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Are They Appropriate in Valuing Noncontrolling Interests in Real Estate Holding Companies?
Are minority interest discounts appropriate in valuing noncontrolling interests in real estate holding companies? Because trust and estate professionals might find themselves answering this question differently from the 1RS, file issue requires close examination.
Noncontrol ling interests in real estate holding companies are those for which the holder cannot exercise prerogatives of control, such as determining policy. It is assumed for this discussion that there is no immediate expectation that the underlying property will be sold.
Valuation Approaches
The following three approaches in valuing businesses, real estate, and other investments are generally recognized by appraisal organizations and the professional literature:
* Asset approach
* Income approach
* Market approach.
The asset approach focuses primarily on the net assets of the business. The income approach principally involves the use of earnings or cash flows to estimate value. The market approach relies on direct comparisons with other transactions in a same or similar industry. 1RS Revenue Ruling 59-60 states that the value of a real estate holding company is closely related to the value of the assets underlying the stock; however, such an approach can be less relevant when valuing a real estate holding company in which management is actively involved, because such involvement reflects the attributes of an operating company, rather than a holding company. Nonetheless, business appraisers have continued to use a type of asset approach-the "net asset value" (NAV) method-to value real estate holding companies, regardless of the level of control.
NAV method. This approach adds together the total value of a holding company's assets-including the appraised value of its real estate, cash, and other assets-and subtracts its liabilities. The NAV is generally considered to be the net value that could be realized by a controlling interest, excluding liquidation cost (Bruce A. Johnson, Spencer Jeffries, and James R. Park, Comprehensive Guide for the Valuation of Family Limited Partnerships, 3rd ed., Partnership Profiles Inc.). When valuing these noncontrolling interests, business appraisers have simply applied discounts to the NAV in order to account for the interest's lack of control and marketability.
Real estate limited partnerships (RELP) trade in the secondary market at discounted prices compared to their NAVs. Business appraisers often consider these...