Real Property Interests and Ownership Forms

Chapter 2: Real Property Interests and Ownership Forms

I. Introduction to Real Property Interests

Real property, as distinct from personal property, encompasses land and anything permanently affixed to it, including buildings, fixtures, and other improvements. The ownership of real property confers a bundle of rights, including the right to possess, use, enjoy, and dispose of the property. These rights can be divided and distributed among different parties, creating various real property interests and ownership forms. Understanding these interests is crucial for accurate real estate appraisal, as they significantly impact property value.

II. Estates in Land

An estate in land refers to the degree, nature, and extent of interest a person has in real property. Estates are classified primarily based on their duration:

A. Freehold Estates: Characterized by an indefinite duration, indicating ownership.
1. Fee Simple Absolute: Represents the highest form of ownership, granting the owner complete and unrestricted rights to the property. This estate is inheritable and transferable without limitations (within the bounds of the law, i.e. zoning, etc.).
2. Fee Simple Defeasible: An estate that can be terminated if certain conditions are not met or are violated. There are two main types:
a. Fee Simple Determinable: Automatically ends when a specified event occurs or a condition is violated. The property reverts to the grantor (or their heirs). For example, “To A, as long as the land is used for educational purposes.”
b. Fee Simple Subject to Condition Subsequent: The grantor has the right to re-enter and reclaim the property if a condition is violated, but they must take legal action❓❓ to do so. For example, “To A, but if the land is used for commercial purposes, the grantor has the right to re-enter and take possession.”
Mathematical representation of Value Impact:
𝑉𝑑 = 𝑉𝑓𝑠 − 𝑃(𝐶)∗𝐶𝑜𝑠𝑡
Where:
𝑉𝑑 is the value of defeasible fee simple estate.
𝑉𝑓𝑠 is the value of fee simple absolute estate.
𝑃(𝐶) is probability of condition being violated.
𝐶𝑜𝑠𝑡 is the cost to cure condition violation (including legal fees, loss of use, etc.)
3. Life Estate: An estate that lasts for the duration of someone’s life (the life tenant).
a. Ordinary Life Estate: Grants the life tenant the right to possess, use, and enjoy the property during their lifetime. Upon their death, the estate reverts to the grantor (reversion) or passes to a named remainderman (remainder).
b. Life Estate Pur Autre Vie: Based on the lifetime of another person. For example, “To A for the life of B.” When B dies, A’s estate terminates.

B. Leasehold Estates (Non-Freehold Estates): Grant a tenant the right to possess and use property for a specified period.
1. Tenancy for Years: Has a definite beginning and ending date, specified in a lease agreement. This estate terminates automatically upon the expiration of the lease term.
2. Periodic Tenancy: Renews automatically for a specific period (e.g., month-to-month) until either the landlord or tenant gives proper notice of termination. The notice period is usually determined by state law.
3. Tenancy at Will: Can be terminated by either party (landlord or tenant) at any time. This type of tenancy typically exists without a written lease.
4. Tenancy at Sufferance: Occurs when a tenant remains in possession of the property after the lease has expired without the landlord’s consent. The tenant is essentially a trespasser.

III. Encumbrances on Real Property

An encumbrance is a claim or liability that is attached to and binding real property. Encumbrances can diminish the value or restrict the use of the property.

A. Financial Encumbrances (Liens): Claims against the property to secure payment of a debt or obligation.
1. Mortgages: A voluntary lien placed on the property by the owner to secure a loan.
2. Property Taxes: An involuntary lien imposed by the government to secure payment of property taxes. Ad Valorem taxes are based on the assessed value of the property.
Tax Formula:
𝑇𝑎𝑥 𝐵𝑖𝑙𝑙 = (𝐴𝑠𝑠𝑒𝑠𝑠𝑒𝑑 𝑉𝑎𝑙𝑢𝑒 × 𝐴𝑠𝑠𝑒𝑠𝑠𝑚𝑒𝑛𝑡 𝑅𝑎𝑡𝑖𝑜) × 𝑀𝑖𝑙𝑙𝑎𝑔𝑒 𝑅𝑎𝑡𝑒
3. Mechanic’s Liens: A lien placed on the property by contractors, laborers, or material suppliers who have not been paid for their services or materials.
4. Judgment Liens: A lien resulting from a court judgment against the property owner.

B. Non-Financial Encumbrances: Affect the physical use or condition of the property.
1. Easements: A right to use another person’s land for a specific purpose.
a. Easement Appurtenant: Benefits a specific parcel of land (the dominant tenement) and burdens another parcel of land (the servient tenement). The easement “runs with the land” and is transferred automatically with ownership.
b. Easement in Gross: Benefits a specific person or entity, not a specific parcel of land. An example would be a utility easement.
c. Creation of Easements: Easements can be created by express grant, express reservation, implication, necessity, or prescription.
d. Termination of Easements: Easements can be terminated by abandonment, merger, release, or expiration.
2. Profit a Prendre: A right to enter another person’s land and remove natural resources, such as timber, minerals, or water.
3. Licenses: A personal, revocable permission to use another person’s land. Unlike easements, licenses are not considered an interest in real property.
4. Encroachments: A physical intrusion onto another person’s property, such as a fence or building that extends beyond the property line.
5. Private Restrictions (Covenants, Conditions, and Restrictions - CC&Rs): Limitations on the use of property imposed by private parties, such as developers or homeowners associations. These restrictions are often recorded in the deed and are binding on subsequent owners.

IV. Shared Ownership Interests

Real property can be owned by one individual (sole ownership) or by multiple individuals or entities (concurrent ownership).

A. Tenancy in Common: Each owner holds an undivided interest in the property, meaning they have the right to possess and use the entire property. Interests can be unequal, and each owner can sell, lease, or transfer their interest without the consent of the other owners. Upon an owner’s death, their interest passes to their heirs.
B. Joint Tenancy: Owners have equal rights to possess and use the property. A key feature of joint tenancy is the right of survivorship, meaning that when one owner dies, their interest automatically passes to the surviving joint tenants. To create a joint tenancy, four unities must be present:
1. unity❓ of Time: All joint tenants must acquire their interests at the same time.
2. Unity of Title: All joint tenants must acquire their interests in the same deed or document.
3. Unity of Interest: All joint tenants must have equal interests in the property.
4. Unity of Possession: All joint tenants must have the right to possess and use the entire property.
C. Tenancy by the Entirety: A form of joint tenancy available only to married couples. It includes the right of survivorship and requires the consent of both spouses to transfer the property. It provides additional protection from creditors of one spouse.
D. Community Property: In some states, property acquired during a marriage is considered community property, with each spouse owning an equal share. Separate property is property acquired before the marriage or received as a gift or inheritance during the marriage.

V. Other Forms of Ownership

A. Condominiums and PUDs (Planned Unit Developments):
1. Condominiums: Individual ownership of a unit within a multi-unit building, combined with shared ownership of common areas (e.g., hallways, elevators, grounds). Owners pay assessments to cover the costs of maintaining the common areas.
2. PUDs: A type of development that combines different land uses, such as residential, commercial, and recreational. Owners typically own their individual lots or units and have shared ownership of common areas.
B. Cooperatives: Residents do not own their individual units but instead own shares in a cooperative corporation that owns the entire building. Residents have a proprietary lease that grants them the right to occupy their unit. The cooperative corporation is responsible for maintaining the building.
C. Timeshares: Allow multiple purchasers to buy interests in real estate (typically resort properties) with the right to use the facilities for a specified period each year. Timeshares can be structured as fee simple ownership or as a right-to-use agreement.
D. Manufactured Homes: Dwellings constructed in a factory and transported to a site. They can be classified as real property if permanently affixed to the land.
E. Prefabricated/Modular Homes: Homes built in sections in a factory and then assembled on-site. Similar to manufactured homes, they can be classified as real property if permanently affixed to the land.
F. Ground Leases: A lease of land only, typically for a long term (e.g., 50-99 years). The tenant constructs improvements on the land and owns those improvements during the lease term. At the end of the lease, the land and improvements revert to the landowner. Ground leases are often used for commercial development.

VI. Partition Action

When co-owners of a property (e.g., tenants in common or joint tenants) cannot agree on how to manage or dispose of the property, a partition action may be filed in court. The court can either physically divide the property among the owners (partition in kind) or order the property to be sold and the proceeds divided among the owners (partition by sale).

VII. Appraising Partial Interests

Appraising properties involving partial interests requires specialized techniques and considerations due to the diminished bundle of rights. Some common examples of partial interests include leasehold estates, leased fee interests, easements, liens, and shared ownership interests. The income capitalization approach is frequently used where there is income generated by the partial interest.

A. Leasehold and Leased Fee Interests:
The leasehold interest is the right to use and occupy a property for a specified term under a lease agreement, while the leased fee interest is the landlord’s (lessor’s) right to receive rental income and reversion of the property at the end of the lease term.
* Leasehold Value: The present value of the difference between market rent and contract rent over the remaining lease term.
* Leased Fee Value: The present value of the contract rent payments plus the present value of the reversion.
Valuation Example:
𝑁𝑒𝑡 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒 (𝑁𝑂𝐼) = 𝐺𝑟𝑜𝑠𝑠 𝑃𝑜𝑡𝑒𝑛𝑡𝑖𝑎𝑙 𝐼𝑛𝑐𝑜𝑚𝑒 (𝐺𝑃𝐼) − 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠 (𝑂𝐸)
Value = NOI / Capitalization Rate
B. Easements: The value of an easement depends on its impact on the dominant and servient estates. An easement that provides access or utilities can increase the value of the dominant estate while potentially decreasing the value of the servient estate due to restricted use. The “before and after” method can be used. The value of the dominant estate with the easement is compared to the value of the dominant estate without the easement.
C. Liens: The presence of a lien on a property can significantly impact its value, as the lienholder has a claim against the property. The value of the property is typically reduced by the amount of the outstanding lien.
D. Shared Ownership Interests: Appraising shared ownership interests can be complex, particularly in cases of tenancy in common or joint tenancy where owners have unequal interests or where there are disputes among❓ the owners. Discounts may be applied to reflect the lack of control, lack of marketability, or potential costs of partition.

Experiment example:
Imagine two identical adjacent lots. Lot A has an easement allowing access to Lot B, which is landlocked. Conduct a market analysis to compare the sale prices of similar landlocked lots with and without access easements. This demonstrates the added value the easement gives to Lot B (Dominant Estate) and potentially the reduced value to Lot A (Servient Estate) due to the encumbrance.

VIII. Conclusion

A comprehensive understanding of real property interests and ownership forms is essential for accurate real estate appraisal. These interests determine the rights and responsibilities of property owners and can significantly impact property value. Appraisers must be knowledgeable about the legal aspects of these interests and their potential effects on market value.