Real Property Interests and Ownership Forms

Chapter 2: Real Property Interests and Ownership Forms

I. Introduction to Real Property Interests

Real property encompasses not only the physical land and its improvements (buildings, fixtures) but also the intangible rights associated with its ownership. These rights, often referred to as a “bundle of rights,” can be separated and conveyed to different parties, creating diverse real property interests. Understanding these interests is crucial for accurate real estate appraisal, as they significantly impact property value.

II. Estates in Real Property

An estate is the degree, quantity, nature, and extent of interest that a person has in real property. Estates are broadly classified into freehold and lease❓hold estates.

A. Freehold Estates
Freehold estates represent ownership for an indefinite period. They can be further subdivided into:

1. Fee Simple Absolute: This is the highest form of ownership, granting the owner complete control and the right to dispose of the property as they see fit. This estate is inheritable and perpetual, subject only to governmental powers (eminent domain, taxation, police power, escheat).
   Mathematical Representation: Let V represent the value of the property. For Fee Simple Absolute, V is maximized, reflecting the comprehensive bundle of rights.

2. Fee Simple Defeasible: Ownership is subject to certain conditions. If these conditions are violated, the ownership may revert to the grantor or a third party. There are two main types:
   a. Fee Simple Determinable: Ownership automatically terminates upon the occurrence of a specified event. The grant includes words of duration such as “so long as,” “during,” or “until.”
   b. Fee Simple Subject to Condition Subsequent: Ownership can be terminated if a specified condition is violated, but the grantor must take legal action to reclaim the property. The grant includes words such as “but if,” “provided that,” or “on the condition that.”

3. Life Estate: Ownership lasts for the duration of someone’s life (the life tenant). The life tenant has the right to possess and use the property but cannot commit waste (damage or destruction that reduces the property’s value). Upon the life tenant’s death, the property reverts to the original grantor (reversion) or passes to a designated remainderman (remainder).
   Valuation Considerations: Appraising a life estate requires considering the life expectancy of the life tenant. Actuarial tables and discounting techniques are used to estimate the present value of the income stream the life tenant is entitled to receive.
   Formula for present value of future income stream:
   PV = CF/(1+r)^n
   where
   PV = Present value
   CF = cash flow
   r = discount rate
   n = number of periods.

Experiment/Practical Application:
Scenario: You are appraising a property with a life estate. The life tenant is 70 years old, and similar properties generate an annual net operating income (NOI) of $20,000. Using actuarial tables, the life expectancy is estimated at 15 years. Applying a discount rate of 8%, calculate the present value of the life estate’s income stream.
PV = $20000/(1.08) + $20000/(1.08)^2 + … + $20000/(1.08)^15
PV = $171,235.39

B. Leasehold Estates
Leasehold estates grant the right to possess and use property for a specified period. The landlord (lessor) retains ownership, while the tenant (lessee) holds the leasehold interest. Common types include:

1. Tenancy for Years: A lease with a fixed term, such as one year or five years.
2. Periodic Tenancy: A lease that automatically renews for a set period (e.g., month-to-month) until either party gives notice.
3. Tenancy at Will: A lease that can be terminated by either party at any time.
4. Tenancy at Sufferance: Occurs when a tenant remains in possession of the property after the lease has expired without the landlord’s consent.

Valuation Considerations: The value of a leasehold interest is the difference between the market rent and the contract rent❓ over the lease term, discounted to present value. A leased fee estate is the lessor’s interest (i.e., the discounted value of rent plus the reversion value).

III. Encumbrances

An encumbrance is any right or interest held by someone other than the property owner that affects the title or value of the property.

A. Liens
A lien is a financial claim against property, used as security for a debt.
1. Mortgage Lien: A voluntary lien created when a property owner borrows money and pledges the property as collateral. The lender can foreclose on the property if the borrower defaults on the loan.
2. Tax Lien: An involuntary lien imposed by the government for unpaid property taxes. Tax liens have priority over other liens.
3. Mechanic’s Lien: A lien filed by contractors, laborers, or suppliers who have not been paid for their work on a property.

B. Easements
An easement is a nonpossessory right to use another person’s land for a specific purpose.
1. Easement Appurtenant: Benefits a specific parcel of land (the dominant tenement) and burdens another parcel (the servient tenement). The easement “runs with the land” and is transferred automatically when either property is sold.
2. Easement in Gross: Benefits a person or entity rather than a specific parcel of land (e.g., a utility company’s right to run power lines across a property).
3. Easement by Prescription: Created when someone uses another’s land openly, notoriously, continuously, and hostilely for a statutory period (usually 5-20 years).
4. Easement by Necessity: Created when a property is landlocked and has no access to a public road.

Impact on Value: Easements can either increase or decrease property value. An easement benefiting a property increases its value, while an easement burdening a property decreases its value.
Experiment/Practical Application:
Analyze the impact of an easement on property value. Assume two identical properties exist. Property A has an easement granting a neighbor access to a shared driveway. Property B has no easement. Collect comparable sales data for properties with and without similar easements. Calculate the average difference in sale prices to estimate the easement’s impact.

C. Other Non-Financial Encumbrances

1. Profit a Prendre: The right to take something from another’s land, such as minerals, timber, or crops.
2. Private Restrictions: Limitations on land use imposed by developers or homeowners’ associations (HOAs). These restrictions are typically found in the deed or covenants, conditions, and restrictions (CC&Rs).

IV. Forms of Ownership

A. Sole Ownership (Ownership in Severalty)
Ownership by one individual or entity. The sole owner has complete control over the property.

B. Concurrent Ownership
Ownership by two or more individuals or entities. There are several types of concurrent ownership:

1. Tenancy in Common: Each owner has an undivided interest in the property. Interests can be unequal, and each owner can sell, lease, or will their interest without the consent of the other owners. If a tenant in common dies intestate (without a will), their interest passes to their heirs.
2. Joint Tenancy: Requires the four unities: possession, interest, time, and title. All owners must have equal interests and acquire title at the same time. The key feature of joint tenancy is the right of survivorship: if one owner dies, their interest automatically passes to the surviving owners.
3. Tenancy by the Entirety: A form of joint tenancy available only to married couples. It offers additional protection from creditors, as neither spouse can transfer their interest without the other’s consent. In many states, divorce automatically converts a tenancy by the entirety into a tenancy in common.

Partition Action: If co-owners cannot agree on how to manage or sell the property, they can file a partition action in court. The court may order the property to be divided physically (partition in kind) or sold, with the proceeds divided among the owners.

C. Other Forms of Ownership
1. Condominiums: Each unit owner owns their individual unit in fee simple, plus an undivided interest in the common areas (e.g., hallways, elevators, swimming pool). The condominium association manages the common areas and enforces the bylaws.
2. Planned Unit Developments (PUDs): Similar to condominiums, but typically include single-family homes as well as common areas. Owners may own the land beneath their homes, unlike condominiums.
3. Cooperatives: Owners purchase shares in a corporation that owns the building. Shareholders receive a proprietary lease granting them the right to occupy a specific unit.
4. Timeshares: Ownership is divided into time intervals, allowing multiple owners to use the property for a specific period each year.
5. Manufactured Homes: Factory-built homes that are transportable in one or more sections. If permanently affixed to land, they can be considered real property.
6. Prefabricated/Modular Homes: Factory-built homes constructed in modules and assembled on site. They are typically considered real property.
7. Ground Leases: A lease of land only, often for a long term (e.g., 99 years). The tenant can construct improvements on the land, but ownership of the improvements reverts to the landowner at the end of the lease term.

Impact on Value: Different ownership forms have distinct impacts on property value. Condominiums and cooperatives require consideration of association fees and rules. Timeshares often sell at a discount due to limited usage rights. Ground leases require analyzing the terms of the lease and the reversionary interest.

V. Appraising Partial Interests
Partial interests are any interests in real property that are less than fee simple absolute. They arise from the separation of the bundle of rights.

A. Leasehold and Leased Fee Interests
The value of a leasehold interest is the present value of the difference between the market rent and the contract rent over the remaining lease term. The value of the leased fee interest is the present value of the contract rent plus the present value of the reversionary interest (the value of the property at the end of the lease term).
Mathematical Representation:
Leasehold Value = PV (Market Rent - Contract Rent)
Leased Fee Value = PV (Contract Rent) + PV (Reversionary Interest)

B. Easements
The value of an easement is the difference in value of the property before and after the easement is granted. This is typically determined by the cost approach, looking at loss in property value caused by the easement.

C. Liens
The value of a property encumbered by a lien is reduced by the amount of the lien.

D. Shared Ownership Interests
Appraising shared ownership interests, such as tenancy in common or joint tenancy, requires careful consideration of the ownership rights and the potential for partition. Fractional interests are often discounted to reflect the lack of complete control.

VI. Conclusion

A thorough understanding of real property interests and ownership forms is essential for accurate real estate appraisal. Appraisers must be able to identify and analyze the various rights and encumbrances that affect property value, considering the legal and economic implications of each interest. By applying the principles and techniques discussed in this chapter, appraisers can provide reliable and credible opinions of value.