we undertake and require a very experienced appraiser to complete the assignment. Often, these appraisals will be completed for submittal to revenue agencies for litigation proposes.
Partial Interest Estimate
Partial interest estimate occurs in one of two ways, either by valuing a property that has lost some ownership rights or in valuing the ownership right that is lost, such as valuing an easement. Valuing a partial interest in real property is based on the concept of the “Bundle of Rights”, which are:
- Fee simple is the purest form of ownership, unencumbered by other interests or estates, subject only to the governmental restrictions such as taxation, expropriation, police power and escheat.
- The bundle of rights is the rights a person has when they own property and what they can do with it.
- The bundle of rights includes the right to sell, lease, mortgage, donate, another means of transfer or to do nothing at all.
- Each right has some value, and if one or more is removed, then a partial interest is created and valued accordingly.
Appraisers will appraise the fee simple interest or an interest less than fee (a partial interest). They can be created economically, legally, physically, or financially. Following are examples of partial interest that we have experience in appraising:
- Leased fee and or leasehold interests
- Life estates
- Transfer of development rights
- Air rights
- Water rights
- Riparian rights
- Aviation easements (the right to the use of the air space above a specific height for the flight of aircraft)
- Clearance easements
- Conservation easements
- Drainage easements
- Highway easements
- Line-of-sight easements (view or scenic easements)
- Overhead easements
Fractional Interest Estimate
Interests in real property are often held directly by multiple owners. The market values of these fractional interests are generally discounted from their pro rata share of the whole.
Appraisers are accustomed by practice and training to appraising entire properties, or property interests that are divided by leases, easements and many other methods of apportioning rights of use. Fractional interests in real property are, by contrast, undivided interests in the underlying property (whose rights may, in turn, be divided), and are identified as “Financial Interests”.
Undivided, fractional interests are created whenever a property is owned by two or more persons or entities. They may have no agreement whatsoever concerning the property or their relationship, or they may create all manner of joint ventures, partnerships, syndications, corporations and other legal entities to perfect the rights and obligations of the parties, and provide for orderly operation of the property.
In valuing a fractional interest in a property, consideration must be given to the risk associated with the ownership of the fractional interest. The key element in the analysis of a fractional ownership interest understands how investment risk and return factors change as the investor moves from a 100% fee ownership of the underlying real estate to ownership in a fractional interest.
There are two general categories to be considered in the valuation of fractional ownership interest in real estate. These categories, the main components when considering if a discount for fractional interest is appropriate, are:
- the relative lack of control because of the interest being held, and
- the relative lack of marketability of partial ownership as it compares to ownership of an entirety.
When comparing these elements to 100% fee simple ownership, there is obviously more risk and less desirability from an investor’s (owner’s) standpoint. This less desirable position thus requires a higher return to an undivided fractional interest to attract a willing buyer. Willing sellers recognize the structure of an undivided fractional interest and therefore must value that interest accordingly. These preceding elements are the basis for recognition that an undivided fractional interest in real estate must be discounted from its pro rata share of the entirety for that share to be truly a “market value” estimate. In other words, a pro rata interest in the property will not sell via an arms-length transaction without a significant discount.