Changes in a Long-Standing Valuation Resource

A Trusted Valuation Resource is Going Away? Oh No! What Do You Do?

Read on if you want to know…

When valuing a non-controlling interest in a pass-through entity comprised primarily of real estate or real estate-related assets, best practice suggests applying both an income approach and a market approach. The best source for comparative transactional data for the market approach is the secondary market for syndicated or publicly traded limited partnerships. Partnership Profiles, Inc. (PPI) is the primary provider of data for publicly held partnerships that are not traded on a formal securities exchange. Various secondary market trading firms supply pricing data to PPI on trades that are conducted between third-party buyers and sellers of limited partnership interests. From this information PPI developed the “Minority Interest Discount Database.” This database has allowed valuation professionals to search for comparative partnerships from over 300 partnerships that own real estate and real estate mortgages. Using the database, a search for limited partnerships with similar characteristics to the subject company can be done. Characteristics such as cash flows, distribution history, whether a liquidation announcement has been made, number of properties, property types, and debt levels can be analyzed to ensure that the transactional data is comparable to the subject company. Using the comparable partnerships from the database, a Price-to-NAV (Net Asset Value) ratio, which is based on actual transactional data, can be applied to the subject company to arrive at a non-controlling estimate of value.

Additionally, PPI annually publishes its “Rate of Return Study.” This study looks at the expected holding periods for publicly registered partnerships and Real Estate Investment Trusts (REITs). The study can also be used in the income approach by helping to determine a required rate of return (discount rate). The study develops a real estate risk premium by looking at the average long-term return for publicly held limited partnerships and subtracting the average long-term return on government bonds.

On March 1, 2024, PPI sent an e-mail out to its customers in reference to their Discount Database saying, “There is not enough new data this year to create meaningful reports for real estate-related entities, and we will not publish data that may be insufficient, misleading or not valuable to appraisers.”

PPI Discount Database Alternatives

So, what options does an appraiser have now? In the March 1^st announcement, PPI offered the following insights for appraisers:

• Despite there being no new data in the current year, the PPI data reflects a discount for lack of control (DLOC) involving third-party transactions that is the only pure DLOC data that appraisers have available for valuing minority interests in real estate entities.
• In light of the above, PPI has collected and continues to make available a large body of data that reflects the pricing behaviors of third parties buying and selling minority interests in real estate entities over almost 30 years. This data was collected over several economic cycles and consistently shows that investors make pricing decisions based on rates of return to compensate for the risk level of the investment. In other words, buyers discount the net asset value of the entity in order to receive a 15%-20% return on their investment. This is dependent, of course, on the risk factors of the entity.
• Appraisers continue to use restricted stock data going all the way back to 1966 and historical private company transactions from Deal Stats and other databases. Therefore, it is appropriate to use the 1994-2023 PPI data to value non-controlling interests in privately held FLPs and LLCs. Appraisers should continue to use both the Income and Market Approaches to value minority interests in FLPs and LLCs, and then deduct a discount for lack of marketability (DLOM) to account for the risk of lack of marketability.

PPI suggests that going forward, appraisers should not rely on information derived from a single year of activity in the Database, but rather look at an average Price-to-NAV ratio for a five-year period for comparable partnerships and develop a range. PPI suggests that adjustments to the range could be made for differences in size/diversification, growth, profitability (cash flow), and leverage between the guideline partnerships and the subject company. PPI indicates that it has changed its 2024 Minority Interest Discount Database to accommodate their suggestion and that it will continue to publish the Rate of Return Study to support the development of a discount rate in the Income Approach.

I have used PPI’s Minority Interest Discount Database and Rate of Return Study information when appropriate. I was disappointed when I learned that the Database could not be updated for 2024, but after reading PPI’s thoughts and insights, and reasoning through them myself, I am comfortable that the Database can continued to be used to develop values in non-controlling interests in pass-through entities primarily owning real estate related assets.

Should you have questions about valuing non-controlling interests in pass-through entities primarily owning real estate related assets, or business valuations in general, please reach out to T. Eric Blocher, Partner and Director of Business Valuation Services.

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