A partnership that holds a fractional interest in real estate (common tenancy or interest in another partnership or LLC) rather than a 100% fee interest in the property, is part of a “tiered” or “layered” entity structure. It can almost always be valued by PVX. However, such structures can become woefully complicated. It may take some time for you to analyze the structure and determine how you can describe the tiered structure as a single “effective” entity for valuation, and you will almost certainly need to make offline calculations. You can read a more detailed description here. Tiered entities require multiple steps to prepare them for valuation by PVX:
- Prepare a flow diagram of the entity structure, showing all of the ownership linkages.
- Create a balance sheet for the combined entity, consisting of the entire balance sheet of the “top” entity (in which the subject you are valuing has a at least one interest; it may have others) plus fractional portions of the balance sheet(s) of the underlying entity(ies).
- Create an income statement for the combined entity.
- Adjust cash flow. PVX is designed with a very simple income statement: cash flow is based on net operating income (real estate value × cap rate), plus increases in working capital, less debt service. The combined income statement will likely be more complex than for an average partnership, and require some adjustment. The eventual work-around (not implemented yet) will require determining the first years’ cash flow offline, and then adjusting a cash flow field in the Entity window so that it matches the offline amount.
Appraiser-users can prepare both income statements and balance sheets offline, adjusting PVX entries so the yield and growth rates shown in the advanced portion of the Entity window match those calculated in the offline model.
- Determine management-related control risk for the combined structure.
- Determine subject-related control risk for the combined structure.
- Determine a restriction period and related risks; enter in the time and risk windows.
- If the lowest tier is common tenancy, then consider whether a partition right attributable to any of the cotenants is likely to be exercised. (It is not important whether it can be exercised because an interest in the cotenancy is not being valued directly. Consider only whether the actual holders might be willing to bring such an action.)
The process for combining entities in this way requires careful consideration of all the interrelationships, agreements and distribution of rights. Further complexity is introduced if the subject interest-holder has interests in more than one of the entities, in which case cash flow can take multiple paths, and control can be exercised through more than one interest. Such complexity is more of a conceptual matter; once the structure is understood, then its meaning for risk affecting the subject interest can be understood.
It is possible that the fact patterns will be more complicated than PVX can handle. On the other hand, it is also possible that the tiered structure is no more than a paper structure if the same parties control throughout, in which case it might be collapsed into an effective, fairly simple, partnership. There are many conditions under which PVX can be used for tiered structures, but is often a good idea to engage a qualified valuer who can use more complex income methods.