Cap Rates: Leasehold vs. Lease Fee

Discussion in 'Commercial/Industrial Appraisals' started by barcelona, Apr 17, 2012.

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  1. barcelona

    barcelona New Member

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    Mar 30, 2009
    Professional Status:
    Appraiser Trainee
    State:
    California
    What kind of spread should there be between a Leasehold valuation and a Lease Fee valuation for the SAME property.

    Looking for input on valution of an improved commercial property under two scenarios:

    1. Leasehold Estate on a commercial property subject to a long-term ground lease with 25 years remaining on the ground lease.

    2. Leased Fee Estate (same property but client wants to assume land and improvements are owned outright subject to normal leases).

    Property is well located and fully leased.

    Thanks for any input.

    I have heard other appraisers say a 50 to 75 basis point spread is a good rule of thumb but I have not heard why or how to arrive at such a conclusion.

    Thanks!!!!
     
    Last edited: Apr 17, 2012
  2. Lost Cause

    Lost Cause Senior Member

    1
    Sep 17, 2004
    Professional Status:
    Certified General Appraiser
    State:
    New York
    As far as why there might be a spread between the two, generally, a leasehold is riskier than the fee position.

    What spread is appropriate, if any, will depend. There are numerous variables that impact the risks of each position. Some include the terms of the lease itself, the relative strength of the feeholder vs the leaseholder, and the prevalence of leaseholds in your market.
     
  3. Howard Klahr

    Howard Klahr Senior Member

    12
    Oct 4, 2004
    Professional Status:
    Certified General Appraiser
    State:
    Florida
    What are the differences between the contract terms and market derived terms? Until this is known any response would be pure speculation. Also, how is the reversion treated?
     
  4. barcelona

    barcelona New Member

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    Mar 30, 2009
    Professional Status:
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    State:
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    Market rent and contract rent are basically at par. Leases are written on three year terms (for most tenants).

    The DCF analysis uses NO reversion and just discounts the cash flows over the 25 year remaining on the ground lease.

    For the direct capitalization, I have sale comps which are leased fee more or less at market rent. So presumably implicit in those cap rates there is the future benefit of reversion.
     
  5. Howard Klahr

    Howard Klahr Senior Member

    12
    Oct 4, 2004
    Professional Status:
    Certified General Appraiser
    State:
    Florida
    Not for the tenants occupying the propery, the terms for the land lease.

    You are looking to value the leasehold vs the leased fee of the tenant to the land lease, correct? Any differential in cap rates would be due to above/below market terms and anticipated growth rates for land values as compared to rental rates (of land leases) during the remaining lease term.
     
  6. Vernon Martin

    Vernon Martin Senior Member

    0
    Jun 8, 2005
    Professional Status:
    Certified General Appraiser
    State:
    California
    Appraising a leasehold interest on a ground lease

    It is hard enough to find leasehold comps, but then you have to adjust cap rates for remaining lease term and any unique tenancy situations, such as leases at above or below-market rents. Considering that cap rates vary with remaining economic life, which can differ dramatically in leasehold situations. I once was asked by a lender to appraise a leasehold interest with only one year remaining. My response: Don't even consider this for collateral.

    Rather than use direct capitalization, I prefer to use a DCF model with no reversion, and I think that is the way investors would look at it.

    Irvine Company?
     
    Last edited: Apr 18, 2012
  7. barcelona

    barcelona New Member

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    Mar 30, 2009
    Professional Status:
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    State:
    California
    I apologize for not being very clear.

    My question(s) are:

    What is the difference (or spread) between the capitalization rate for a "Leasehold Interest" and a "Leased Fee" interest for similar commercial properties?

    In other words, I am appraising the "leasehold interest" of Building X but have cap rates for buildings A, B, and C which are all owned in "leased fee". I suspect that the cap rates for the comparables (A, B, and C) would be LOWER, all things being equal. The owners of the "leased fee" have a reversionary interest where as the "leasehold interest" does not (after the 25 year lease ends).
     
  8. George Hatch

    George Hatch Elite Member

    17
    Jan 15, 2002
    Professional Status:
    Certified General Appraiser
    State:
    California
    +1

    I think that method better demonstrates the impact of rental payment increases and lease option renewals at different intervals, too. When they're present, that is.
     
  9. Pittsburgh Pete

    Pittsburgh Pete Elite Member

    7
    May 6, 2008
    Professional Status:
    Certified General Appraiser
    State:
    Pennsylvania
    Therein lies the answer to your question--direct cap is inappropriate for valuing the leasehold. Think discount rate as suggested by Mr. Vernon.
     
  10. barcelona

    barcelona New Member

    0
    Mar 30, 2009
    Professional Status:
    Appraiser Trainee
    State:
    California

    Vernon: Yes, that is the method I am using: A DCF model with no reversion. The ground lease has 25 more years to go.

    HOWEVER, as a check I am also doing a direct capitalzation as that is how most sales are reported. That is "leased fee" sales. I don't have ANY "leasehold interest" sale comps. The trick is trying to figure out how much higher the cap rate for the "leasehold interest" should be as compared to the "leased fee" sale comps.

    By the way, this is not the Irvine Company. Location is in LA County.
     
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