Leased Fee or Fee Simple - That is the Question

[PS111222333444]

Mentor Reasoning

I questioned them on this and the response was "The reason we are calling it leased fee is that if the subject were to sell, it would likely sell to an investor or an investor-user, given that it has the apartment application. Therefore, it is not strictly a user property. For this reason, we are reconciling to the Income Approach".

I plan to reply with the dictionary definition of both Leased Fee and Fee Simple.

 

[David Mescon]

I questioned them on this and the response was "The reason we are calling it leased fee is that if the subject were to sell, it would likely sell to an investor or an investor-user, given that it has the apartment application. Therefore, it is not strictly a user property. For this reason, we are reconciling to the Income Approach".

I plan to reply with the dictionary definition of both Leased Fee and Fee Simple.

In most markets it would likely sell to an owner-user, not an investor. As it would likely be predominantly owner occupied, with the remainder being rented short term, fee simple would be more appropriate. The higher-ups are probably incorrect, in this instance. The term "reconciling to the (pick one) approach is somewhat of a misnomer. Giving one approach "greatest consideration" would probably be a more appropriate descriptor. Good luck!

 

[Howard Klahr]

I questioned them on this and the response was "The reason we are calling it leased fee is that if the subject were to sell, it would likely sell to an investor or an investor-user, given that it has the apartment application. Therefore, it is not strictly a user property. For this reason, we are reconciling to the Income Approach".

Reconciling to the Income Approach is not the issue. The bundle of rights that represent your opinion of market value, that is the issue. The value of the Lease Fee interest may equate to the value of the Fee Simple interest, but they may not. What valuation approach is utilized does not determine the interest appraised. In fact, a property may have two distinctly different values based on which interest is appraised, fee simple vs leased fee.

This is why the portion of USPAP that requires the appraiser to properly identify the subject (i.e. what interest is being appraised) is part of the beginning not the end of an assignment. Who is the intended user and what is the intended use of the report will be part of the decision on what interest (fee simple or leased fee) is valued. Do not confuse the point that the method of valuation does NOT determine the interest appraised.

Having stated all this, in your situation as described, there are no long term (beyond 1 year) leases in place. Consequently, it would be a fee simple value. In regard to what happens in the future (i.e. if it is purchased by an investor or an owner occupant) has absolutely nothing to do with properly identifying the interest being appraised.

I plan to reply with the dictionary definition of both Leased Fee and Fee Simple.

No need to post the definitions. Most of us are quite familiar with the content.

In most markets it would likely sell to an owner-user, not an investor.

This is a big assumption and is not accurate. But furthermore, it does not address the issue outlined by the OP.

Why is a lease-up cost deduction wrong for a owner occupied property whose H&B use is for investor ownership.

Because the property, as of the date of value is occupied.

a) Most banks would want to see the lease-up cost deducted because they would want to know what would happen if they foreclose on the property which in all likelihood will occur contemporaneous with the loss of the occupying tenant

While that may be correct, that would be reported not as market value but rather a "go dark" or "as if vacant" value. There are more than one values associated with real estate and why citing the definition of value and its source is so important to the analysis.

b) but even for a non bank appraisal if a property is offered for sale that has a investor owner as the H&B use then the purchaser would have to factor in the cost/probability of getting the existing tenant into a market lease

realistically the lease with the owner/user would be negotiated as part of the sale and the owner would get more money if he signed a market rate lease versus if he sold the building without a lease negotiated up front.

The market value is influenced by the lease terms (duration, rent level and allocation of expenses). However, you are reading too much into the process. To begin, market value does not presume default, especially in terms of a mortgage. That would be credit risk and is imputed into the lending transaction by the lender not the analysis of market value.

Secondly, you indicate that H&BU for an investor owner. Although part of the Highest and best Use analysis includes a typical owner (profile), it is not an exhaustive identification. Notwithstanding, the type of ownership will not influence the market value. It may impact the price paid by certain ownership categories, but that is due to factors beyond market value (i.e. cost and availability of funds, benefits of/to ownership, opportunity costs, etc).

As described by the OP, the subject property as of the valuation date is 100% occupied under market terms. Your assumption that the owner occupied portion doesn't reflect market terms is not taking into account opportunity cost.

Hope this helps.

 

[PS111222333444]

To clarify, I am replying with the definitions to the folks I do work for. Maybe they haven't read the dictionary in many years.

 

[PS111222333444]

I asked the supervisor/mentor for their rationale and here is the response:

The reason we are calling it leased fee is that if the subject were to sell, it would likely sell to an investor or an investor-user, given that it has the apartment application. Therefore, it is not strictly a user property. For this reason, we are reconciling to the Income Approach.

 

[PS111222333444]

My MAI mentor elaborated on his position and the responses from this forum that I sent to him:
"My opinion is that if the property is an investment property, developed for multi-use and multitenant occupancy. The property was developed for investment return, and the income approach is most applicable in these situations. The length of the lease seems immaterial to me. Without leases the building would have no income. The fact that this owner has no leases in place is simply poor management. He is the sole owner of the building but a part owner of the business. He should have a lease with the accounting company. He should have lease agreements with the apartment tenants. We need to assume competent management would encumber this property with leases. I don’t agree with many of the comments (from the forum)."

 

[PropertyEconomics]

You are appraising the property rights as they exist as of the date of your appraisal .. not some future date based on some future leases ... I respectfully disagree with your MAI ... the property is what it is and its not leased fee in my opinion as of your date of valuation based on what you have said.

If the current leases are at market levels ... it is fee simple subject to the short term leases in place. If the leases are significantly below market levels then you may have fee simple less some lease up period to market levels ... in any case the property is not encumbered by long term leases, again from what you have said.

 

[PS111222333444]

PE, I completely agree with your comments. How can I get this through to him? I've sent the Dictionary definintions and all these comments, but he will not be swayed. Nothing in USPAP that's very clear. Its their company and their clients, but I sign the reports too and feel responsible that we are in error.

Thanks again for all the input.

 

[PL1957]

PE, I completely agree with your comments. How can I get this through to him? I've sent the Dictionary definintions and all these comments, but he will not be swayed. Nothing in USPAP that's very clear. Its their company and their clients, but I sign the reports too and feel responsible that we are in error.

Thanks again for all the input.

PS, I'm sure that you are well meaning in trying to supplement your appraisal education/experience by asking questions on this board, but you need to take these answers with a giant grain of salt. The experiences of the posters can vary wildly, as can practice in different geographic areas. Responses here do not represent the cutting edge of appraisal theory (nothing personal Howard and PE).

The leased fee/fee simple question for apartment properties is one I've seen go both ways, depending on the client. There is no right or wrong answer. The Dictionary of Real Estate Appraisal doesn't have a 1+ year requirement - it just has a requirement that a lease be in place. I've labelled apartments both ways, because it really doesn't matter because of the short term nature of the leases.

 

[leasedfee]

Coming to this late, I'm going to vote for PE's argument. The owner is free to demolish, condominiumize, convert, modify, or not occupy the building. Leased fee is a third-party (generally) interest encumbering the bundle of property rights, and can be enforced in court. By calling it the later, even if it is likely to be LF, you're saying that the former cannot be true. It may be likely that it will be a LF interest in the future; but the future isn't here yet.

Conversely, I'm always flustered by the big name brokerage houses calling a property fee simple when on the same brochure they say there are long-term leases.