By Ryan King, SRA
Imagine sitting at your desk on a typical day, when you get a phone call from an attorney, and she says she needs an appraisal on a home for estate/probate purposes. No problem, you think. You’ve done this many times before, so you start asking the usual questions. As it turns out, the property has a life estate, where the owner allows another person (the life-tenant) to occupy the home rent-free until they die, at which point the full interest reverts back to the owner (the remainderman). In a common scenario in these situations, the life tenant would be an elderly relative and would die first, at which point the owner would then have the full bundle of rights reassembled in their name. In this instance, however, the remainderman predeceased the life tenant (or the life estate holder).
The attorney/client actually needs two appraisals:
- one to value the partial interest held by the remainderman (the remainder interest) as of the date she died two years ago, and
- one as of two months ago when the full bundle of rights was reassembled after the life tenant died, and the partial interest was quit claimed between the two estates a few times. (I am not going to speak much about the latter, as it is a typical fee simple appraisal.
What would you do?
Admittedly, I was a bit perplexed when this exact situation happened to me, but I was also very intrigued. I had no idea where to even begin, but I don’t simply decline assignments because they are difficult. I made sure I got all the pertinent information, then told her that since this was an unique assignment I would do a little research before giving her a quote. I called Steve to get his opinion. As it turns out, neither Steve nor Scott have done a valuation on a partial interest in their combined 50+ years of experience! So, we called James Hyde, and we all talked through the problem for over half an hour.
Since we had never done an assignment like this, I was sort of a guinea pig for testing out the fee. We decided to land on $1,200 for the fee for the remainder interest assignment, and a separate standard fee for the fee simple appraisal.
To start off, I did research. One of the most valuable resources for me came from the Appraisal Institute’s Lum Library, which is available to designated members (yet another reason to get your designation, but I digress). From there I found an article written in 1998 called Valuing Life Estates by David Keating, MAI that explains the exact process to use. Since the mathematical processes do not change with time, the article is still relevant today.
There are three main steps to follow to value the remainder interest of a life estate (taken from Valuing Life Estates):
- Estimate the most likely time of death of the life tenant.
- Forecast the future value of the property at that time.
- Discount the forecast future value of the property over the remaining duration of the life estate at the appropriate discount rate.
Estimating the most likely time of death of the life tenant is done by use of actuarial tables. Current and past actuarial tables can be found on several government websites, including the IRS, Social Security Administration, CDC, etc. For example, using the tables from the CDC, a 95-year-old man could be expected to live another 2.8 years.
Once you’ve determined the anticipated date of death of your life tenant, you must forecast the value of the home to that date. This is a highly subjective part of the process and will require the use of extraordinary assumptions for the appreciation rate over time. Fannie Mae is currently projecting an annual housing appreciation rate of 2.4% in 2024, and 2.7% in 2025. Using these projections, as well as historical data, you would appreciate the present market value of the home out the 2.8 years for the expected life of your 95-year-old life tenant. This number could vary greatly if you have a younger life tenant that could be expected to live 15-20 years! That is why your extraordinary assumptions about the appreciation rate are so important in this part of your report.
Fortunately for me, since the life tenant had already passed away, I knew the exact date of death and the exact date that the life estate ended. I did not have to use the actuarial tables and forecast the value, I actually did a retrospective valuation as of that date, and discounted it from there.
Next, you determine an appropriate discount rate. This all boils down to risk. Think of it this way: from an investor’s perspective, what percentage of return on investment would I want in order to purchase the remainder interest from the owner? I interviewed several investors; some of them from inside DS Murphy, some individual investors I know from my market, and even professional financial advisors. The range of answers I got was from 8%-25% return.
From there, you must consider market factors such as market conditions, how established the neighborhood is, and the remaining life expectancy of the life tenant. Established or growing neighborhoods carry less risk than declining areas, and shorter life expectancies carry less risk than longer ones.
My subject was in a decent market area with some older homes and some newer homes and is in the best high school district in the Tampa area, however, it had not been updated since the 1980’s and was extremely outmoded. After considering all these factors, I determined that a typical investor would likely seek about a 15% return on their investment, and this became my discount rate.
After all the research is complete, applying the discount rate becomes a math formula:
Remainder Value equals Future Value divided by one plus the Discount Interest Rate raised to the power of the remaining Life Expectancy.
Or
PV = FV / (1+i)n
You can also use an HP12C calculator, utilizing the FV, i, n, and PV buttons to solve.
For example:
You project that your 75-year-old life tenant will live another 11.4 years, according to CDC actuarial tables. The current market value of the home is $500,000 and you expect an average of 3% appreciation, which would put the future value of the home at $700,000 (rounded) at the end of the expected life of the life tenant.
You figure the appropriate discount rate is 15%, and apply it as follows:
PV = 700,000 / (1 + 0.15)11.4
If you run the math, the rounded present market value of the remainder interest is $142,000.
In other words, from an investor’s perspective, you would pay $142,000 for the partial interest so that in roughly 11.4 years you would gain the fee simple interest in a roughly $700,000 home.
And that’s it!
I will be the first to admit that taking this assignment was a bit daunting at first. Since DS Murphy has so many resources available to all its appraisers, I was easily able to gain the competency needed for the assignment, per USPAP, and it turned out to be much less difficult than I had anticipated. I believe that the fee of $1,200 was very fair. If I needed to use the actuarial tables and forecast a future value, a fee of $1,500 would not be out of line, in my opinion.
In the end if you ever have the opportunity to take an assignment like this one, whether it’s valuing the interest of the remainderman or the life tenant, I highly recommend that you accept the assignment with enthusiasm! There are plenty of resources out there (and within DS Murphy) to help you along the way. It will be an excellent learning experience and will get you thinking outside the box of the typical assignment! Who knows? You may even have fun doing it!