Fractional Interests In Commercial Real Estate Appraisals

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Real Estate Appraiser with Commercial Investment Appraisers

 

When appraising commercial real estate, it is the value of the interest held by an owner of an asset that is actually appraised, and when there is more than one owner, there can be what is called a fractional (or undivided) interest.  A fractional interest consists of a percentage in the ownership interest for a real estate asset.  Since it is "undivided" there is no actual respective physical piece of the real property that any party owns, but instead, each party’s ownership is considered a percentage of the whole.  In other words, if I have a 20% undivided interest in a 10-acre piece of commercial land, I don’t automatically have the right to sell two acres out of it at will.  It would require the agreement of all of the interest owners to sell the entire parcel, and then the proceeds are split based on the ownership-interest percentages. 

 

If someone owns a 20% undivided interest in a commercial property, and the appraiser is employed to estimate the value of that person’s 20% interest, the appraiser must consider whether or not the value to the interest owner is solely 20% of the “whole” value, or if a discount should be applied to the partitioned value because of the fractional interest. It is widely accepted among real estate appraisers that the value of each individual fractional interest in a property is typically worth less than the percentage value of the “whole”.  This is based on the premise that the interest owners do not have complete control over the asset to sell or mortgage the property without the agreement of the other fractional interest owners.  However, the fractional interest itself can be sold without agreement by all owners, but is usually sold at a discount due to the limited right to control the asset. 

The ideology of discounts to fractional interests is recognized by the United States Tax Court, and there have been many court cases which support these discounts.  In the case of Ludwick v. Commissioner, the owners argued for a 30% discount to the value attributable to their share of the real estate to reflect the partial interest disadvantages.  The IRS felt that only an 11% discount was applicable.  The court ultimately ruled that a 17% discount was appropriate.  However, certain types of property are considered more or less risky to own, and marketability of a partial interest in a higher risk property may be more difficult. All of these factors must be considered when real estate appraisers estimate the discounts applicable for the fractional interests.

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