Fee Simple vs Leasehold

[xm72mhd]

The problem is the bank wants to lend against an interest that won’t come into existence until after the sale is completed.

I'd agree with most of what you say, but the above is awkward. In a purchase situation doesn't the bank always have a hypothetical condition. I mean they are lending the money to somebody that doesn't own the interest, but is planning on purchasing it and the payment must be made before the deed can transfer.

I recall when I first discovered that "it ain't over till its over", my boss said, "Well what are you going to do, have a draw down on main street?" At some point you have to proceed as if it is gonna happen. Somebody has to take that leap, and its done daily. Nobody ever thinks about the hypothetical unless they are obsessed with analysis.

Another thing, since you brought the banks into it. My experience with lenders in this situation is that they call this a refi and not a purchase. Now where does that leave us with hypos and all that USPAP jazz?

 

[Bill_FL]

Why would it have to be prospective?

The bank wants to know what the fee simple estate is worth as of a given effective date. Period.

 

[Fred]

The basics are that there is a property with divided interests. There are three potential subjects for an appraisal (this is beginning to sound like a life estate thread)
1 the landlords interest
2 the tenants interest
3 the as-if-recombined-into-one interest (hypothetical)

The bank wants to know what the fee simple estate is worth as of a given effective date. Period.

If I understand your use of the term, “the” fee simple, you would be appraising interest #3 (above) that doesn’t exist on any date prior to the termination of the lease, so this would entail a hypothetically condition. Again, this creates a conflict, because there is a general requirement for banks for as-is value.

In a purchase situation doesn't the bank always have a hypothetical condition.

No. Normally, the rights that the seller owns are the rights that the buyer will own. Those rights will have the same value, regardless of who owns them on the effective date. In a tenant buyout, this is not the case.

 

[Steve Owen]

Nothing like the confusion that ensues once people start saying, “leased fee.”
....

FWIW, if someone appraised it now, as it the inerests were already re-joined, that might be a mistake because of the general requirements for "as is" value, but IMO it might not be a very significant mistake.

I agree with most of what you say on this matter, but it does have the problem of complicating something that is actually pretty simple. (And, IMHO, defining and using the terms fee simple, leased fee, and leasehold actually simplify things rather than complicating them.) There is such a thing as being technically correct and practically wrong. For an example of another "not very significant" mistake, see this thread:

http://appraisersforum.com/urgent-help-needed/123766-new-sales-between-inspection-report.html

Here's the deal, as I understand it from the original posting. I've seen quite a few of these over the years, so I'm going to fill in some details that the original poster did not provide based on the typical contract... call it an HC, if you will.

The lease contract, probably for a one year or 18-month period, calls for the property to be leased and for some portion of the amount (usually about half) paid during the lease period to go towards down payment on the purchase price. Purchase price was set at the time of the lease signing, and usually will have a little bit of "blue-sky" in it to cover the owner's loss by giving back half of the lease dollars. If the tenant does not exercise the right to purchase, the contract expires and is either renewed or goes to a month-to-month rental agreement... often, owners will renegotiate for an additional period, during which, again, the amount paid in rent is partly refunded if the tenant decides to buy. They say that contract for deed is just a little bit better than a glass eye... then, these contracts are about the same as really strong glasses.

Now, if you appraise the property for the owner's leased fee interest, you are not appraising what the bank will be loaning on. In that respect, as another poster pointed out, it is really not much different than any other purchase.

Sometimes it is good to take a step back and look at these things from a practical point of view. Who is the client? The lender. What interest are they interested in having valued? Fee simple.

From a technical view point, you might be correct. But, I would never appraise this situation as leased fee. Still, you do have to consider and analyze the purchase contract, which in this case includes a lease leading up to the purchase. Don't be surprised if the opinion of market value of the fee simple interest comes in a little bit lower than the contracted purchase price.

 

[Fred]

I agree with most of what you say on this matter, but it does have the problem of complicating something that is actually pretty simple.

Everything should be made a simple as possible, and no simpler.

In general, I would say tenant buyouts are anything but simple. There is no reason for such a deal to occur at the "market value" of anything.

Here, it is likely the issues often invovled in a tenant-buyout are not part of the assignment. The fact that a lender probably needs to know what the hypothetical re-joined value, is complicated by the fact hypothetical conditions are generally not acceptable in federal banking regulations. That's why prospective value is, in my opinion, the simplest solution. The client gets the value benchmark they need and without the hypothetical condition they don't need.

 

[PropertyEconomics]

I dont believe the seller has Fee Simple interest to sell. I think the only thing he has to sell is that of the leased fee interest as he has granted a portion of the bundle of rights to another via lease.
Look at it this way, what if the buyer ... were NOT the lessee ... then what interest does the seller have to sell? The fact that the buyer is also the lesee and will rejoin all of the rights, honestly should not have any bearing on the interest being appraised here.
I agree with Mr. Santora, the SELLER does not own the property in fee simple as of the date of the assignment and therefore CAN NOT sell the property in fee simple. The right to occupy and enjoy the property has been granted to another by lease and as such the only rights he has to sell today are those of the leased fee estate.

 

[Michigan CG]

Mr. Santora and Mr. Economics:

We can convolute this in so many ways you can make peoples heads spin. There is most likely an agreement that the renter gets to buy the property FEE SIMPLE if all other terms are met in the lease agreement.

The property, on the day it is sold, the interest in the property, although there is a leased fee interest and a leasehold interest now...at the date of sale there is a Fee Simple interest, and that is what the bank is loaning on. The leased fee interest and the leasehold interest die at the date of sale.

It is possible to over analyze the situation infinitum.....It is like analyzing a softball game (the greatest sport for girls IMHO). A girl hits the ball with a runner in scoring position. The shortstop commits an error therefore allowing the runner to score. Is this an RBI? Most say no, but in fact it is. The hitter caused a situation for the runner to score no matter what the defense did (or did not do).

The bank wants a FEE SIMPLE value....doesn't matter what the other players in the game are doing, at the time of the transaction, the softball is hit and now the RBI is scored in the resulting FEE SIMPLE ESTATE.

Now, if you were to consider the Leased Fee interest, on a single family home, the lease (AKA contract terms) are ALWAYS above market, because they tend to be aimed at people with substandard credit, and do not represent TYPICAL buyers and sellers.

The gentleman from Missouri (a great state by the way -- GO CHIEFS) has it right.

 

[Joyce Potts]

The fee simple interest is only temporarily encumbered during the Chinese new year of the dog. However, if the buyer and seller have agreed to allow partial/all of those payments to apply towards the contract price, then the leased fee portion calls for the appropriate discount, and that's where I agree with Mr. Hawkings--I smell a regression analysis.

 

[PropertyEconomics]

Mr Evans .. I do not disagree with you that the lender will most likely want Fee Simple .. HOWEVER ... the date of appraisal occurs prior to closing and at the time of appraisal the SELLER did not own the property in FEE SIMPLE. If the parties wish to cancel the lease in order to satisfy the lending documents then so be it, and while it may be of little consequence in this discussion, I do not believe the SELLER owns the property in fee simple and thus cannot sell it that way.
You did not address what would be were the buyer to be a THIRD party ... I see no reason to treat this assignment any differently.

Cancellation of the lease agreement, signed by both parties, places the subject in fee simple again and allows it to be sold in fee simple. I believe Mr Santora is right on this one. The seller CANNOT SELL SOMETHING HE DOESNT OWN .. and HE DOESNT own the subject in fee simple. Its really as simple as that.

And FRANKLKY .. it doesnt make a difference WHAT the lender wants. WHAT IS ... is what must be appraised. All baseball analogies aside. In addition, I am FROM the great state of Missouri and I know for a fact the ROYALS are a horrible baseball team and I also know the SELLER in this transaction ONLY OWNS the leased fee estate. The leasehold may or may not have value depending on the terms of the lease and the amount of the lease payments attributable to the purchase. In my experience most lenders will not recognize lease payments as a credit toward a down payment but in this instance perhaps they will. I post here not to aruge but to show that WHAT IS ... IS.

 

[Joyce Potts]

Yes, indeed. Just because you are appraising the fee simple interest does not mean you can ignore the lease. In this case, the least is part of the purchase agreement, if I understood the situation correctly. USPAP says that you must analyze the purchase agreement, so therefore you must consider the lease. Appraise the fee simple, but describe and analyze the lease as part of the agreement.

And what if the appraiser is asked to appraise the property and has no knowledge or disclosure of a lease?