English
Transferable Rights, Ownership Forms, and Financial Interests
Chapter: Transferable Rights, Ownership Forms, and Financial Interests
Introduction
This chapter delves into the multifaceted aspects of real estate rights, focusing on how these rights can be transferred, the various forms of ownership that exist, and the associated financial interests. Understanding these concepts is crucial for accurate real estate valuation and investment analysis. We will explore the legal and economic principles that govern these areas, providing a comprehensive framework for mastering real estate rights.
1. Transferable Rights
Transferable rights represent the ability to convey certain aspects of real property ownership to another party. This can involve various types of rights, including development rights, easements, and other specific entitlements associated with the land.
-
Transferable Development Rights (TDRs)
- Definition: TDRs are a mechanism that allows landowners to transfer development potential from one property (the sending site) to another (the receiving site). This is often used to preserve historically significant sites or to protect agricultural land.
- Legal Basis: TDRs are governed by local zoning ordinances and state laws, which define the conditions under which these rights can be transferred. Internal Revenue Code §170A 14(c)(1) defines organizations that are eligible donees of TDR’s, which includes governmental units and charitable organizations.
- Practical Applications:
- Density Bonuses: In development districts, landowners can use TDRs to build at higher densities than typically permitted by zoning laws.
- Utility Constraints: If a community imposes a construction moratorium due to limited utility capacity, a landowner with allocated utility rights can sell those rights to another landowner who needs immediate access.
- Experiment: Simulate a TDR market using a spreadsheet. Model different scenarios with varying sending and receiving sites. Consider factors such as zoning regulations, land values, and potential development profits. Calculate the potential gains for both the sending and receiving sites under different transfer scenarios.
-
Mathematical Formulation: Let Ds represent the development potential of the sending site, Dr the development potential of the receiving site, Ps the price per unit of development right from the sending site, and N the number of development rights transferred. The total revenue for the sending site is N * Ps, and the increased development potential for the receiving site is N.
2. Air Rights* -
Definition: Air rights are the rights to use the airspace above a designated property.
- Legal Framework: Air rights are established and regulated by local zoning authorities, which dictate building heights, setbacks, and other development parameters.
- Practical Applications:
- Urban Development: Air rights can be sold or leased to developers to construct buildings over existing structures, such as railway lines.
- Density Adjustments: Transferring air rights allows developers to adjust land use density without adversely impacting surrounding areas.
- Example: New York City Zoning Regulations. Developers can buy adjacent lots to increase the floor area ratio (FAR), allowing for larger building construction.
- Mathematical Model: FAR Calculation. The Floor Area Ratio (FAR) is calculated as:
FAR = Total Building Area / Lot AreaBy merging adjacent lots, the Lot Area increases, which can allow a higher Total Building Area if the FAR is the limiting factor.
3. Subsurface Rights- Definition: The right to use and profit from the underground portion of a property.
- Applications: Extraction of minerals, construction of tunnels for utilities, and transportation infrastructure.
- Legal Considerations: Subsurface rights can be separated from surface rights.
2. Ownership Forms
The form of ownership significantly impacts the rights and responsibilities associated with real property. Different ownership structures offer varying degrees of liability protection, tax benefits, and management control.
-
Individual Ownership (Severalty)
- Definition: Ownership by a single individual or entity.
-
Characteristics: The owner has complete control and responsibility for the property.
2. Concurrent Ownership -
Definition: Ownership by two or more persons.
- Joint Tenancy:
- Joint ownership with the right of survivorship.
- Each party has an identical interest and right of possession.
- Upon the death of one joint tenant, ownership automatically vests in the remaining tenant(s).
- Tenancy by the Entirety:
- Ownership held by spouses.
- Neither spouse has a disposable interest in the property during the lifetime of the other, except through joint action.
- Includes a survivorship provision.
- Tenancy in Common:
- Ownership by two or more persons, each with an undivided interest.
- Interests may or may not be equally shared.
- No right of survivorship.
- One tenant in common can sell their interest without the approval of other tenants.
3. Legal Entity Ownership
- Joint Tenancy:
-
Land Trusts:
- Properties are conveyed to a trustee, who conditionally owns the real property.
- The original owners become beneficiaries of the trust.
- Trust agreement outlines the trustee’s duties and functions.
- A judgment against a beneficiary is not a lien against the real estate.
-
Partnerships:
- General Partnerships:
- All partners share in business gains and are personally responsible for all liabilities.
-
Limited Partnerships:
- General partners manage the business and assume full liability.
- Limited partners are passive and their liability is restricted to their capital contribution.
- Corporations:
-
Stock Corporations:
- Investors own shares of stock, not direct interests in the real property.
- The corporation is the legal owner of the real estate.
- Real Estate Investment Trusts (REITs):
- Pool funds of small investors to acquire real estate investments.
- Offer freedom from personal liability, expert management, and readily transferable shares.
- Must pay dividends of at least 90% of its taxable income.
- Real Estate Operating Companies (REOCs):
- Can reinvest earnings into the business rather than distribute them to unit holders.
- More flexible than REITs in terms of investment types.
- Limited Liability Companies (LLCs):
- Incorporate features of both corporations and partnerships.
- Offer limited liability to members.
- Function as a pass-through entity with earnings taxed only at the level of the interest holder.
4. Syndications
- General Partnerships:
-
Create partnerships to pool funds for real estate acquisition, development, management, or disposition.
-
Special Forms of Ownership
- Condominium Ownership:
- Separate ownership of individual units within a multiunit building, with undivided ownership of common elements.
- Variants can include hotels, offices, industrial buildings, and land subdivisions.
- Cooperative Ownership:
- Residents own shares in a corporation that owns the building.
- Shareholders have the right to occupy a specific unit.
- Timesharing:
- Multiple owners have the right to use a property for a specific period each year.
- Condominium Ownership:
3. Financial Interests
The financial interests in real property involve the economic rights associated with ownership, including the right to income, appreciation, and equity.
-
Equity Interests
- Definition: The owner’s interest in the real property after all claims and liens have been satisfied.
- Forms of Ownership: Individual owner, joint owner, partner, or shareholder in a corporation.
- Valuation Considerations: An equity interest does not necessarily represent a pro rata share of the value of the whole. Partial interests are often valued at less than their pro rata share due to limited management control or other factors.
-
Experiment: Model equity valuation. Calculate the equity value under different scenarios, such as varying debt levels (Mortgage/Equity Ratios), vacancy rates, and operating expenses. Use a discounted cash flow (DCF) analysis to determine the present value of the expected future cash flows to equity holders. Sensitivity analysis will highlight the risks and rewards of the project.
-
Mathematical Formulation:
Equity = Asset Value - Total Liabilities
2. Mortgage Interests -
Definition: A secured debt position where the property serves as collateral.
- Mortgage-Equity Analysis: Techniques for comparing mortgages with different terms are well established.
- Market Influence: Mortgage market conditions can significantly impact property values.
- Secondary Market: Mortgage interests are traded regularly in the secondary market.
4. Conclusion
This chapter has provided a comprehensive overview of transferable rights, ownership forms, and financial interests in real estate. A strong understanding of these concepts is essential for effective real estate valuation, investment analysis, and property management. By mastering these principles, professionals can make informed decisions and navigate the complexities of the real estate market.
Chapter Summary
This chapter, “Transferable Rights, Ownership Forms, and Financial Interests,” from the “Mastering Real Estate Rights: Ownership, Interests, and Valuation” training course, delves into the complexities of real property rights beyond simple fee simple ownership. It explores how rights can be separated, transferred, and held, impacting value and investment decisions.
Key Scientific Points and Conclusions:
- Transferable Development Rights (TDRs): The chapter highlights how development rights can be separated from land and transferred to other parcels. While attached to land, they are considered real property, but become personal property upon sale, reverting to real property when attached to another parcel. TDRs allow for adjustments to density and land use, often driven by zoning regulations or utility constraints. The concept of banking TDRs to facilitate timing of transfer is also presented.
- Physical Interests (Horizontal and Vertical): Physical interests can be divided horizontally through subdivision and assemblage, where plottage value (incremental value created by assemblage) may arise. Vertical divisions include subsurface rights (mineral extraction, tunnels) and air rights (use and control of airspace). Technological advancements have increased the significance of vertical divisions, driving demand for air rights development in dense urban areas. Air rights can be sold, leased, or subdivided, and their transfer can influence land use density in accordance with zoning regulations, demonstrated by the example of merging lots to increase floor area ratio (FAR).
- Financial Interests (Mortgage and Equity): The financial components of property interests significantly affect investment practices. Mortgage funds are secured debt, while equity investments are venture capital. Fee simple, leased fee, and leasehold interests can be mortgaged, dividing them into mortgage and equity components. Equity is the owner’s interest after all claims and liens are satisfied, and it can be held in various legal forms (individual, joint owner, etc.). The legal form doesn’t always affect property value, but appraisers may need to value specific equity interests for purposes like estate tax or sale/purchase decisions. Mortgage interests are regularly traded, and mortgage-equity analysis is a well-established appraisal technique. The state of the mortgage market directly impacts property values.
- Forms of Ownership: Ownership can be held individually (ownership in severalty) or concurrently (joint tenancy, tenancy by the entirety, tenancy in common). Joint tenancy features right of survivorship, tenancy by the entirety is specific to spouses, and tenancy in common allows for unequal, undivided interests without survivorship rights. Ownership can also be vested in legal entities like land trusts, partnerships, corporations, and syndications. The choice of ownership form often depends on tax advantages, liability limitations, or corporate reporting requirements. Land trusts utilize a trustee to conditionally own property, partnerships pool funds for ownership and operation (general and limited partnerships), corporations issue stock representing ownership shares in the corporate entity that owns the real estate, REITs and REOCs offer different investment and distribution structures, and LLCs combine corporate liability protection with partnership pass-through taxation. Syndications are used to pool funds and transfer interests in real property, although their use as tax shelters has diminished. Special forms include condominium ownership (separate units with common elements), cooperative ownership, and timesharing.
Implications:
- Valuation Complexity: Understanding the specific rights being appraised is crucial for accurate valuation. Separating and transferring rights creates partial interests, which are not always valued pro rata and can be significantly impacted by factors like control and management rights.
- Investment Strategies: Knowledge of different ownership forms is essential for real estate investors to optimize tax benefits, limit liability, and structure investments effectively.
- Regulatory Environment: Zoning regulations, utility capacity, and state laws governing ownership and legal entities all play a significant role in shaping the value and transferability of real estate rights.
- Market Dynamics: Mortgage market conditions and capital market trends directly influence property values and investment decisions.
