Partial-interest properties: How to sell what no one wants to buy
Jul 30, 2013
It began with a death. An elderly woman who owned a 50% tenant-in-common interest in a duplex (the upper floor) passed away with no will, and the property passed into probate court. A valuation was performed, and the unit was put on the market. But it didn’t sell.
It wasn’t that the property was undesirable. As part of the valuation, we performed a complete interior and exterior inspection of the property, and found that both units of this duplex had been well-maintained and updated over the years, and the property was of average to good quality and in average to good condition. It occupied a desirable street in a well-to-do neighborhood where demand is strong for residential real estate.
What kept it on the market for nearly a year with nary a buyer to be found was that only a partial-interest in the property was for sale. Notoriously difficult to sell, partial-interest properties are exceedingly rare, representing roughly one out of every 10,000 sales – though you might encounter only one in a million, as these sales are not normally made public. There are a number of reasons why these properties are difficult to sell, and we’ll dig into them, but suffice it to say that a discount is necessary. Here’s how to appraise and sell a property that no one wants to buy.
What are partial-interest properties?
In a partial-interest property, ownership is broken down into fractional interests from a single, unified ownership. These fractions are expressed as percentage interests. This means that a property could have two 50-50 partners, four 25% partners, and so on.
One way in which these types of properties are created is through estate planning. Oftentimes, an owner will split a property among multiple inheritors, commonly family members, creating a partial-interest property. Most of these shares are transferred over time, without any money involved. More uncommon, and more troublesome, is when one of these partial-interests goes to market.
Appraising a partial-interest for sale on the market might initially seem straightforward. By applying simple math, one might assume that the price of a partial-interest property would be the total value of the property multiplied by the percentage ownership.
A proportional appraisal seems like a reasonable solution, but the partial-interest is really worth less than that percentage. Few people actually want to own a fraction of a property and a non-liquid asset, lowering its marketability on the open market. Consumers tend to steer away from partial-interest properties for a number of reasons.
Problems in selling partial interest properties
One of the biggest deterrents to purchasing a partial-interest property is the limited control the buyer would have in making decisions about the property. Because such investments have multiple stakeholders, any renovations or modifications to the property, for example, must be approved by another owner who might not share your views. Lack of control weeds out many potential buyers and the property tends to stay on the market for an extended period of time, further driving down the discount price.
Even if a buyer is interested, it’s nearly impossible in many markets to obtain a loan to buy a partial-interest property. Many banks refuse to grant financing for a partial-interest purchase because they would have no way to foreclose on only a portion of a property if a borrower can’t keep up with payments. As a result, many of these transactions are cash only, severely limiting the pool of potential buyers. For these reasons, a discount on the value of the partial-interest property needs to be calculated when crafting an appraisal.
How to appraise and sell partial-interest properties
Any appraisal of a partial-interest property includes these four steps:
- Appraise the entire property.
- 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.
- Determine the appropriate partial-interest discount to apply.
- 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.
The discount is necessary to find a buyer, but how much of a discount is appropriate? The best indicator of discount rates for partial-interest properties is a sale on the open market, but because this type of sale is so rare, market data on appropriate discount rates can be more than 30 years old. Fortunately, we now have current market data from the sale of the 50% partial-interest in the duplex that began this post.
It took nearly a year to sell, but finally the owner of the lower floor of the duplex bought the upper floor at a discount. He was able to finance the purchase because the bank could base the financing on the entire property. Buyers for partial interest properties are often like this man, consolidating ownership of a property fraction by fraction.
Partial-interest properties are rare, and so are potential buyers of those partial interests. But by applying appropriate discount rates based on real-world market data, the interest’s true value is revealed and it can be more readily sold.
