(answer at end of this article)

Two buildings may look the same to the naked eye, but to the trained Valuation Expert an ownership interest in these Buildings can be vastly different. Let’s take a look…….

The Facts

Building A, a location at 123 Main Street, was built in 1984 for $12 million and has 100% occupancy in its 100,000 square feet of rentable office space. Building A is owned by Good Limited Partnership ("Good LP").

Amazingly, Building B, located at 125 Main Street, was built at the same time by the same builder for the same price and also has 100% occupancy of its 100,000 square feet of office space. Building B is owned by Bad Limited Partnership ("Bad LP").

A real estate MAI Appraiser was engaged to prepare appraisals for both of the underlying properties. As it turns out, each building produces a Net Operating Income ("NOI") of $1,500,000. As a result, they are both appraised at $15,000,000. Both buildings are subject to a $10 million mortgage.

Now, let us look at the owners. It just so happens that Mr. and Mrs. Fatcat own a 10% limited partnership interest in both Good LP and Bad LP. The Fatcats wish to know what their partnership interests are worth.

Easy ---- Appraisal ($15,000,000) less Mortgage ($10,000,000) = $5,000,000 equity value times 10% Interest = $500,000.

Hopefully, Eye on Value has taught you that this is not correct. At a minimum, we must consider discounts for lack of control and lack of liquidity. This Case Study describes some of the factors that enter into the valuation process.

Let us assume the following:

The general partner of Good LP does a great job and is a well respected person who owns a 1% general and 24% limited partnership interest.

Building B has been owned by Bad LP since it was built 12 years ago. It has been managed since that time by an affiliated company of the general partner. The general partner of Bad LP owns a 1% general partnership interest, but owns no limited partnership interest. This general partner receives above market management and leasing fees. He has a tendency to hire and make loans to other entities he owns and has a bad relationship with the limited partners.

Below is a table of some relevant information an expert should take into consideration in order to prepare a valuation. The analysis of this information should demonstrate that equal partnership interests in two seemingly identical properties which, on first blush, might be similar in value, are quite different based on the specifics of the individual valuations.

Which 10% interest would you rather own? What are the Interests really worth? A valuation expert would use the above facts to come to two completely different values for seemingly similar interests.

As can be seen from the above illustration, a limited partner in Good LP is expecting a greater cash flow, primarily due to the terms of the loan, not the amount of the loan. Some investors would not even consider being a limited partner of Bad LP due to the fact the general partner is Shady at Best. However…for a higher return (that is, pay a lesser price for the interest) you might get an investor to purchase the interest in Bad LP. In addition, the fact that the general partner in Good LP owns 25% of the partnership and his/her profits and distributions are, to a large part, dependent on distributions of cash flow, creates incentive to maximize cash flow distributions (which is the source of cash flow for all the partners). Shady at Best receives most of his/her cash flow from property management, leasing and additional fees, and has substantial incentive to maximize fees and not cash flow distributions to partners. In addition, Shady at Best is substantially less likely to ever sell the building due to the fact that he would get very little from a sale, compared to substantial amounts from managing and operating the property.

As can be seen from this case study, the value of Mr. and Mrs. Fatcat’s investment in two seemingly similar buildings is clearly not the same. The 10% limited partnership interest in Good LP is worth more than a similar 10% interest in Bad LP.