Discovering Value in Valuations of Real Estate


When defining the services provided by a CPA firm, most would quickly list tax and audit. However, when taking a deeper look into the services provided by larger firms throughout the country, a menu of advisory services are typically available. One of the more popular advisory services is valuation. Valuation services are usually relied upon for purposes such as corporate litigation, tax compliance, financial reporting requirements, financing, and succession planning. Additionally, real estate appraisal services may be required for entities that own real property or land.

There are several techniques utilized by valuation experts when determining the value of real property and other assets.

  • Sales Approach: This valuation technique, also referred to as the market approach, compares the property to recent sales of similar properties. Multiple factors such as property size, location, and improvements are taken into consideration under this approach.
  • Cost Approach: This method is based on determining the actual cost that would be incurred if the property were to be rebuilt. This would include everything from the current fair market value of the land to all necessary building materials, labor, and other expenses that would be associated with fully replacing the property.
  • Income Approach: Under this approach, a valuation expert determines the amount of income a property would be able to generate. This is a popular technique in valuing investment or rental properties.

Family Limited Partnerships

A family limited partnership, or FLP, is a powerful tool when it comes to estate planning. The general definition of a FLP is in the name – a partnership that consists of family members. The structure of a FLP is usually a general partnership consisting of both general and limited partners. The general partner(s) in a FLP are usually parents or grandparents who would have legal control over day-to-day operations of the entity. The limited partners would normally be the children or grandchildren. The general partners are able to transfer partnership interests, via gift or sale, to existing or new limited partners.

One of the major benefits of a FLP is the ability to apply valuation discounts primarily to limited partnership interests. A valuation discount considers the argument that a hypothetical buyer of a minority interest would demand a reduction in the pro-rata value due to his or her lack of control of the operations of the entity, and the lack of liquidity associated with the ability to sell the minority interest. Therefore, the fair market value, or FMV, of a partner’s interest in the FLP is less than the pro-rata FMV of the actual book value of the partnership and takes into account discounts for lack of control and lack of marketability.

The concept of lack of control is that minority partners, such as limited partners in a FLP, do not have a direct say in how the operations of the partnership are managed. For example, if the FLP holds real estate as an asset, a minority partner cannot decide when to sell that property. Additional examples may include, but are not limited to, the inability to issue dividends, receive financing, or terminate agreements with tenants. The inability to control the operations of a partnership infers that the limited partners’ interest in that partnership is theoretically worth less than the FLP’s pro-rata book value. Therefore, for example, owning a real estate FLP with a FMV of $1 million may yield a lower valuation when compared to owning said real estate as an individual taxpayer. Additionally, while considering the book value, on a FMV basis, it may be more prudent to consider the cash flows available to the minority interest being valued. The minority interest holder would not possess the ability to liquidate the FLP and receive the concluded value under this approach. This method of concluding a value based upon cash flows would fall under an income approach.

Taking a look at lack of marketability, the main concepts are FMV and liquidity. A minority partnership interest, such as an FLP holding real estate, does not have a direct market where the liquidation of such interest can be consummated quickly. When considering liquidity, a limited partnership interest is at a disadvantage when compared to more liquid assets such as publicly traded securities. With that said, a valuation expert can determine a discount for lack of marketability to discount the FLP interest. Some considerations of the marketability discount include a review of the partnership agreement, the historical distributions, and the estimated time to liquidity. Similarly to the lack of control discount, the end goal is to properly reflect the FMV of the interest in consideration of a minority owner’s lack of control and marketability.

There are many factors to consider before deciding if a family limited partnership is the most advantageous tax planning technique for a particular situation. A valuation expert should be consulted to assist in that determination prior to a decision about forming a family limited partnership.

Matrimonial Proceedings

Divorce proceedings can quickly become complicated, especially when it comes to dividing and valuing assets. Some assets, such as cash and marketable securities, can be less arduous when attempting to determine a value. However, specific co-owed assets are not as straightforward to appraise, such as the marital home. When a married couple owns additional pieces of real estate, such as a vacation home, investment property, or rental property, it becomes clearer how important valuation services become during a divorce.

While going through a divorce can be stressful, it is important that the end result is as fair as possible. In addition to a competent attorney, a valuation expert should also be part of the team, especially if the marital assets include sizable real estate interests.

Estate Planning

As the cliché goes, there are only two guarantees in life – death and taxes. The latter is usually a common theme throughout life, while the former is delayed as much as possible. However, when that time does come, the assets that one has accumulated over his or her lifetime are carefully combed over and disseminated to new owners. Proper tax planning is paramount during one’s lifetime to maximize the asset distribution to heirs. Highly liquid assets, such as cash, are easier to value and distribute. But what about real estate? Should a highly appreciated asset be sold and liquidated during one’s lifetime? Or should it be passed down to the heirs? How is value determined as of the date of death?

It is important to consider the above questions, among many others, when determining a tax-favorable estate plan. A valuation expert will be able to provide guidance during the planning process.

Business Disputes

Business disputes can lead to splitting off assets in litigation. In addition to amicably deciding the rightful owners of said assets, a determination of market value is just as important. Performing a valuation on the entire business is a complex but necessary task. A major component of that valuation will include real property held by the business. Quite a few factors come into play, and a valuation expert will utilize many of the techniques and theories mentioned above when concluding on an accurate valuation of all business assets, including real estate. For businesses that own real estate, it is important to normalize the business’ cash flows to represent cash flows that would be achieved if the business were to pay rent to an unrelated party. The determination of the FMV rent can be determined through a real estate appraisal.

Conclusion

Valuation services can impact aspects of real estate holdings under many different scenarios. It is important to consider the services and value a valuation expert can provide before one is actually needed – planning in advance is key.

Author: Andrew Murray, CPA, Real Estate Services Group | [email protected]


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