Interests in Real Property: Legal and Financial Dimensions

Chapter: Interests in Real Property: Legal and Financial Dimensions

Introduction

This chapter delves into the multifaceted realm of real property interests, exploring their legal underpinnings and financial implications. Understanding these interests is crucial for anyone involved in real estate, as they dictate the rights, responsibilities, and potential returns associated with a property.

1. Physical Interests in Real Property

Physical interests delineate the tangible rights associated with land and its improvements. These interests can be separated horizontally and vertically.

1.1 Horizontal Divisions: Subdivision and Assemblage

• Subdivision: The process of dividing a larger parcel of land into smaller, individual units.
  • Practical Application: A developer divides a 10-acre lot into ten 1-acre residential lots.
  • Related Experiment: A market analysis could determine the optimal lot size for a given area, balancing the cost of subdivision with the potential for increased sales revenue.

• Assemblage: Combining two or more adjacent parcels of land into a single, larger parcel.

  • Plottage Value: The incremental increase in value resulting from assemblage, where the combined parcel is worth more than the sum of its individual parts.

  Formula: Plottage Value = Assembled Value - (Sum of Individual Parcel Values)

  Example: Two adjacent lots are valued at $500,000 each. Assembled, the value becomes $1,200,000.
  Plottage Value = $1,200,000 - ($500,000 + $500,000) = $200,000

1.2 Vertical Divisions: Subsurface and Air Rights

• Subsurface Rights: The right to use and profit from the underground portion of a property.
  • Typically involves mineral extraction or construction of underground infrastructure (tunnels, utilities).
  • Legal Considerations: Subsurface rights can be severed from surface rights, leading to complex ownership scenarios.
• Air Rights: Property rights associated with the use, control, and regulation of the airspace above a parcel of real estate.
  • Critical for high-density urban development.
  • Engineering Advances: Steel-framed construction, elevators, and communication technology have facilitated the development of air rights.
  • Transfer of Air Rights: Allows developers to adjust land use density without negatively impacting surrounding areas.
  • Zoning Regulations: Local authorities regulate building heights, functions, and setbacks, influencing air rights development.

1.2.1. Transferable Development Rights (TDRs)
Rights that may vary from state to state but are generally real property only as long as they are attached to the land.
When they are sold, they become personal property, only becoming real property again when they are attached to another tract of land.
TDRs can often be banked to facilitate the timing of the transfer of rights.

1.2.2. Air Rights Transfer Example: Floor Area Ratio (FAR)
FAR = Total Building Floor Area / Lot Area
Example: A developer combines two lots. The allowable aboveground area can be doubled by building higher on the combined lot without violating the maximum floor area ratio.

2. Financial Interests in Real Property

Financial interests are claims or stakes in a property’s value, impacting investment strategies. Mortgage and equity components are key.

2.1 Equity Interests

• Equity: The owner’s interest in a property after all claims and liens have been satisfied.
• Legal Forms of Ownership: Individual ownership, joint ownership, partnership, corporation, etc.
• Valuation Considerations: An appraiser may value equity for estate tax purposes or sale/purchase decisions.
• Partial interest: Partial interests are often valued at less than their pro rata share of ownership because the investor does not have voice in the management or control of the asset.

2.2 Mortgage Interests

• Mortgage Instrument: Creates mortgagor (borrower) and mortgagee (lender) positions.
• Mortgage-Equity Analysis: Techniques for comparing mortgages with different terms (Chapter 21) and analyzing the relationship between mortgage and equity returns (Chapter 25).
• Secondary Mortgage Market: Mortgages are traded, influencing property values.
• Economic Impact: Mortgage market conditions significantly affect property values (e.g., the 2007 housing crisis).

3. Forms of Ownership

This section identifies who owns the interests discussed, exploring various legal structures.

3.1 Concurrent Ownership

• Ownership in Severalty: Individual ownership.
• Tenancy: Holding of property by any form of title.
• Joint Tenancy: Joint ownership with the right of survivorship.
• Tenancy by the Entirety: Ownership by spouses with survivorship rights (specific to some states).
• Tenancy in Common: Ownership by two or more persons with undivided interests (no survivorship).

3.2 Legal Entity Ownership

• Land Trusts: Property conveyed to a trustee who manages it for beneficiaries.
• Partnerships: Business arrangement where partners share profits and losses.
  • General Partnership: All partners share gains and liabilities.
  • Limited Partnership: General partners manage, while limited partners have limited liability.
• Stock Corporations: Investors own shares of stock, not direct interests in the property.
• Real Estate Investment Trusts (REITs): Pool funds of small investors to acquire real estate.
  • Tax Pass-Through: REITs must distribute at least 90% of taxable income as dividends.
• Real Estate Operating Companies (REOCs): Similar to REITs, but can reinvest earnings.
• Limited Liability Companies (LLCs): Combine features of corporations and partnerships (limited liability and pass-through taxation).
• Syndications: Private or public partnerships to pool funds for real estate ventures.
  • Tax Considerations: Syndications were once popular for tax shelter benefits, but the Tax Reform Act of 1986 reduced these advantages.

3.3 Special Forms of Ownership

• Condominium Ownership: Separate ownership of units with undivided ownership of common elements.
• Cooperative Ownership: Residents own shares in a corporation that owns the building.
• Timesharing: Multiple owners have the right to use a property for specific periods.

4. Relevant Scientific Theories and Principles

• Economic Theory: Supply and demand principles influence property values and the feasibility of development projects (subdivision, assemblage).
  Formula: Value = f(Supply, Demand, Interest Rates, Economic Growth, Location)
• Game Theory: In situations involving multiple landowners, game theory can be used to model negotiations and strategic decisions related to assemblage or air rights transfers.
• Agency Theory: Explains the relationship between principals (owners) and agents (managers), relevant in partnerships, corporations, and trusts.

• Financial Modeling: Discounted cash flow (DCF) analysis is used to evaluate the present value of future cash flows, crucial for assessing the financial viability of real estate investments (equity, mortgages).

  Formula: PV = CF1 / (1 + r)^1 + CF2 / (1 + r)^2 + … + CFn / (1 + r)^n
  Where: PV = Present Value, CF = Cash Flow, r = Discount Rate, n = Number of Periods

5. Practical Applications and Examples

• Urban Planning: Understanding air rights and TDRs is vital for urban planners aiming to promote sustainable development and manage density.
• Real Estate Investment: Analyzing mortgage and equity components is essential for making informed investment decisions.
• Property Appraisal: Appraisers must understand the various forms of ownership to accurately value real property interests.
• Legal Practice: Real estate lawyers must navigate the complexities of property rights, contracts, and ownership structures.

Conclusion

Mastering the intricacies of real property interests, both legal and financial, is fundamental to success in real estate. This chapter has provided a comprehensive overview of these interests, equipping you with the knowledge and analytical tools necessary to navigate this complex landscape.