Valuation of Ranch and Mineral FLPs

Executive Summary

A central consideration is the distinction between owning an asset outright and owning a noncontrolling interest in an entity that holds the asset. A minority investor generally cannot independently direct asset sales, compel liquidation, or determine the timing of distributions. Consequently, the investor's expected economic benefits, the timing of those benefits, and the risks associated with realizing them become critical components of value.

Historically, valuations of FLP interests have frequently relied on an asset-based approach, followed by discounts for lack of control (DLOC) and lack of marketability (DLOM). However, valuation literature and judicial scrutiny have increasingly emphasized the need for greater empirical support and a clearer connection between the characteristics of the subject interest and its concluded value.

The Income and Market Approaches offer a framework for addressing these concerns. By analyzing expected future cash flows, asset appreciation, liquidation horizons, required rates of return, and observable pricing relationships among comparable investments, appraisers can develop values that more directly reflect the economic characteristics of noncontrolling interests.

This paper examines best practices for valuing ranch and mineral FLPs, including:

• The limitations of applying NAV-based methods to noncontrolling interests.
• The importance of distinguishing between a controlling interest and a minority interest.
• The development of risk-adjusted discount rates and projected cash flows.
• The use of empirical market data from real estate partnerships, nontraded REITs, and oil and gas partnerships.
• Two case studies illustrating the application and reconciliation of the Income and Market Approaches.

The central principle is that discounts from NAV should reflect the return requirements of market participants rather than reliance on generalized discount averages.

The Evolution of FLP Valuation Methodology

Three Approaches to Value

Business valuation generally recognizes three approaches: the Income Approach, the Market Approach, and the Asset-Based Approach. Each provides a different perspective on value, and its appropriateness depends on the nature of the entity, the ownership interest being valued, and the underlying premise of value.

The Asset-Based Approach focuses on the value of the entity's assets less its liabilities. It is particularly relevant when valuing a controlling interest capable of directing the sale or liquidation of the underlying assets.

The Income Approach considers the present value of future economic benefits expected to accrue to the investor. The Market Approach estimates value by reference to comparable ownership interests traded in the marketplace.

Noncontrolling interests in ranch and mineral FLPs are distinct from other FLP's in their valuation considerations. A minority investor's economic position in an entity that holds valuable ranchland, mineral reserves, or production of oil and gas is determined by the benefits that can reasonably be expected from the partnership-not simply by a proportionate claim on its assets.

Why the NAV Method Can Be Problematic

The NAV method establishes the difference between the market value of an entity's assets and its liabilities. While this calculation provides a useful measure of underlying asset value, it does not necessarily establish the market value of a noncontrolling ownership interest. The limitations include an inability to directly capture the timing and amount of future distributions, insufficient consideration of the investor's ability to influence liquidation decisions, and reliance on subjective discounts when converting a controlling value into a minority value.

The PPC Guide to Business Valuations distinguishes between controlling and minority interests, noting that the NAV method is more appropriate when the subject interest can cause the sale of the company's assets. For minority interests, it identifies the Price-to-NAV method under the Market Approach and discounted net cash flow under the Income Approach as alternatives.

Similarly, Valuing a Business, Sixth Edition, emphasizes identifying the specific risk k ,-and-reward relationship of the ownership interest and considering empirical methods that directly reflect its noncontrolling and nonmarketable characteristics.

This distinction is also reflected in USPAP Standards Rule 9-3, which addresses investigating liquidation value when the ownership interest being appraised has the ability to cause liquidation.

Judicial Scrutiny and the Need for Supportable Conclusions

FLP valuation methodology has been examined in numerous court cases, including Estate of Church, Estate of Peracchio, Estate of Giustina, Estate of Jones, and Estate of Cecil.

A recurring issue is the rationale supporting discounts for lack of control and lack of marketability. The question is not simply whether discounts are appropriate, but how their magnitude is determined.

The Comprehensive Guide for the Valuation of FLPs and LLCs emphasizes this distinction, explaining that judicial concerns have centered on the lack of adequate rationale for the discounts selected. This underscores an important best practice: rather than beginning with NAV and applying generalized discounts, appraisers should evaluate the economic attributes of the subject interest and use methods that directly incorporate the risks and benefits available to the investor.

Understanding the Economic Basis of Discounts

Discounts from NAV are often presented as separate adjustments for DLOC and DLOM. However, the underlying economic principle is more fundamental.

Investors evaluate an investment based on the return they expect to receive relative to its perceived risks. If an ownership interest provides limited control, uncertain distributions, or a lengthy investment horizon, an investor may require a higher rate of return to compensate for those characteristics. The resulting purchase price may be below the investor's proportionate share of NAV. In other words, the discount is an outcome of the investor's required return-not necessarily an independent input used to determine value. This distinction has significant implications for valuation methodology.

Under the Income Approach, the appraiser can incorporate the expected timing and magnitude of future cash flows, the anticipated liquidation horizon, and a discount rate reflecting investment risk. Under the Market Approach, observed Price-to-NAV ratios provide evidence of how market participants have priced interests in entities with comparable economic characteristics. Together, these approaches allow the appraiser to evaluate the economic basis of a minority interest's value without relying exclusively on generalized discount studies.

Best Practices for Valuing Ranch FLPs

Ranch FLPs present a distinctive valuation challenge. The underlying property may represent substantial wealth, while the partnership generates relatively modest annual operating income. The value of the ownership interest may therefore depend heavily on future property appreciation and the timing of a potential sale or liquidation.

For these partnerships, a valuation should begin with an understanding of the underlying property and its income-generating characteristics, followed by an analysis of the economic benefits available to a noncontrolling investor. The Income Approach can capture expected operating cash flows and eventual asset-sale proceeds, while the Market Approach can provide evidence from comparable real estate partnerships and nontraded REITs.

The following case study illustrates how these approaches can be applied and reconciled.

Case Study 1: Valuing a Noncontrolling Interest in a Ranch FLP

Tarbell Ranch, LP - A 9,800-Acre Ranch: This case study demonstrates the application of the Income and Market Approaches to a noncontrolling interest in a ranch partnership with substantial underlying real estate assets but relatively modest annual income.

Step 1: Establish the Market Value of the Underlying Assets

Although NAV should not automatically determine the value of a noncontrolling interest, establishing an accurate market-value balance sheet remains an important starting point.

The case study involves Tarbell Ranch, LP, which holds a 9,800-acre ranch.

The resulting NAV provides an important reference point for the valuation. However, it does not establish what an investor would pay for a minority interest in the partnership.

Step 2: Evaluate the Partnership's Economic Characteristics

The analysis should consider the nature of the underlying assets, income-generating ability, historical profitability and cash flow, leverage, prospects for capital appreciation, and anticipated liquidation horizon. For a ranch FLP, the relationship between current income and underlying property value may be particularly significant.

In the Tarbell Ranch example, the partnership generated rental income ranging from $190,000 in 2020 to $215,000 in 2024. Reported net income increased from approximately $128,678 to $153,253 over the same period. While these earnings demonstrate the property's income-producing capacity, the annual cash flow is relatively modest compared with the partnership's approximately $15 million NAV.

Consequently, future property appreciation and the timing of asset realization are important components of the valuation.

Step 3: Develop the Income Approach

The Income Approach requires two principal inputs: a forecast of future economic benefits and a discount rate reflecting the risk associated with receiving those benefits. In the ranch case study, the projections assume:

• A partnership continuation period of three to five years.
• Annual lease income growth of 2%.
• Annual operating expense growth of 2%.
• Annual property appreciation of 7%.

The presentation develops a discount rate using a build-up methodology, incorporating a risk-free rate, a real estate risk premium, and a specific risk adjustment.

The real estate risk premium is informed by long-term returns for publicly traded REITs relative to government bond returns. This presentation also identifies publicly held real estate limited partnerships and nontraded REITs as sources of empirical return data. The resulting 13.7% discount rate is applied to the projected cash flows and terminal proceeds.

Step 4: Evaluate Alternative Liquidation Horizons

The Tarbell Ranch case study considers both a three-year and a five-year investment horizon.

Income Approach results for a 1% noncontrolling, marketable interest. Equal weighting of the two scenarios. The difference demonstrates the importance of the assumed liquidation horizon. The longer period delays realization of the underlying property's value, reducing the present value of the ownership interest. This analysis illustrates why an investor's lack of control over the timing of asset sales is economically relevant, even when the underlying property is expected to appreciate.

Step 5: Apply the Market Approach

The Market Approach provides an independent perspective by examining how comparable investment interests trade relative to their underlying NAV. For ranch FLPs, this presentation identifies real estate limited partnerships and nontraded REITs as particularly relevant sources of comparable market evidence.

The Partnership Profiles Minority Interest Discount Database includes more than 400 partnerships and nonlisted REITs, with data extending from 1994 through 2026. For the Tarbell Ranch case study, six guideline real estate entities were selected, including undeveloped and non-distributing entities. Their observed Price-to-NAV ratios ranged from 0.552 to 0.800, with an average of 0.698.

The analysis selected a Price-to-NAV ratio of 0.800 for the subject partnership. Applied to the NAV of a 1% interest, the selected ratio produced a Market Approach indication of $119,769.

Step 6: Reconcile the Approaches

The case study assigns equal weight to the Income and Market Approaches.

The final conclusion reflects both the economic characteristics of the noncontrolling interest and an additional adjustment for lack of marketability. Importantly, the valuation does not begin with a pro rata share of NAV and rely solely on discounts to reach the concluded value. Instead, the Income and Market Approaches independently develop minority interest values that are subsequently reconciled.

Best Practices for Valuing Mineral FLPs

Mineral FLPs introduce additional complexities because the economic value of the underlying assets may be tied to production levels, commodity prices, operating expenses, taxes, and the depletion of reserves.

Unlike ranch properties, which may be expected to appreciate over time, producing mineral interests frequently generate declining cash flows as reserves are extracted. As a result, the Income Approach must account for the projected production and economic life of the underlying mineral assets.

An important distinction in valuing mineral FLPs is the availability of detailed production and cash flow forecasts within the underlying oil and gas appraisal. These forecasts can provide the foundation for the partnership-level Income Approach.

The Market Approach offers an additional perspective through observed transactions involving oil and gas partnerships. However, the appraiser must understand how the guideline entities' underlying asset values were calculated, particularly when using Price-to-NAV ratios based on PV10.

The following case study demonstrates the application of these methods to a mineral partnership holding producing interests.

Case Study 2: Valuing a Noncontrolling Interest in a Mineral FLP

A Mineral Partnership with $79.5 Million in Net Asset Value

This case study illustrates the valuation of a noncontrolling interest in a mineral FLP using projected mineral cash flows, a risk-adjusted discount rate, and historical oil and gas partnership transaction data.

Step 1: Establish the Market-Value Balance Sheet

The mineral FLP case study begins with the following balance sheet as of December 31, 2025.

Although the partnership has substantial NAV, the value of a noncontrolling interest must reflect the economic benefits available to its investor.

Step 2: Examine the Underlying Mineral Appraisal

An important distinction in valuing mineral FLPs is the availability of detailed production and cash flow forecasts within the underlying oil and gas appraisal. These forecasts provide the foundation for the partnership-level Income Approach.

This presentation emphasizes three components: forecasting declining net cash flow from the mineral appraisal, deducting applicable taxes and ad valorem taxes, and calculating the remainder interest. The underlying appraisal includes projected oil and gas production, pricing, revenue, production taxes, ad valorem taxes, operating costs, and annual net cash flow. These inputs allow the appraiser to model expected future benefits rather than relying exclusively on the mineral assets' estimated market value.

Step 3: Develop a Risk-Adjusted Discount Rate

The mineral case study uses the Capital Asset Pricing Model (CAPM) to develop the discount rate.

The resulting discount rate is applied to the projected future cash flows associated with the ownership interest. As with the ranch valuation, the objective is to reflect the risks associated with realizing the expected future economic benefits.

Step 4: Forecast Future Cash Flows and Terminal Value

The mineral case study projects five years of partnership cash flows, followed by a terminal value representing the present value of remaining cash flows and the remainder interest. The first year includes $19.8 million of mineral income, $10,000 of operating expenses, and $1.45 million of excess cash distributed.

The forecast also includes declining mineral income over the subsequent years, reflecting the expected economic performance of the underlying mineral interests. The terminal calculation incorporates projected remaining cash flows through 2035 and a remainder interest. Applying the 12.2% discount rate produces an Income Approach value of $709,472 for a 1% noncontrolling, marketable interest.

This illustrates the importance of evaluating the expected stream of future benefits, including both ongoing production income and the remaining economic value of the assets.

Step 5: Apply the Market Approach Using Oil and Gas Partnerships

The Market Approach for mineral FLPs relies on transactions involving comparable oil and gas partnerships. Partnership Profiles identifies historical data covering 25 oil and gas partnerships, with transactions from 1998 through 2007.

These data provide observed Price-to-NAV relationships that can be used to assess the value of noncontrolling interests. One important consideration is the basis used to determine NAV for the guideline entities. It is important to understand that the NAV of these entities was based on the present worth of future net revenues discounted at 10%, commonly referred to as PV10. This is significant because the Price-to-NAV ratios are meaningful only when the underlying asset valuation measures are appropriately understood.

The Partnership Profiles data illustrates an inverse relationship between historical oil prices and Price-to-NAV ratios during the period examined. This observation reinforces the importance of evaluating market conditions and the characteristics of the comparable investments rather than applying historical ratios without analysis.

For the mineral FLP case study, the selected Price-to-NAV ratio is 0.850.

Step 6: Reconcile the Valuation Indications

The mineral case study reconciles the Income and Market Approaches using equal weighting.

The reconciled conclusion illustrates how the two approaches provide complementary perspectives. The Income Approach reflects the projected future cash flows and associated investment risks, while the Market Approach provides evidence from historical transactions involving comparable oil and gas partnerships.

The result is a valuation grounded in the expected economics of the ownership interest and observable market evidence.

Key Valuation Considerations: Ranch vs. Mineral FLPs

Although ranch and mineral FLPs share important structural characteristics, their underlying assets require different assumptions and analytical considerations.

The comparison demonstrates why the underlying asset characteristics must inform the valuation model. For ranch FLPs, expected appreciation and the timing of property realization may represent a substantial portion of the value. For mineral FLPs, production-related cash flows and the remaining economic life of the assets may be more influential.

In both cases, however, the fundamental objective remains the same: determine the value of the economic benefits available to a noncontrolling investor.

Recommended Valuation Practices

The methodology and case studies presented support several important practices for appraisers valuing noncontrolling interests in ranch and mineral FLPs.

First, distinguish the value of the underlying assets from the value of the ownership interest. An accurate NAV provides a useful starting point, but the investor's ability to realize that value must be considered.

Second, evaluate the Income Approach even when current income is limited. For a ranch FLP with modest operating income, projected property appreciation and eventual liquidation proceeds may be substantial components of value. For a mineral FLP, future production cash flows and remaining economic benefits provide a basis for the analysis.

Third, develop discount rates that reflect the risk characteristics of the subject investment. Empirical return data from comparable investments can help support the rate selected.

Fourth, use market evidence that reflects comparable economic characteristics. Real estate partnerships and nontraded REITs may provide useful data for ranch FLPs, while oil and gas partnerships may provide relevant evidence for mineral FLPs.

Fifth, consider the timing of future benefits. A longer investment horizon can materially affect present value, particularly when a significant portion of the expected return depends on eventual asset realization.

Finally, distinguish between lack of control and lack of marketability. The Income and Market Approaches can directly reflect the economic characteristics of a noncontrolling interest. Any additional marketability adjustment should be evaluated separately and supported by the facts of the assignment.

These practices help establish a clearer relationship between the subject interest's economic characteristics, the valuation methodology, and the resulting conclusion.

Conclusion

The valuation of noncontrolling interests in ranch and mineral FLPs requires more than determining the market value of the underlying assets and applying generalized discounts.

The Income and Market Approaches provide a framework for evaluating what investors would reasonably pay for the future economic benefits associated with a noncontrolling interest. The ranch and mineral case studies demonstrate how different asset characteristics affect valuation assumptions, cash flow projections, discount rates, and comparable market evidence.

For ranch FLPs, the analysis may place substantial emphasis on property appreciation and the anticipated timing of liquidation. For mineral FLPs, production forecasts, declining cash flows, and remaining economic benefits are central considerations. Both examples reinforce the importance of using empirically supported methodologies that reflect the economic characteristics of the ownership interest being valued.

Ultimately, the objective is not to determine an arbitrary discount from NAV that is difficult to objectively support, but to establish a value using real world methodologies based on the returns investors require for the benefits and risks associated with the investment.