Partial Interest Valuation
Partial interest valuation is a technique used by appraisers and other valuation professionals to estimate the value of a fractional interest in real estate. Fractional interests in real estate result from the owner’s ownership of less than 100% of a given property.
Partial-interest properties can seem like a myth in the real estate world. These properties are not only rare, but also notoriously difficult to sell. If you ever happen across a partial-interest property, here’s how to work with the seller and find a buyer.
Partial Interest Defined
Partial-interest properties divide ownership into smaller fractional percentages held by multiple owners. These properties may have two owners with 50-50 stakes, five 20-percent owners, or any other combination. Partial interests typically stem from estate planning. Owners might parse a property among multiple inheritors, usually family members. Splitting the property this way often prevents the partial interests from ever entering the market, since the transfer of shares usually occurs within the owning group. One of the most popular partial-interest structures is the tenant-in-common ownership, or TIC. Prior to the 2008 financial crisis, financing for the acquisition of partial interest in real estate was more readily available than it currently is in many regions of the country. Today, many partial-interest transactions are completed as cash purchases out of necessity. However, in regions of the country where partial-interest ownerships are more common, and the lending community is therefore more familiar and comfortable with partial- interest transactions, it is still possible to obtain a loan on the acquisition of partial interest in real estate.
A Hard Sell
Brokers struggle to find buyers for partial-interest properties because most real estate buyers understandably desire 100 percent ownership. If the buyer holds only a partial interest, any modifications require the input and approval of the other owners. Even if a broker beats the odds and finds a willing buyer, the list of potential buyers narrows further because in many markets it’s nearly impossible to obtain a loan to purchase a partial interest. Most banks view such financing as too risky because it’s impossible to foreclose on a piece of a property if the borrower fails to maintain payments. As a result, many banks turn down such loan requests, and the limited financing shrinks the potential purchasing field to cash buyers. Selling partial-interest properties is a complicated dance between appeasing the client and making the sale. The first step for selling brokers is determining a discount percentage to apply to the asking price and communicating its need to the seller. The discount rate is to the overall cost of the asset given the limited number of potential buyers and the property’s limited desirability on the open market. An appraisal of a partial-interest property includes these four steps: 1. Appraise the entire property. 2. Multiply the percentage ownership of the partial interest by the value of the entire property, which will equal the value of the partial-interest in the property before applying the discount. 3. Determine the appropriate partial-interest discount to apply. 4. Multiply the appropriate discount percentage by the value of the partial share to arrive at the discounted value of the partial interest in the property. While sellers might balk at the applied discount rate, that discount is necessary for the property to sell, and brokers must convey this to sellers. The next step is targeting the right buyer. The most obvious buyer is an owner of another piece of the property. The other property owners tend to be good targets since they already have a stake in the property and would benefit from owning the entire asset. In addition, if another owner would gain 100 percent ownership with the new purchase, he or she will have an easier time acquiring a loan because the bank would issue the loan on the entire property, making foreclosure possible if the borrower defaults.
Buying Partial Interests
For the buyer broker, partial-interest properties can be one of the trickiest assets to close on, since few buyers seek out a partial interest. But for unique buyers who want to eventually own a full property — and have the patience to buy in pieces — significant discounts are possible. Because partial interests can be so heavily discounted due to their undesirability, they can be opportunities for patient investors to gradually gain full ownership of a property at a substantial savings to what they would pay to buy the whole property at once. As a broker, it’s important to keep in mind the regional attitudes toward partial-interest properties. For example, partial-interest sales are rare in Los Angeles, but less unusual in San Francisco, where banks are more willing to grant financing. The opportunity to obtain loans opens the pool from strictly cash buyers to a more diverse market. When faced with selling a partial interest, brokers should seek out professional advice and guidance on how to discount these properties. Discount rates are best defined by past market sales, and despite the infrequency of partial-interest sales, professional appraisers will likely have the most recent market data.
