Identifying Real Estate Value Types and Rights

Chapter 7: Identifying Real Estate Value Types and Rights

7.1 Introduction

Understanding real estate value requires not only assessing market❓ conditions but also identifying the specific type of value sought and the associated property rights❓ being appraised. This chapter delves into the nuances of various value types and property rights, providing a scientific basis for their identification and application in real estate valuation.

7.2 Types of Real Estate Value

Different situations and purposes necessitate different value definitions. Choosing the correct value type is critical for accurate appraisal.

• 7.2.1 Market Value:

  • Defined as the most probable price a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus.
  • Scientific Basis: Market value aligns with the principles of supply and demand, efficient market hypothesis, and game theory. The efficient market hypothesis suggests that asset prices fully reflect all available information. Thus, market value represents an equilibrium point where supply equals demand.

  • Mathematical Representation: While not directly expressed in a simple equation, market value ($MV$) is conceptually related to discounted future cash flows:

    $MV = \sum_{t=1}^{n} \frac{CF_t}{(1+r)^t}$

    Where:
    * $CF_t$ = Expected cash flow in period t.
    * $r$ = Discount rate reflecting risk and opportunity cost.
    * $n$ = Number of periods.
    * Practical Application: Determining market value is fundamental for sales, financing, and investment decisions.
    * Related Experiment: A comparative market analysis (CMA) simulates market behavior. By analyzing recent sales of comparable properties, adjustments are made for differences, predicting the most probable sales price. The accuracy of the CMA depends on the completeness and accuracy of the data and the appropriateness of the adjustments.

• 7.2.2 Use Value:

  • The value of a property for a specific use, which may or may not align with its market value.
  • Scientific Basis: Use value is based on utility theory and the principle of diminishing marginal utility. A property’s value increases with its utility to a specific user, but the additional utility decreases as the user obtains more of the same property.
  • Practical Application: Relevant for special-purpose properties like schools, fire stations, or unique industrial facilities. An example is the fire station built for $2.5 million having a comparable commercial building market value of $2 million. Its use value is closer to $2.5 million due to the specific function it provides.
  • Example: A specialized manufacturing plant may have a high use value to the owner but a lower market value because few other buyers can utilize it effectively.

• 7.2.3 Investment Value:

  • The value of a property to a specific investor, based on their individual investment criteria.
  • Scientific Basis: Investment value is aligned with portfolio theory and discounted cash flow analysis. An investor’s unique risk tolerance and required rate of return influence the perceived value.

  • Mathematical Representation:

    $IV = \sum_{t=1}^{n} \frac{CF_t}{(1+r_i)^t}$

    Where:
    * $IV$ = Investment Value
    * $CF_t$ = Cash Flow in period t as perceived by the investor.
    * $r_i$ = Investor’s specific discount rate.
    * $n$ = Number of periods.
    * Practical Application: Used by investors to assess whether a property meets their specific investment goals. An appraiser providing an opinion of value based on the client’s investment criteria, including an overall capitalization rate, is assessing investment value.

• 7.2.4 Insurable Value:

  • The value of a property covered by casualty insurance.
  • Scientific Basis: Based on risk assessment and actuarial science. Insurable value reflects the cost to replace or repair physical structures, excluding land value.
  • Practical Application: Used by insurance companies to determine premiums and coverage amounts.
  • Consideration: Often set in the insurance contract, state law also may affect insurable value.

• 7.2.5 Assessed Value:

  • The value assigned to a property by a local government for taxation purposes.
  • Scientific Basis: Based on legal frameworks and mass appraisal techniques. Ideally, assessed value should correlate with market value, though often it’s a percentage of it.
  • Practical Application: Determines property tax liabilities. An assessor’s opinion of assessed value can be converted into an opinion of market value in some states.

• 7.2.6 Liquidation Value and Disposition Value:

  • Liquidation Value: Value assuming a forced sale with a severely limited marketing period.
  • Disposition Value: Value reflecting a less-than-ideal marketing period, but not as constrained as liquidation.
  • Scientific Basis: These values reflect distressed sale conditions and deviations from market equilibrium. The shorter exposure time violates assumptions of market value.
  • Practical Application: Relevant in foreclosures, short sales, or situations where a quick sale is necessary. Adjustments for the conditions of sale (e.g., the brief exposure time) are critical but difficult to support.

• 7.2.7 Value of the Going Concern:

  • The total value of a business operation, including real property, personal property, and intangible assets (e.g., business name, client list).
  • Scientific Basis: This value takes into account the business’s ability to generate income beyond the real estate’s inherent value, reflecting principles of business valuation and intangible asset analysis.
  • Practical Application: Essential when appraising businesses like hotels, restaurants, or manufacturing plants where the operation’s success significantly contributes to overall value.

7.3 Real Property Rights and Interests

Real estate ownership involves a bundle of rights, and appraisals often focus on specific rights rather than the entire bundle.

• 7.3.1 Fee Simple Estate:

  • The most complete form of ownership, granting the owner all possible rights to the property.
  • Scientific Basis: Based on legal and economic principles. Fee simple represents the highest possible claim to real property, enabling the owner to exercise all ownership rights.

• 7.3.2 Partial Interests:

  • Various types of partial interests including economic, legal, physical, and financial interests.

  • Economic Interests:

    • Leased Fee Interest: The landlord’s (lessor’s) right to receive rent and reversion of the property after the lease term. A property sold with existing leases requires the new owner to adhere to the lease terms.
    • Leasehold Interest: The tenant’s (lessee’s) right to occupy and use the property during the lease term. Positive leasehold occurs when lease rates are below market rates.

    • Subleasehold (Sandwich) Interest: The interest created when a tenant subleases the property to another party.

    • Mathematical Representation for Leasehold Value:

      $LV = \sum_{t=1}^{n} \frac{(MR_t - CR_t)}{(1+r)^t}$

      Where:
      * $LV$ = Leasehold Value
      * $MR_t$ = Market Rent in period t
      * $CR_t$ = Contract Rent in period t
      * $r$ = Discount rate
      * $n$ = Number of periods (remaining lease term)

  • Legal Interests:

    • Life Estate: Ownership rights limited to the lifetime of a specific person (life tenant). Upon their death, the property transfers to a remainderman.
    • Easements: The right to use another person’s property for a specific purpose (e.g., access, utilities).
      • Easement Appurtenant: Benefits a specific parcel of land.
      • Easement in Gross: Benefits a specific individual or entity.
      • Right of Way: Right to cross the land of another.
      • Party Wall: A common wall erected on the boundary between two adjoining properties, buildings, or units.
      • Affirmative Easement: Gives the right to access a portion of another person’s real estate for a specific task.
      • Negative Easement: Describes real estate burdened by an easement.
    • Transferable Development Rights (TDRs): Rights to develop property that can be transferred to other properties.

  • Physical Interests:

    • Air Rights: The right to use the space above a property.
    • Subsurface Rights: The right to extract minerals or other resources from below the surface.
    • Riparian Rights: Rights associated with land bordering a flowing body of water (e.g., river).
    • Littoral Rights: Rights associated with land bordering a stationary body of water (e.g., lake, ocean).

7.4 Conclusion

Identifying the appropriate type of value and the relevant property rights is a cornerstone of sound real estate appraisal. By understanding the scientific principles underlying each value type and the complexities of property rights, appraisers can provide accurate and reliable valuations that meet the specific needs of their clients.