Contract rent is higher than market rent

[hal380]

good Morning all;

I need some help. Here is the scenario:

Tax appeal

2 separate buildings on abutting sites, on busy road at a corner
Active sports bar on other corner.

Very Very limited parking in front of the buildings (approx 3 spaces) and cars must back on
the busy road. Additional parking on side of property and at rear

4 tenants in buildings, bagel shop, Chinese restaurent, dry cleaner, and pizza shop.

Pizza shop owner has abandoned his lease and moved out due to parking difficulties caused by sports bar.

On "Busy Sport Event days" like summer soft ball leagues, major boxing or wrestling events, super bowl days, sunday foot ball etc. the patrons of the sports bar fully occupy the parking lot of my client and this fends off customers of the tenants of the my client. My client negotiated his leases prior to the sports bar becoming the attraction it has become. The rents he is getting is above market. I used market rent in my analysis. In the preliminary hearing the judge did not appear to agree with my use of market rent and felt that the existing leases were evidence of the income producing ability of the two buildings, in spite of the fact that these leases were established prior to the parking problem caused by the sports bar.

Here is my request/question

How would you support the use of market rents vs contract rent?

Any advise would be appreciated.

Hal

 

[PropertyEconomics]

Hal,
I have just had a very similar situation to this. I determined market rent and the capitalized NOI using market rent at market cap rates. I then discounted the excess rent (contract rent vs market rent) over the term of the leases and added that back into the value indications from both my market and income approaches.
Contract rent has value, and if that value is above market, a buyer would be willing to pay more for the property because of the additional income. I used the overall rate plus the rate of change as my discount rate and simply brought the excess contract rent to a present value.

While I may agree with you that the parking situation may adversely affect value, the best measurement of that is in determination of market rent for similar properties with similar adverse situations. It may be found that at the end of the contract periods leases will be rewritten to reflect the adverse parking and traffic issues and that can best be reflected in your market analysis. That being said, the discounted value of the rent in excess of market would still have value and would need to be added to your value indications.

I hope this helps in your analysis.

PE

 

[DTB]

The fact that the pizza shop abandoned his lease would also support your position especially if the space cannot be re-rented at those rental prices.

 

[farmguy]

Would you worry renters would not stay full term of lease if they are paying above market rent? Obviously one renter decided to leave.

 

[Y-TOWN]

Fair market value ​

​

​

.is generally best ascertained by reference to​

market sales . . . . Where this method is unavailable, however, other
means are to be found by which to determine value . . . . A variety of
such alternative methods of calculation of ​

​

.true and actual value. have​

been approved by the court: use of the cost of reproduction with an
adjustment for depreciation; . . . use of the original property cost less
depreciation; . . . and the capitalization of actual income approach . . . .​

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.​

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[/FONT][FONT=Times+New+Roman0][FONT=Times+New+Roman0]As a rule, however, no one method is controlling; consideration​

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should be given to them all, if they have been utilized, in arriving at the
value of the property.​

​

.. Uniroyal, Inc. v. Board of Tax Review, 174​

Conn. 386, 380, 384 A.2d 734 (1978).

This case law came from - you should probably give it a glance if you have not already.

http://www.jud.ct.gov/lawlib/Notebooks/Pathfinders/PropertyTaxAppeals.PDF

From your post it appears the judge has not read this case law and market sales may be king in a Conn. Tax appeal case.

It also appears in Conn. a case can be made the property owner should not pay more than like property owners, is he/she? It is under Conn. "unfair burden" statute.

Good luck

 

[PropertyEconomics]

Would you worry renters would not stay full term of lease if they are paying above market rent? Obviously one renter decided to leave.

All of these factors would be considered in development of current market rent and in the risk associated with the excess rent when developing the discount rate.

Contracts are contracts however and must be considered as part of the analysis.

 

[hal380]

Thank you

You guys are great.

Hal

 

[Kali the Boston Terrier]

Hey Hal!

In our State we had a case which pretty much meant, depending on the date of the lease, that market rent was to be used no matter what the contract rent said.

Research your statute, you may find case law already states how to handle it.

 

[jtvaluation]

Property Economics,

I am new to this forum and this would be my first post. I was wondering how you go about selecting a proper discount rate when analyzing above or below market rents. Is there a general rule of thumb? How is this related to the direct capitalization rate?

 

[PropertyEconomics]

Property Economics,

I am new to this forum and this would be my first post. I was wondering how you go about selecting a proper discount rate when analyzing above or below market rents. Is there a general rule of thumb? How is this related to the direct capitalization rate?

JT ... welcome to the forum. I hope you find this to be as great a place of learning as I have.

Typically discount rates are associated with risk and rates of return. The riskier the investment the higher the rate of return. Some believe that the discount rate is equal to the overall rate plus the rate of change, others think that analysis of competing investments is a good method of estimating a discount rate, and yet others believe, when available, an interview with market participants (investors) is a good measure of how they perceive risk and Im sure there are others here who have differing ideas on how to estimate a discount rate.
I am a fan of taking a broad look at all of these potential indicators and typically I will use three or four discount rates in .5% increments and then make my selection of indicated value from the range. I probably use more competitive investment analysis and market interview than anything else.

Naturally whether the contract rent is above or if it is below would measure different levels of risk and must be considered. Rent that is above market rates are typically more risky than those which are below market levels and the risk levels should be appropriately reflected.