Appraising life estate

[Pittsburgh Pete]

Fundraising suggestion: cage match between Webbed and Mr. Larkin. I'd pay to see it!!

 

[Calvin the Airedale]

Can the brainiacs in this thread cease their harangues long enough to comment about rate selection for PW of the remainder estate?!

 

[Calvin the Airedale]

Fundraising suggestion: cage match between Webbed and Mr. Larkin. I'd pay to see it!!

I can see these two in a remake of the "Odd Couple".

 

[The Warrior Monk]

PS. Will someone please opine on rate selection?

I don't expect you to get an answer, because it opens the flaw in the methodology.

It's my contention that certain methodologies may be accepted just because it appears to be a reasonable solution to a difficult problem. The valuation of life estates is one such example.

Certain properties may not have a (fair) market value, and the life estate may very well be such an example, depending on the conditions. If the estate has value only to the holder of the life estate, then it does not have a (fair) market value. However, since certain entities, such as the IRS, specifically require a fair market value, where one does not exist, then the parties simply agree to some type of meeting of the minds. Essentially something is called a (fair) market value when it is really doesn't have anything to with this value type as defined.

So, it can be readily seen why the argument arises. The use of actuarial tables is simply a mathematical formula. Unless it can be shown that buyers of life estates use these tables in their pricing, it's not market value as defined.

The only thing that can link the valuation of the life estate with the market is a market rate derived from the sale of life estates. If it is not, then it's simply someone's best guess...and it isn't market value. In that case, you might as well use tea leaves or some type of divining rod.

That fact that nobody (sans one person) wants to discuss how this rate is derived leads me to conclude that the rates are not derived from life estates.

 

[PropertyEconomics]

I offered a suggestion as to how to appraise life estates ... use sales of life estates. Seems everyone here thinks they dont happen and they do happen. When used as a percentage discount off the fee they can be quite telling in their market participant reaction to the encumberance of the life estate on the property.
Measurement from the market is the absolute best means of measuring the discount.

 

[Louis Pompeo]

Ok

Dave said:

I don't expect you to get an answer, because it opens the flaw in the methodology.

Not true. Valuing a life estate is the same as valuing a lease or a sublease. The only difference is the uncertainty of the date of death, which is an educated projection compared to a lease termination date.

PE said:

I offered a suggestion as to how to appraise life estates ... use sales of life estates. Seems everyone here thinks they dont happen and they do happen. When used as a percentage discount off the fee they can be quite telling in their market participant reaction to the encumberance of the life estate on the property.
Measurement from the market is the absolute best means of measuring the discount.

Also not true. If PE said that, I will bet that he never valued a life estate. But if he believes what he says, lets see a case study.

Webbed said:

It may sound fine to say that as we can't figure anything else out we've decided to declare this method to be "Credible." Only any investor, that has seriously thought about what such a statement means, won't about be ready to blindly accept that as an answer when it comes to that investor's money. A shot in the dark in the general direction of noise, in the end, is still a shot in the dark.

Also not true. Investors buy real estate all the time based upon "projections." They figure out what they want for a return on their investment and factor in the risk associated with that investment to form a capitalization rate. If discounting, they factor the return on and of money, appreciation, depreciation, vacancies, contingencies, inflation, costs of expenses. ALL of this is what? Fact? No! Its a projection. The holding period is a projection too. Who knows how long someone will hold onto a piece of real estate. Perhaps a situation down the road forces a sale, sickness, divorce, a rethinking of investment strategies, tax benefits, etc. The list goes on and on.

Its a crapshoot at best. But this is held up as the holy grail compared to a life estate.

Do investors buy property that does not provide cash flow throughout the life of the investment? Yes. And this is done intentionally on small and extremely large scales. The only benefit is the reversion at the end of the investment.

I have news for you. That is what a life estate is. An investment with no income or dividends throughout the life of the investment. The payoff comes at the reversion. But compared to the other non-dividend paying "traditional" investments, the investor doesn't have to try to collect rents from deadbeats, fix toilets in the middle of the night, hire an accountant to tell him if the property manager is stealing from him, and a 1000 other things that "traditional" property owners do.

The ONLY difference is the expected date of the reversion, but, as I said, the other reversions are just as unpredictable.

What discount rate would be apropos for such a valuation? Look to alternative investments. Establish a "safe rate" and build on it from there. Consider discount premiums being used in the commercial markets for long term investments and adjust according to type of property, location, age of the life tenant, and whatever else that you feel should be considered to make a responsible, competitive discount.

I put together a case study that even Webbed can understand. I, of course, do not expect him to agree with any of it, but its representative of what takes place EVERY DAY.

Read it and weep. Read it and whine. Read it and agree. Or read it and die. I don't care.

I have NOTHING to defend. Not anymore, and not before.

If anyone has ANYTHING to say about the attached case study or anything else for that matter on THIS subject, keep in mind that I really don't want to hear from a theorist that has never done one, can't spell it, wouldn't be trusted by anyone to do one, but wants to argue about it till doomsday.

Questions are fine. I like to share whatever I know with anyone who is genuinely interested.

Professional arguments are fine too. But I prefer to argue with a worthy adversary, such as a PRACTIONER WHO VALUES LIFE ESTATES!

See my case study attached, and then be my guest and jump off a tall building.

Respectfully submitted,

Conor LarkinView attachment Valuation of a Life Estate Case Study 2.pdf

 

[Elliott]

Let me get this right. The house in Washington DC is currently worth $500,000,
there is a note from a doctor the tenant will live 19 years when the value will be
$950,000 (really?) and the discount rate is 10% (is it always 10%? Why do I
always see that rate?). And the value of the life estate is $345,000.

Why would I need to know the value of my life estate? Do I get a
tax deduction so I can stick the guy behind the tree with taxes?

What would the value of the life estate be assuming no increase in
value (those future dollars will be worth a lot less than they are
today) and a discount rate of 3.5% (20-year long term bond rate)?
What if we have a period of 10 years of inflation at 5% to 10%
per year, will that affect LE value?

 

[Calvin the Airedale]

Dave said:



Not true. Valuing a life estate is the same as valuing a lease or a sublease. The only difference is the uncertainty of the date of death, which is an educated projection compared to a lease termination date.

PE said:



Also not true. If PE said that, I will bet that he never valued a life estate. But if he believes what he says, lets see a case study.

Webbed said:



Also not true. Investors buy real estate all the time based upon "projections." They figure out what they want for a return on their investment and factor in the risk associated with that investment to form a capitalization rate. If discounting, they factor the return on and of money, appreciation, depreciation, vacancies, contingencies, inflation, costs of expenses. ALL of this is what? Fact? No! Its a projection. The holding period is a projection too. Who knows how long someone will hold onto a piece of real estate. Perhaps a situation down the road forces a sale, sickness, divorce, a rethinking of investment strategies, tax benefits, etc. The list goes on and on.

Its a crapshoot at best. But this is held up as the holy grail compared to a life estate.

Do investors buy property that does not provide cash flow throughout the life of the investment? Yes. And this is done intentionally on small and extremely large scales. The only benefit is the reversion at the end of the investment.

I have news for you. That is what a life estate is. An investment with no income or dividends throughout the life of the investment. The payoff comes at the reversion. But compared to the other non-dividend paying "traditional" investments, the investor doesn't have to try to collect rents from deadbeats, fix toilets in the middle of the night, hire an accountant to tell him if the property manager is stealing from him, and a 1000 other things that "traditional" property owners do.

The ONLY difference is the expected date of the reversion, but, as I said, the other reversions are just as unpredictable.

What discount rate would be apropos for such a valuation? Look to alternative investments. Establish a "safe rate" and build on it from there. Consider discount premiums being used in the commercial markets for long term investments and adjust according to type of property, location, age of the life tenant, and whatever else that you feel should be considered to make a responsible, competitive discount.

I put together a case study that even Webbed can understand. I, of course, do not expect him to agree with any of it, but its representative of what takes place EVERY DAY.

Read it and weep. Read it and whine. Read it and agree. Or read it and die. I don't care.

I have NOTHING to defend. Not anymore, and not before.

If anyone has ANYTHING to say about the attached case study or anything else for that matter on THIS subject, keep in mind that I really don't want to hear from a theorist that has never done one, can't spell it, wouldn't be trusted by anyone to do one, but wants to argue about it till doomsday.

Questions are fine. I like to share whatever I know with anyone who is genuinely interested.

Professional arguments are fine too. But I prefer to argue with a worthy adversary, such as a PRACTIONER WHO VALUES LIFE ESTATES!

See my case study attached, and then be my guest and jump off a tall building.

Respectfully submitted,

Conor LarkinView attachment 18500

Thank you for the example. I also appreciate the expanded explanation of the rate selection. Nothing in this example contradicts the methods I was taught to apply to such problems or my experience in observing such transactions.

 

[Michigan CG]

Thanks for the contribution Conor.

 

[Calvin the Airedale]

Let me get this right. The house in Washington DC is currently worth $500,000,
there is a note from a doctor the tenant will live 19 years when the value will be
$950,000 (really?) and the discount rate is 10% (is it always 10%? Why do I
always see that rate?). And the value of the life estate is $345,000.

Why would I need to know the value of my life estate? Do I get a
tax deduction so I can stick the guy behind the tree with taxes?

What would the value of the life estate be assuming no increase in
value (those future dollars will be worth a lot less than they are
today) and a discount rate of 3.5% (20-year long term bond rate)?
What if we have a period of 10 years of inflation at 5% to 10%
per year, will that affect LE value?

The note from the doctor merely attests to the good health of the owner. The mortality tables determine his longevity.

You can disagree with what the property will be worth in 19 years, or even the basis on which it was estimated, but in the end some basis must be used to make that estimate. Call it a guess if it makes you feel better. I'm sure other methods of establishing the future worth might have credibility as well but will be equally tenuous.

Why would you need to know the value of your life estate? Typically, the life estate holder already owns the house in fee simple. He is selling the house to the remainderman at his demise for which he will receive the present worth of that reversionary value. In otherwords, the remainderman will pay the fee owner $155k for the right to own the property free and clear at his death. If this owner lives longer than 19 years (or if a variety of things do not pan out as anticipated, ie. a lower rate of appreciation, neighborhood instability, etc) the remainderman's return on his investment will be less than 10%. Conversely, if the fellow dies next year, the remainderman's return will be a jackpot.

The investment by the remainderman is that of a zero coupon bond, due in 19 years. That bond is expected to pay $950k, the problem is to determine its present worth.

In the example given, the life estate hold has tax implications from his sale, I surmise, since the report is being submitted with his 1040.

You can ask what if rate, value appreciation, or inflation questions till the cows come home but at some point, one must reconcile the various probabilities and the example given does so as reasonbly well as any examples I've seen.