For the last several years Management Planning, Inc. has prepared valuations for a large number of Family Limited Partnerships. The great majority of our clients have been funding them with closely owned corporate stock, closely owned partnership interests, portfolios of marketable securities (bonds and common stocks) and with real property. In most cases, we have been able to support significant minority interest and marketability discounts in valuing gifted limited partnership interests.
Valuation of Fractional Interests in Real Estate Companies
For example, we approach the valuation of fractional interests in real estate companies in the following manner. We are not real estate appraisers but are specialists in business valuation. We have successfully used a business valuation approach to the valuation of real estate holding companies and partnerships for many years. Our approach demonstrates and supports three basic discounts which are applicable to the valuation of fractional interests in real estate partnerships:
- A minority interest discount
- A qualitative investment attractiveness discount
- A lack of marketability discount
The Minority Interest Discount
The minority interest discount is based on the relationship between the trading prices of publicly held real estate companies and their net asset values, where net asset value reflects the appraised fair market value of real estate assets. In the last ten years or so, many publicly held real estate companies have retained real estate appraisers to value their assets and have reported the appraised value in annual reports to shareholders.
The prices paid for shares in public markets are, of course, minority interests and in our continuing study of the relationship between minority interest prices and net asset values we have found that, with rare individual exceptions, the market values of minority interests have always been at a significant discount from net asset value. This spread, which has historically ranged from around 20% to 50%, is what we call the minority interest discount. We rely on the real estate appraisals obtained by our client to compute the net asset values of the real estate.
The Qualitative Investment Attractiveness Discount
A smaller, less diversified privately held partnership is generally a less attractive investment than the large and geographically diversified publicly-held firms and this can be a discount consideration.
The Discount for Lack of Marketability
The application of this discount is well accepted. Conceptually, it is called for because our basic valuation percentages are developed from actively traded public companies. The owner of a closely held business interest has no ready market for his interest. Our discount for lack of marketability is well supported by our ongoing study of the prices paid in private placements of restricted stock in comparison to their freely traded counterparts.
Methodology Summary
Let us assume, for example, that we are valuing a 60% interest in real estate appraised at $1,000,000. Our final results might look like the following:
| Real Estate per Appraisal Less: 25% Discount for Lack of Marketability |
$1,000,000 |
$750,000 |
|
| 60% Interest Less: Marketability Discount of 35% |
450,000 |
| Fair Market Value of 60% Interest | $292,500 |
In this example, the total combined discount amounts to just over 51%.
Valuing Fractional Interests in a Portfolio of Marketable Securities
In the case of a portfolio of marketable securities in a FLP, we would probably use closed-end mutual funds (NYSE traded) to develop a minority interest value. Today these generally trade at discounts of between 5% and 10%. From that a discount for lack of marketability of 30% to 35% is realistic. The total of 35% to 40% from current market value of the securities should be a significant incentive for a client to consider a partnership aspect to his or her estate planning. Our valuation efforts are cost-effective.
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