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Comments on "Revisiting valuation of real estate partial interests: Recent case Studies." (Letters to the Editor).

In the first example, the Estate of Williams, the author deducted attorney's fees too soon in the process. As a result, the attorney's fees are incorrectly subject to a discount because the buyer would pay the full attorney's fees to accomplish the partition process. The sales costs are also presented in the wrong order and they reduce the net proceeds accruing to the subject interest. Therefore, they should be deducted to calculate the net sale proceeds to the buyer of the fractional interest. The deductions for holding, sales period, and attorney's fees should come out of net proceeds. When the deductions are arranged properly, the discount increases to 48.5% from 44.0%. The correct sequence is shown in Table 1.

The discounting process in the Neighborhood Shopping Center case is also incorrectly structured. The net income from the property and the holding costs should be shown as separate line items, because they will not necessarily offset. Based on statements in the article, the total time necessary to partition and sell the property is 24 months. Without discounting for time, the net income accruing to the subject fractional interest over the 24-month holding and sales period equates to $360,000. The authors argued that no discount is needed for time "because the cash flow to the investor from the shopping center offset any loss of opportunity cost during the time to partition." This implies that a buyer of the fractional interest would expect a yield rate equal to the capitalization rate. Since this is undoubtedly false, we argue that a higher yield rate should be used in the discounting analysis. Using the same discount rate as Case 1 (16.0% per year), the combined deductions for holding the property ($456,000) substantially exceed the income to the subject interest. The disparity between the net income and the "loss of opportunity cost" would be even greater if the net income were discounted for time; we have not discounted the income solely to be consistent with the example in the article.

When the deductions are arranged properly and income and holding costs are calculated separately, the indicated discount increases to 14.1% from the 7.5% shown in the article. The correct sequence of deductions for this problem is shown in Table 2.

The Residential Lots case also suffers from incorrect placement of the attorney's fees. 'When the order of the deductions is corrected, the indicated discount increases to 64.4% from the 58.3% shown in the article. The corrected calculations are shown in Table 3.

The result of the placement of the costs in the correct order is an increase in the indicated discounts across the board, as shown in the following table. The increases in Cases 1 and 2 are not large, but the discount in Case 2 nearly doubles. This is primarily due to the failure of the study in the article to reflect that the carrying costs are higher than the net income.

Our intent is to point out the correct order to consider the different deductions, so that the actual cash flows to the fractional interest are accurately reflected.

Robert N. Jones, MAI

Stephen D. Roach, MAJ

San Diego, California
Table 1

Estate of Williams--Revised

Appraised value of fee simple interest $1,096,000
Pro rata value at 50% $548,000
Less cost of sale (10%) (54,800)
Net sale proceeds $493,200
Less discount for 17-month holding period (22.67%) (111,808)
Less discount for 9-month sales period (12.00%) (59,184)
Less attorney's fees (40,000)
Indicated value of 50% fractional interest $282,208
Indicated percentage discount 48.5%
Table 2

Neighborhood Shopping Center--Revised

Appraised value of fee simple interest $3,000,000
Pro rata value at 50% $1,500,000
Less cost of sale (5%) (75,000)
Net sale proceeds $1,425,000
Plus net income from property for 24 months 360,000
Less discount for 12-month holding period @ 16% per year (228,000)
Less discount for 12-month sales period @ 16% per year (228,000)
Less attorney's fees (40,000)
Indicated value of 50% fractional interest $1,289,000
Indicated percentage discount 14.1%
Table 3

Residential Lots--Revised

Appraised value of fee simple interest $48,000
Pro rata value at 50% $24,000
Less cost of sale (10%) (2,400)
Net sale proceeds $21,600
Less discount for 12-month partition period (2,160)
Less discount for 5-month sales period (907)
Less attorney's fees (10,000)
Indicated value of 50% fractional interest $8,533
Indicated percentage discount 64.4%
Table 4

Comparison of Discounts

Table Case Original Discount Correct Discount

 1 Estate of Williams 44.0% 48.5%
 2 Neighborhood Shopping Center 7.5% 14.1%
 3 Residential Lots 58.3% 64.5%

Table Increase In Discount

 1 10.2%
 2 87.6%
 3 10.5%
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Publication:Appraisal Journal
Article Type:Letter to the Editor
Date:Jan 1, 2002
Words:802
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