Standards of Value When Valuing Real Estate in Divorce

STANDARD OF VALUE TO BE APPLIED IN REAL ESTATE VALUATION IN DIVORCE


By


Charles F. Vuotto, Jr., Esq. and Cheryl E. Connors, Esq.


As matrimonial practitioners we often fall into the trap of concentrating on valuation, tax and other issues only in the context of business valuation and fail to consider that the same issues exist with regard to many other assets that are addressed in divorce including but not limited to real estate. This article will address the appropriate standard of value to be utilized when valuing real estate incident to divorce and whether it is consistent with the standard used in valuing a business.
What “standard of value” should be applied when valuing real estate incident to divorce? Perhaps the more interesting question is whether there should be one “standard of value” for all assets being valued in the context of divorce. Unfortunately, no New Jersey matrimonial case specifically discusses the appropriate standard of value to be applied when valuing real estate incident to divorce. Therefore, we must evaluate standards applied to real estate valuation in other contexts.
The “standard of value” is that standard by which a property or asset is measured. Shannon Pratt, discussing standard of value, states the following:
The standard of value usually reflects an assumption as to who will be the buyer and who will be the seller in the hypothetical or actual sales transaction regarding the subject assets, properties or business interests. It defines or specifies the parties to the hypothetical transaction. In other words, the standard of value addresses the questions: “value to whom?” and “under what circumstances?” The standard of value, either directly by statute or (more often) as interpreted in case law, often addresses what valuation methods are appropriate and what factors should or should not be considered.
Shannon P. Pratt, Robert F. Reilly & Robert P Schweihs, Valuing a Business - The Analysis and Appraisal of Closely Held Companies 28 (4th ed. 2000). The standard of value sets the criteria upon which valuation analysts rely. Jay E. Fishman, Shannon P. Pratt & William J. Morrison, Standard of Value: Theory and Applications xvii (2007) [hereinafter “Fishman I”]. A standard of value is “a definition of the type of value being sought.” Pratt, supra, at 28. “Among many factors, it dictates whether you use a hypothetical buyer and seller, a market-participant buyer and seller, value to a single person, or a willing or unwilling buyer and seller.” Fishman I, supra, at xvii. Before we explore the standard of value applicable to real estate, we will briefly summarize the definitions of the more widely utilized standards. These are most often, but not always, in the context of business valuation.
The essence of our discussion in this section is an analysis of “value.” Black’s Law Dictionary defines value as “the significance, desirability, or utility of something” or “the monetary worth or price of something; the amount of goods, services, or money that something will command in exchange.” Black’s Law Dictionary 1586 (8th ed. 2004). Therefore, notwithstanding the numerous standards of value that exist, the standards are essentially divided into two camps (i.e., “value in use” and “value in exchange”).
There are certain conclusions we can reach from the foregoing analysis: (1) the Legislature has declared that “Article VIII, Section I, paragraph 1 of the Constitution of the State of New Jersey requires that all real property in this State be assessed for taxation under the same standard of value, which the Legislature has defined as “true” or “market” value.” The meaning of “true value” in the Constitution and the statutory scheme has been defined by case law as “Fair Market Value”; (2) “Fair Market Value” appears to be the most common “standard of value” referenced in reported matrimonial cases, which address the valuation of real estate including but not limited to Brown v. Brown; (3) “Fair Market Value” may not have any functional difference with “Fair Value” since there is a “ready market” for most real estate addressed in a divorce context and there are usually no minority owners – therefore there should be no need for a Marketability Discount or Minority Interest Discount; and (4) at least one court (i.e., Gemignani) used a different approach when dealing with income producing property that more accurately reflected the benefit to the holder when the facts required such an application and under certain circumstances leased fee value may the appropriate standard of value.
However, if the general conclusion is that “Fair Market Value” or “Market Value” is the “standard of value” to be applied when valuing real estate incident to divorce, the question is how does this jive with Brown’s mandate for “Fair Value” in valuing a business? This writer respectfully submits that it does not. Assuming Brown is correct, then shouldn’t all assets in a divorce be valued by the same “standard of value”? I respectfully answer this question in the affirmative. It is clear that the “standard of value” follows the area of the law (e.g., (1) estate and gift tax is “Fair Market Value”; (2) real estate valuations for taxation is “Fair Market Value”; (3) shareholder disputes is “Fair Value”, etc.). Our research has not disclosed varying standards of value within an area of law. This is logical since the “standard of value” is linked to the policy underlying the particular area of law. Remember the definition of “standard of value”: the standard of value addresses the questions: “value to whom?” and “under what circumstances?” The answers in the context of divorce are: husband and wives going through a divorce. The question does not ask, “what kind of property?” If the policy in divorce is to treat divorcing parties fairly and compensate them for the present value of the lost future benefit of the asset they will not retain (as Brown suggests), then this salutary policy should apply to all assets, not just businesses. If the value of a closely-held business interest may have more value in the hands of the owner than to a third party purchaser, the same may apply to the value to a custodial parent’s retention of the marital home versus selling it on the market. How such value may be quantified is problematic. Perhaps one calculates the present value of the future rental value of the home for the retaining party’s lifetime or fixed period before a contemplated sale. This writer understands that there are many potential problems with such an approach. However, that does not mean that one “standard of value” should not be used for all assets, but highlights why the use of “Fair Value” for a business interest is incorrect. As this writer has stated elsewhere, the correct “standard of value” is “Fair Market Value” and should be applied to all assets in a divorce.