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Valuation of Leased fee interest with ground lease

Discussion in 'Commercial/Industrial Appraisals' started by Rob Lentz, Dec 30, 2008.

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  1. Rob Lentz

    Rob Lentz Sophomore Member

    0
    Nov 8, 2005
    Professional Status:
    Certified General Appraiser
    State:
    Michigan
    Subject is retail pad, being purchased and subsequently (presuming all preconditions met) leased to national retailer.

    Lease is a 20 year ground lease, with 4 five yr options and 10% bumps at each. Tenant pays all taxes, liability insurance, etc. Tenant is (BBB+) credit tenant and lease is corporate backed.

    What bearing does market rent have on developing the income approach? In my mind all that would show is whether the contract rent is above or below market - which I would place my coins on "above", i.e. a negative leasehold interest.

    My thoughts are that the fee simple interest is likely nearer the purchase price, and the leased fee interest is valued by capitalizing the contract rent (less expenses, if any).

    Also, subject is in the northeast Columbus, OH market. I've gathered a handful of listings, and sales - about a 1/2 dozen of each, via Loopnet and Costar. I've also got the subject's fee simple land sale (pending now) and the ground lease (pending closing of the land sale) - which would be two comps. I'd like to have more data than what I've been able to locate thus far and would gladly share what I've found so far with anyone who could provide additional ground lease comparables. Contact me via private message to discuss data sharing.

    Thanks for your thoughts on the market rent issue, in advance.
    Rob Lentz
     
  2. Vernon Martin

    Vernon Martin Senior Member

    4
    Jun 8, 2005
    Professional Status:
    Certified General Appraiser
    State:
    California
    NNN-leased properties are typically valued like bonds, so the market rent would not be particularly important unless the tenant had a doubtful credit rating and the buyer would have to consider the possibility of finding a new tenant for the property. This latter scenario is becoming more realistic all the time, and I'm not sure if a BBB+ rating would be enough to inspire investor confidence.

    I've seen a deluge of NNN-leased properties put on the market, so the investment climate for such properties may be changing rapidly.
     
  3. PropertyEconomics

    PropertyEconomics Elite Member

    1
    Jun 19, 2007
    Professional Status:
    Certified General Appraiser
    State:
    New Mexico
    Rob ... if the lease rate is significantly above market rent, would you not capitalize the market rent NOI and then add the discount for excess rent to the value conclusion of capitalization in order to arrive at the value of the leased fee? While it could be arugued that a 20 year lease with additional 20 years in option terms could be in perpituity, I may also do a discounted cash flow analysis as a test of reasonableness. Given current market conditions determination of the correct overall rate (perhaps not so much for land) and an appropriate discount rate my be somewhat subjective, but I would use both methods as a measurement and tests, one against the other.
    I would measure the rates of return of similar leases and see how the contract rent reflects on the rate of return for your subject in order to further support my market rent conclusions.
    I think we are seeing that large anchor tenants are not immune to vacating a property via bankruptcy, ie Mervyns, Comp USA, etc etc ... and these assignments are more difficult now than they have been in the past.
     
  4. Howard Klahr

    Howard Klahr Senior Member

    110
    Oct 4, 2004
    Professional Status:
    Certified General Appraiser
    State:
    Florida
    Rob,

    Local retail market rent is one thing, NNN national pad site rental is another. You will find that the rent is usually based on land cost plus construction costs with a factor for return added in.

    You may want to do some research for other recent leases by this retailer in other markets as well as some of their competitor leases to help with defining market rent versus contract rent. For example, Walgreens may pay $20/per sq ft for the prototype store in cities of a certain size. CVS is likely to pay a similar amount. Same for Wendy's and McDonalds. You get the idea.


    PE - For this type of transaction "If" the cap rate is properly selected, there is often not a material difference between the two methods. On thing to keep in mind is that the improvements will be fully depreciated by the end of the primary lease term.
     
  5. PropertyEconomics

    PropertyEconomics Elite Member

    1
    Jun 19, 2007
    Professional Status:
    Certified General Appraiser
    State:
    New Mexico

    Howard .. I agree with you which is why I run the analysis as a test of reasonableness ... never hurts to confirm your data and I find this is one good way to do so. If there is a large difference, or material enough to cause alarm, then its an indication best to go back and look at the data a bit more.
    Thanks for the comment.
     
  6. Artyman1200

    Artyman1200 Sophomore Member

    0
    Jun 21, 2004
    Professional Status:
    Certified General Appraiser
    State:
    Tennessee
    You've probably already done this, but I always tap into the parties involved in the transaction to get more rent comps if possible. Could they provide any additional comps for you?

    I would add that if the seller has done this before for, especially for the same tenant, contract rent is probably equal to market rent for that pad. You would probably need a very solid set of comparable ground leased retail pads to confidently conclude that market rent is higher or lower than contract rent. I would just be cautious about the market rent issue without really good data. What interest(s) have you been asked to appraise?
     
  7. Rob Lentz

    Rob Lentz Sophomore Member

    0
    Nov 8, 2005
    Professional Status:
    Certified General Appraiser
    State:
    Michigan
    PE and DB - thanks for sharing your thoughts.

    The developer was asked for comparables - they were able to provide two AutoZones, both in Texas. One a listing, the other a 2/2008 sale - market conditions?

    Appraising the leased fee interest, under the hypothetical that the sale/transfer is completed and pre-conditions to the lease are met.
     
  8. Y-TOWN

    Y-TOWN Junior Member

    0
    Mar 10, 2007
    Professional Status:
    Certified General Appraiser
    State:
    Ohio
    Educationally I was taught (when rent was higher than typical market) the market rent portion was considered at “typical market discount rates" for a value conclusion.

    The excess rent was valued using a substantially higher rate. That rate was in a direct proportion to risk of the tenant fulfilling the stated lease terms (good luck with that rate other than a SWAG of say 4-7 points over the market rate rent calculation).

    The two value conclusions were added together for the final value conclusion.

    With the retail climate being as it is today the excess rent would be severely discounted. Your support being based on D&B reports, number of same store expansions of late, typical same store performance in generally similar social-economic areas (the numbers), and your perception of acceptance of the tenant’s product to occupy the pad, etc, etc., etc.

    There is no 100% correct answer - it’s your opinion.

    These were techniques typically utilized in the old RTC days for problems as you have - may not be applicable now.

    Hope this approach may help you out on the problem or expand your thinking process on the matter - I’m getting kind of reluctant to post on this forum do to a recent reprimand from the head surfer which I took exception with and he will not answer my email about.

    BTW, can any of you folks privately send me the URL of other commercial only forums other the AI ?

     
    Last edited: Dec 30, 2008
  9. appdyn

    appdyn New Member

    0
    Feb 14, 2008
    Professional Status:
    Gvmt Agency, FNMA, HUD, VA etc.
    State:
    Kansas
    What some (me? . . . what me? never me) have found confusing is establishing market rent for major label retail pad any use properties. I've never seen an example where such a property was not leased at a rate that amortized construction costs plus investment return. Hence, such 'comps' are not 'market', either.

    If one finds a such a property (Jiffy Lube, Wendy's, Firestone, etc), recently vacanted and re-leased to a different user (Joe's Garage), such properties are 10 to 20 years and located in 'mature' markets. Hence, they are no longer comparable to the 'new' subject.

    Comments?
     
  10. PropertyEconomics

    PropertyEconomics Elite Member

    1
    Jun 19, 2007
    Professional Status:
    Certified General Appraiser
    State:
    New Mexico
    Market rent doesnt always have to be tied to a dollar amount but rather can be tied to a set of terms. Assuming a return on land of say 10% and amort construction costs plus 10% over the life of the lease could easily reflect market rent, assuming of course those are the standard terms within the market. Construction costs will vary depending upon use and size of improvements, thus the total dollar amount of the lease can vary, however, the terms may be identical between the properties. That being the case the terms would be "market" regardless of the dollar amount of the lease monthly.
     
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