It's Time We Owned Up to a Monumental Fail

The valuation professions must regain the public’s trust

I have written quite a bit about multidisciplinary valuation—about its built-in difficulties and ways of overcoming them. I am designated in both real property appraisal and business valuation, and have and been pushing for ways that the two disciplines can come together to value fractional interests in real estate since 1997. As far as I can tell, none of my efforts have helped, at least on a large enough scale to matter.

A big part of the ongoing problem is that an agreed valuation framework for valuing fractions has never been widely adopted. This leaves a gaping practice deficiency that continues to support bad actors and resulting compliance nightmares for both taxpayers and the IRS. Even with the fact of draconian new powers to sanction appraisers granted to IRS 18 years ago to combat the problem, I find it amazing that such glaring evidence of this epic professional fail has not prompted any meaningful corrective action. The issue is widespread, as even prominent valuation and accounting firms who have otherwise good reputations fail to offer any real analysis when it comes to fractional interest discounts.

The extreme nature of contentious, opaque valuations has eroded trust in the valuation professions at a time when public trust is sorely needed, this to prevent our absorption by machines that will be perceived as legitimately replacing our unreliable, corrupt human judgment. (They’ll just make everything worse, but the public does not know that.)

This short piece may seem like a screed, and it probably is. But it is also part of my sincere effort to correct valuation practice in this niche area by proposing a reorganization of valuation methodology.

You will find a more complete outline of these issues in my essay that appears in a book produced as a project of The Appraisal Foundation’s Business Valuation Resource Panel, The Art of Valuation (Reflections, stories and strategies from business appraisal); The Appraisal Foundation (2023): Chapter 7, It’s Time for Real Change, pps 44-49; and also in my book, Valuing Fractional Interests in Real Estate 2.0. Milonguero Press (2021): pps 10-17.

A methodological cacophony

An assortment of business valuation methodologies have traditionally been employed for valuing fractional interests in real estate. They were developed for valuing businesses generally, but most were never expressly intended for real estate interests. Accordingly, a great deal of ‘judgment’ on the part of the valuer is required to apply the methods to real estate. In my experience, this rarely turns out well. Except, I suppose, for practitioners who want to sell a salad of data and ‘reasoning’ that favors the objectives of their client but do little or no actual work. They seem to be doing great, but to everyone else’s detriment.

Many methodologies have turned out to be the perfect refuge for scoundrels. For example, companies (typically REITs) used in the guideline public company method can easily be cherry picked to support literally any control impairment result. Closed-end fund data, intended for securities-holding partnerships (where those data work just fine), do not work at all for real estate limited partnerships. Transactional data for interests held as common tenancy are extremely hard to use and highly unreliable. Public real estate limited partnership discount study data are the closest to being reliable, but admonitions by the publisher to not use averages, as well as the rest of the stated characteristics of public partnerships, are routinely ignored by valuers. Mergerstat acquisition premiums (the inverse of a discount for lack of control) and real estate company acquisitions are both completely useless for valuing interests in typical real estate partnerships.

Restricted stock transactional data studies are widely used for analyzing marketability impairments for operating businesses, but are so conceptually distant from real estate as to be nearly useless. Chris Mercer addressed this issue in 1997, proposing instead a present value model (QMDM) that can be applied to real estate interests without much trouble. His work is still a shining star that can be used reliably. Finally, cost-to-partition (hard costs believed to represent the only value reduction in a partition lawsuit) has been disposed of, in favor of partition-time-and-cost (my label), although use of the latter—an income method—still suffers from inadequate attention to applicable risk rates.

I have used all of the above-referenced methods in almost 30 years of practice, and written about ways they can be applied to real estate since 1997. It is not easy if done properly, as the methods still require a good working understanding of both BV and real property technologies and their relationship to the meaningful facts & circumstances of the case.

The upshot is that shaky methods mainly provide cover for scoundrels. Explanations are nearly impossible to understand, and usually worthless as evidence for value, both in the courtroom for partner buyouts as well as tax compliance. Further, their proper application is difficult to learn, remains the province of business valuers, and perpetuates the chasm between BV and real property appraisers. With all of the unfortunate but guaranteed professional blind spots intact. That there is no hope has been proved beyond a shadow of doubt. So what can we do?

We really do need a solution

I wouldn’t have written all this if I didn’t have a solution. It would otherwise just be whining, which doesn’t help anybody. The solution is to adopt methods that can be readily understood and implemented by both professions, which means using the income approach. The 2.0 book referenced above describes income methods in detail, as well as how some other methods used in the past can function as tests of reasonableness. Thus, the book now covers the entire body of knowledge for fractional interest valuation. But the process can still get a bit complicated, so I developed an online application, PrimusPVX, whose non-AI algorithm can be used by any valuer with training in income methodologies. PVX also removes the factual and conceptual blind spots that cause improper valuations in the first place.

The PVX application solves the problem of making professional valuation capacity widespread (particularly internationally) without the heavy lift of becoming an expert in two professional fields. The algorithm is entirely transparent, and data application (otherwise subject to manipulation through bad actor ‘judgment’) is handled by the machine. The valuer has a lot to do—exercising their good judgment about the facts and circumstances of the specific case—and that too becomes transparent. PVX leads directly to a value that can be tested and cross-examined, and to a result that can persuade all parties. It does not support hired guns engaging in an incomprehensible ‘battle of the appraisers.’ PVX is complete, easy to adopt, and available for professional valuers as well as non-valuers dealing with fractional interests who need some authoritative understanding of how value is likely to turn out.

Valuation practice using 2.0 requires little more training than is already possessed by both real property appraisers and business valuers, since discounted cash flow analysis is broadly understood, logical, easy to adopt and easy to explain. The goal of having widespread capacity and reasonable, persuasive evidence for value is now within our grasp.

My purpose and passion

If you have gotten this far and now see this piece as a commercial, I apologize for your distress, but that is not my intention. Yes, there is a book and an online subscription involved. But all the evidence points to 2.0 as the only solution to a decades-long professional failure. My entire professional life in valuation has been dedicated to resolving this multidisciplinary problem that has proved it has no other solution. Not for want of trying other solutions, mind you. I have published a lot of articles and made a great many presentations that have perhaps made a small difference. That’s not enough, because bad actors are still very much in business, bringing in fees for doing little or nothing, and providing worthless valuation products to an unsuspecting public. I’ve had it. So now my work is complete. Yes, two helpful, credible products. There was no other choice.

In the age of AI, the valuation professions will either become a credible resource for the public, or they will simply wither and become irrelevant. Replacement by AI would be a giant step backward, of course, since AI cannot provide usable evidence of value since it cannot be cross-examined. And anyone who thinks the large language model or a secretly-designed algorithm will not be biased simply lives on a fantasy planet.

Epilogue

I have dedicated my entire valuation career to this niche. I have spent a massive amount of time developing the original technology and now the new 2.0 version, documenting it and completing all of the moving parts. The technology is now complete. The algorithm was absolutely necessary, as it is entirely unreasonable to expect valuers everywhere to take up yet another discipline (the multidisciplinary one) when it is not their main field of practice, but is still needed. Otherwise, there is nothing more that the professions can or will do. This practice area will remain largely a failure in terms of public service, and become one more reason for the public to end up trusting AI more than human experts.

Adopting the income approach for valuing fractional interests in real estate is now easy, for both practitioners new to the field, and for experienced valuers who can add PVX components to their current valuation work. Pulling this together and driving out bad actors would be a major step forward for both professions, for the future of humans in valuation, and ultimately for current and future generations of the real estate-owning public.

Dennis A. Webb