Property Rights: Divisions, Interests, and Ownership

Introduction

Property rights are the foundation of real estate and represent the legal rights associated with ownership and use of land and improvements. Understanding the various divisions, interests, and forms of ownership is crucial for real estate professionals. This chapter delves into these aspects, providing a comprehensive overview of property rights and their implications.

Divisions of Property Rights

Property rights can be divided in several ways, both horizontally and vertically, to create different interests.

Horizontal Divisions

Horizontal divisions involve splitting land into smaller units.

• Subdivision: The process of dividing a large parcel of land into smaller, individual lots. This is governed by local regulations and zoning laws. The value of individual lots may be influenced by the overall market demand and the specific characteristics of each lot.

• Assemblage (Plottage): Combining two or more adjacent parcels of land into a single, larger parcel. This can result in increased value if the larger parcel has a higher and better use than the individual parcels.

  • Plottage Value: The incremental increase in value that results from assemblage. It can be calculated as:

    • PV = V_assembled - ΣV_individual
    • Where:
      • PV = Plottage Value
      • V_assembled = Value of the assembled parcel
      • ΣV_individual = Sum of the values of the individual parcels

    Example: Two adjacent half-acre sites are valued at $500,000 each. When assembled into a one-acre site, the value is $1,200,000. The plottage value is $1,200,000 - ($500,000 + $500,000) = $200,000.

Vertical Divisions

Vertical divisions involve separating rights above or below the surface of the land.

1. Subsurface Rights: The rights to use and profit from the underground portion of a property, including mineral rights, the right to extract resources, and the right to construct tunnels.

   • Mineral Rights: The right to extract minerals such as oil, gas, coal, and other valuable resources. The valuation of mineral rights involves geological surveys, reserve estimation, and market analysis. The discounted cash flow (DCF) method is often used to estimate the present value of future mineral extraction revenue.

   • Equation for DCF:

     • PV = Σ (CF_t / (1 + r)^t)
     • Where:
       • PV = Present Value
       • CF_t = Cash flow in period t
       • r = Discount rate
       • t = Time period

2. Air Rights: The rights to use, control, and regulate the airspace above a parcel of real estate. Air rights can be sold, leased, or transferred.

   • Transfer of Development Rights (TDR): A mechanism that allows landowners to transfer unused development potential from one property (the sending site) to another (the receiving site). This is often used to preserve historic landmarks, protect environmentally sensitive areas, or increase density in designated development districts.
     • Example: A landowner with a historic building in a low-density zone can sell their unused air rights to a developer who wants to build a taller building in a higher-density zone.

   • Floor Area Ratio (FAR): A zoning regulation that dictates the maximum allowable building size on a given parcel of land. It is calculated as the ratio of the total building floor area to the land area.

     • FAR = Total Building Floor Area / Land Area
     • Developers can sometimes increase the allowable FAR by purchasing air rights from adjacent properties or merging lots.

Interests in Real Property

Real property interests can be categorized as physical or financial, representing different rights and claims to the property.

Physical Interests

1. Fee Simple: The most complete form of ownership, granting the owner full rights to possess, use, and dispose of the property.
2. Leased Fee: The ownership interest held by a landlord (lessor) who has leased the property to a tenant (lessee). The leased fee interest includes the right to receive rent and the reversionary interest in the property at the end of the lease term.

3. Leasehold: The interest held by a tenant (lessee) who has the right to possess and use the property for a specified period under the terms of a lease agreement.

   • Valuation of Leasehold Interest:

     • V_Leasehold = PV of Rent Savings = Σ ((Market Rent - Contract Rent) / (1 + r)^t)
     • Where:
       • V_Leasehold = Value of the Leasehold Interest
       • Market Rent = The current market rent for comparable properties
       • Contract Rent = The rent specified in the lease agreement
       • r = Discount rate
       • t = Time period

Financial Interests

1. Equity Interest: The owner’s interest in the property after deducting all claims and liens, such as mortgages and other debts. Equity represents the owner’s stake in the property’s value.

   • Equity = Property Value - Total Debt

2. Mortgage Interest: The interest held by a lender (mortgagee) who has provided financing for the purchase of the property. The mortgage is a secured debt, giving the lender a lien on the property as collateral.

   • Mortgage-Equity Analysis: A method of analyzing the relationship between mortgage financing and equity investment in a property. It involves calculating the mortgage constant (annual debt service / loan amount) and comparing it to the property’s capitalization rate.

Forms of Ownership

The way in which real property is owned can have significant legal and financial implications.

Individual Ownership

1. Ownership in Severalty: Ownership by one individual or entity. The owner has full control and responsibility for the property.

Concurrent Ownership

1. Joint Tenancy: Ownership by two or more persons with the right of survivorship. If one joint tenant dies, their interest automatically transfers to the surviving joint tenant(s).

   • Requirements for Joint Tenancy:
     • Unity of Possession
     • Unity of Interest
     • Unity of Time
     • Unity of Title

2. Tenancy by the Entirety: A form of joint ownership available only to married couples in certain states. It includes the right of survivorship, and neither spouse can transfer their interest without the other’s consent.

3. Tenancy in Common: Ownership by two or more persons, each with an undivided interest in the property. There is no right of survivorship, and each tenant can sell or transfer their interest independently.

Legal Entity Ownership

1. Land Trusts: A trust arrangement in which a trustee holds title to real property for the benefit of the beneficiaries. Land trusts can provide privacy, asset protection, and flexibility in property management.
2. Partnerships: A business arrangement in which two or more persons jointly own a business and share in its profits and losses.
   • General Partnership: All partners share in business gains and are personally liable for all partnership liabilities.
   • Limited Partnership: Includes general partners who manage the business and limited partners who have limited liability and are not actively involved in management.
3. Corporations: A legal entity separate from its owners (shareholders). Corporations can own real property, and shareholders have limited liability.
   • S Corporation: A type of corporation that passes its income, losses, deductions, and credits through to its shareholders, avoiding corporate income tax.
   • C Corporation: A corporation that is taxed as a separate entity, with profits subject to corporate income tax.
4. Real Estate Investment Trusts (REITs): Companies that own or finance income-producing real estate. REITs allow investors to pool funds to invest in real estate and receive dividends.
   • Requirements for REIT Qualification:
     • Must be managed by a board of directors or trustees.
     • Must have at least 100 shareholders.
     • Must distribute at least 90% of its taxable income as dividends.
5. Real Estate Operating Companies (REOCs): Similar to REITs, but REOCs can reinvest their earnings into the business rather than distributing them to unit holders. They also have more flexibility in the types of real estate investments they can make.
6. Limited Liability Companies (LLCs): A business structure that combines features of partnerships and corporations. LLCs provide limited liability to their members and pass-through taxation.
7. Syndications: A group of investors who pool funds to acquire, develop, or manage real estate. Syndications often involve limited partnerships and can offer tax benefits to investors.

Special Forms of Ownership

1. Condominium Ownership: Ownership of individual units in a multi-unit building, with shared ownership of common elements.
2. Cooperative Ownership: Ownership of shares in a corporation that owns a building. Shareholders have the right to occupy a specific unit in the building.
3. Timesharing: A form of ownership or right to use a property for a specific period each year.

Conclusion

Understanding the divisions of property rights, the various interests that can be created, and the forms of ownership is crucial for real estate professionals. This knowledge enables accurate valuation, effective property management, and informed decision-making in real estate transactions.