It is natural for many parents to want to divide an estate into equal interests for all heirs, but this post which follows up Paul Palley's post last week will present a quantitative explanation of the how much value is lost when a whole property is divided into partial interests. This case was a German estate in which an American daughter was given the same partial interests as her German aunt.
The estate consisted of 3 apartment buildings and one office building in Germany, and each was given a 50% interest by the will. Unfortunately, appraisers must discount the value of partial interests for the following 9 reasons.
1. Risk of asset (such as increasing vacancies in the market).
2. The steadiness of earnings of the property.
3. Property condition and remaining physical life.
4. Growth potential
5. Diversification (is it just a single asset?)
6. Quality of management (Is it professionally managed or just managed by one of the heirs?)
7. Size of the interest. The smaller the interest, the higher the discount.
8. Lack of control. Having an interest of 50% or less presents control issues.
9. Liquidity. (Is this is a functional apartment buildings or an abandoned K-Mart?)
The following spreadsheet indicates how much value was lost in this distribution of assets:
Notice that the daughter (my client) would have had real estate interests worth 2,787,000 Euros rather than 2,270,000 Euros, a 23% increase.
My 93-year-old mother had the same idea about dividing up her estate -- 50% split down the middle shared between my brother and me. She had two significant assets, a home in Tennessee and a rare Nicolo Amati violin from year 1666. Nicolo Amati trained the world's most renowned violinmakers such as Stradivarius and Guarnerius and his son Giralamo in the town of Cremona, Italy, the world's finest violin-building city.
Then she found that a clerical error had already placed my brother's name on the deed to her home and she realized she could not split up her estate in the way she intended. I sent the violin to Kenneth Warren and Sons in Chicago for appraisal, and it was estimated to be worth about $200,000, which coincidentally was approximately the worth of her home.
Now my brother and I could inherit whole assets rather than partial interests. I think it worked out slightly better for him, as I sent the violin for auction in London. The authenticators in London peered with an ultraviolet pen light inside the violin and saw that someone had scratched out the year 1686 and replaced with it 1666. Nicolo Amati died in 1684, before 1686. The authenticators knew, however, that Giralamo Amati kept on using his father's name in the manufacture of his instruments, and it was still an excellent violin, but I had to settle for a slightly lower price of approximately $160,000.
Meanwhile Zillow places a value of $215,600 on the value of the home, which my mother continues to live in. All is considered fair, though, because of the sweat equity he put into that home.
Estate planners and attorneys should re-read the previous guest post by Paul Palley for the various methods of avoiding partial interest value devaluation of real estate assets.
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