HMS Associates April Newsletter
April 26, 2012

Determining Minority Discounts in Partial Interest Property Ownership

When dealing with partial interest ownership of real property, determining minority discounts becomes an important matter for estate planning, taxes, the re-sale process or any other transaction. These discounted valuations vary greatly depending on many different factors and must stand up under great scrutiny, making the process all the more difficult and important. Here's an overview:

Why Minority Discounts?

Logic follows that when you do not own a controlling stake in a property, it's less valuable than when you do. If you own 20% of a property, the person that owns the other 80% has the controlling stake, meaning your ownership is almost in name alone.В 

Would you rather buy 20% of something or the whole thing? It's for this reason the property is less marketable, driving down the true value of that percentage. Thus, your cut might not be worth exactly one-fifth of the total value; it's less.

How do we get to the minority discount?

There are three key ways to determine what the minority discount valuation would be for any given share of a property. First, you can examine comparable sales by unit prices paid for similar interests in the same property or group, but these are usually infrequent at best. Another way to arrive at a discount is to determine future equity cash flow and partnership distribution, but the derivation of the capitalization rate causes problems.В 

The most common way to arrive at this number is through fractional discounting. First, an appraiser determines the fair market value of the full asset. Next, you would calculate the share of the asset held by the minority holder. With that information, you apply a fractional prorated share equivalent to the discount.В 

The data central to this process is substantiated by significant court cases, where judges held that a minority stake is worth significantly lower than the equivalent stake of the property's full value, sometimes as much as 45% less. Precedent is often necessary to determine what the actual discount will be.

Why is this important?

Anything from assessing taxes to handling estates can have to deal with minority discount valuations, so you need to know you're working with an experienced appraiser, attorney or accountant. With everything that goes into it, the process can be tricky. But you don't want to under or overvalue any assets. That causes even more problems down the road…

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