LIFE
INTERESTS
david hornby
A life interest in real estate is the right to occupy a property or
part of a property for the duration of life tenant's life. Therefore,
there are 2 interests in a property subject to a life tenancy:
1. the interest of the life tenant
2. the reversionary interest known as the remainderman's interest.
VALUING A LIFE TENANCY
Similar principles apply to the valuation of a life tenant's interest
as apply to the valuation of a lessee's interest under a normal lease.
However, the life tenant's term is unknown whereas for a lease it is
known.
The valuer must
firstly determine whether or not the life tenant is enjoying a profit
rental.
If he/she has no profit rental and little chance of a profit rental in
the future, the life tenant has no economic interest in the property.
However, it is common under a family arrangement for the life tenant to
be allowed to occupy the property rent free or at a nominal rent for
the remainder of his life. In these circumstances the profit rental is
the rental value of the property.
LIFE TABLES
Life tables are
published by the Australian Bureau of Statistics and provide the valuer
with the expected number of years, on average, a life tenant with
indifferent health is expected to live. “Indifferent" health is typical
health for a person of that age group. The life expectancy of females
is longer than males of the same age.
The value of the life interest is the price that a willing buyer
willing seller
would agree upon to buy the interest. The life tenant may be able to
mortgage the interest but if the tenant is very old or has poor health
it is doubtful that a buyer or mortgagee would accept such a high risk
investment. In this situation, the life tenant has no economic interest
in the property. The life interest must be a marketable commodity to
have value.
If the life tenant is
reasonably young and healthy it can be assumed that he/she will live
the expected life period shown on the life tables. The present value is
found by capitalizing the profit rental at a higher capitalization rate
than that applicable for a leasehold investment because of the extra
risk.
EXAMPLE
A life tenant is male, 20 years of age and in good health. He occupies
a house on a farm rent free and which has a net rental value of $10 000
per annum. The life tables show that he has an expected life of about
55 years.
If he were a lessee
paying no rent for a 55 year period the valuation would be made using a
capitalization rate of 10% per annum:
PV.PMT(10000) = 9.952 * 10000 = 99520 say $99 500
However, for a life tenant's interest the value is substantially less
because of the possibility of the tenant dying before the end of the 55
year period. Therefore, the capitalization rate is increased to take
into account the extra risk.
How is the high risk
capitalization rate found? - by analysing the sales of life tenant
interests.
After the analysis of comparable sales it is found that the appropriate
capitalization rate should be 18% per annum. Therefore, the life
tenant's interest is:
PV.PMT(10000) = 5.555
* 10000 = 55550 say $55 500
Therefore, the value
of the life tenant's interest is much less than for an otherwise
equivalent lease. The market will only buy the life interest after a
discount of 44 000 compared to an equivalent leased investment property
providing for the extra risk.
See:
remainderman's interest
life tables
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