Cap Rates: Leasehold vs. Lease Fee

[George Hatch]

You're being plenty clear. I don't think anyone on this thread misunderstood your question. What we're telling you is that asking what the spreads are between cap rates used for the two property interests is like asking what the cap rates are for retail properties. The answer is that it's going to vary according to circumstance; and it's an opinion to be developed on a case-by-case basis, not a rule of thumb to plug into a model.

 

[barcelona]

Therein lies the answer to your question--direct cap is inappropriate for valuing the leasehold. Think discount rate as suggested by Mr. Vernon.

Ok, then how the spread between the discount rate for a "leasehold interest" vs. a "leased fee" interest, assuming similar properties in similar locations.

Should the "leasehold interest" be higher...???? and by how much?

 

[Michael S]

We're dealing with a similar situation although the ground leases have almost 50 years left on their term. One of the brokers listing the property had done some research and he found about 100 basis point difference just for not having the whole bundle of rights coupled with the uncertainty of a ground lease. Now frankly the reversion or lack thereof at 50 years is not going to be a very large number, but at 25 years would be more of an issue.

One technique would be looking at typical single tenant NNN leased properties. Sometimes the same tenant will have leasehold and leased fee properties in the same or similar markets. Jack in the Box entered the Albuquerque market recently and built several new restaurants. Most are leased fee but at lease one is leasehold. Considering they have the same credit quality and similar location and lease structures, a spread could be derived between the leased fee and leasehold sales. Unfortunately the leasehold property hasn't sold yet, it's just been on the market for a year or two.

 

[Pittsburgh Pete]

Ok, then how the spread between the discount rate for a "leasehold interest" vs. a "leased fee" interest, assuming similar properties in similar locations.

Should the "leasehold interest" be higher...???? and by how much?

I would think that the leasehold discount rate would be lower based on limited risk. Limited expenses and/or depreciation with land

 

[Vernon Martin]

If you must do a leasehold capitalization analysis, consider that cap rates would differ according to remaining lease term. I see direct capitalization done on commercial properties in China, which are all leasehold and are on 45-year ground leases, with the land reverting back to "The People" in the end.

I was once asked by a lender to appraise a leasehold property expiring in one year. My response: Don't even think of considering this for collateral.

 

[Vernon Martin]

Leasehold discount rate should reflect higher risk

I would think that the leasehold discount rate would be lower based on limited risk. Limited expenses and/or depreciation with land

The limited risk would be to the leased fee owner of the land. The possessor of the leasehold interest has an added risk from the ground rent escalation provisions. In some cases, the ground rent escalation can wipe out most or all of the NOI before lease payment.

For example, in the 1990s when I was at Home Savings, one of our biggest loan losses was on the International Marketplace in Waikiki (Honolulu). Ground rent was adjusted every ten years according to revaluation of the land. We had a $50 million loan on the leasehold interest, but with the explosion of land values in Waikiki, the value of the leasehold interest fell to just $7 million.

 

[Terrel L. Shields]

The leaseholder has a higher risk which translates into a higher rate.
I would not say there is any set range of differences but my own experience is with mineral rights. The royalty owner (the leased fee) typically has ~10% cap rate for the cap rate to match the results of actual mineral sales. The leaseholder OTOH will typically exhibit a much higher "risk" and thus 18% or so it the norm...but normal "ain't" normal anymore.

Oil prospects (due to $100 oil) are much more in demand than natural gas ($2 an MCF).. Most calculate the reserves based on the more "traditional" ratio of 1:12 gas to oil. But 1:50 is so distorted, it becomes a meaningless metric.

 

[mgalleshaw]

Why wouldn't you just separately estimate your own leasehold for it's contributory value based on lease terms (up or down), appraise the property based on fee simple data, reconcile to the final fee and adjust for leasehold to infer leased fee? (Exact calculation of leased fee may or may not reflect market reaction; will need research). Leasehold woud require DCFA.

 

[GroundSwell]

I wrapped up an assignment similar to this a few months ago. I actually found a few Leasehold sales on Loopnet by adding the keyword "leasehold" to the search parameters. I don't know about So-Cal, but there was a sale in Monterey and one in San Jose. After speaking with the brokers and using paired sales - the overall rates for the two properties was about 150 basis points above their Leased Fee counterparts.

 

[GregoryK]

I would use the market cap rates as a check on the feasibility of your assumptions in your model. See if the Year 1 NOI divided by your leased fee value conclusion is within the range.