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Debate On Fee Simple Vs. Leased Fee

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Bill_FL

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Ok, an ongoing debate amongst some of us who have nothing better to do:

A shopping center sells. 97% occupied on annual leases. What has sold, the fee simple estate or the leased fee estate?

One side: Fee Simple has been sold, since actual title to the property transferred. Since the leased fee estate is a portion of the bundle of rights, if jsut it were sold, only the right to collect the rents were sold, not the "title" to the property.

Other Side: The leased fee estate was sold. Since the property is encumbered by leases, that is the only estate that can logically sold.

Any opinions?
 
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It's the leased fee interest that sold. If the leases were month to month, I would say that is more akin to fee simple. If you ignore the leases and simply assume market rent, then it's fee simple - based on a hypothetical condition.

Fee simple: unencumbered by leases (if lease income is a factor in the valuation, then it is a reflection of leased fee interest)

Leased fee: encumbered by leases (includes the rights of ownership during the lease terms and after them as well)
 

Mountain Man

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But the tenants in this case are short term (one year), so the whole bundle of rights will revert back to the "owner" in one year. I don't know too many investors that will pay a whopping price for a one year lease. They'll look at that one year lease, and start thinking about how to market it next month. ;)
 

Bill_FL

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What about arguement that the leasefee estate is simply one of the rights contained in the bundle of rights. If that is all you are selling, what about the balance of the bundle of rights?

This is the side that I can not seem to come up with a good response to, other than, that that is what the book says.
 
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Mel,

I disagree. If the net difference between market rent and contract rent during that one year lease is 0, both numbers should be the same (fee simple and leased fee). Assume that the contract rent is much higher (say ten times higher) than market rent for that one year only and after that it goes to market rent. Capitalizing (not your typical cap rate will do(R=I/V)) the difference in NOI resulting from the difference in contract rent and market rent for the first year will give you the difference between leased fee value and fee simple value. Other expenses like lost income during leaseup, lease commissions and expense variations should also be accounted for. Assuming you perforrm a discounted cash flow analysis, if you use contract rent in the DCF, then your value will reflect leased fee. If you use market rent, then it's fee simple.

Simple rule: Use of contract rent reflects leased fee interest which may result in the same or a different value than fee simple interest.

Use of market rent reflects fee simple interest.

To give weight to my opinion, I'll just say that I recently completed and passed the Appraisal Institute's Comprehensive Exam on the first try and that I have taken all of the AI courses needed for the MAI designation over the last 4 years or so. Some 10-11 years experience too.
 
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Bill,

I'll give it a shot.

The leased fee interest accounts for the leases in place, but does not exclude the rest of the rights which exist (the vacant space which can be leased, the income to be generated after the existing leases have expired, the reversion...) It's the value of the whole property, subject to the lease contracts.
 

Bill_FL

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Serge,

I agree with the premise that if you use market rent its fee simple if you use contract its leasedfee.

However, I am speaking of a sale. What did the seller sell. His fee simple interest or his lease fee interest?
 

Paul Ness MAI

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I agree with everything everyone has said in this thread, except Bill’s position (I assume you’re playing devil’s advocate). You’re talking about two different things that need to be isolated – namely the legal transfer of ownership interest versus the value of that ownership interest.

There is a hierarchy (legal, risk, rights of use, etc.) to these interests within the bundle of rights (fee simple, leased fee, sandwich leasehold, leasehold) and they are transferred by different means. Fee simple interest can be transferred by a deed. Example - A buyer purchases a vacant property by deed transfer (purchases the fee simple interest) and then signs a lease with a tenant. The execution of that lease means the owner gives up some of his fee simple rights and a leased fee and leasehold interest are created. The leased fee interest can now be transferred by deed. But the owner of the leasehold interest (the tenant) remains the same after the sale. If a positive leasehold interest exists and is marketable, it may also be sold by its owner (the tenant) and legally transferred by assignment of the lease.

Now, any interest can be appraised to estimate its market value. In your shopping center example - the leases have a year remaining so the difference in value between the leased fee or fee simple interests is likely to be minimal. This was covered well by Serge's posts.
 
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If the property sold had active leases, it's the leased fee interest that sold and that includes all the rights (during and after the leases), but it's encumbered by the leases.

More importantly, what was the effect of the leases on the price paid?
 

Paul Ness MAI

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Page Two...

Bill, when a property is encumbered by a newly signed lease, the fee simple interest can no longer be owned by anyone. However, an appraiser can still estimate the hypothetical value of the fee simple interest. If there is a long-term lease at non-market rents and there is a big difference between the value of the leased fee and fee simple interests, that difference is theoretical because the fee simple interest can not be owned at that point, although an appraiser can still appraise it. If I am a buyer seeking due diligence, I want an appraisal of the value of the interest I am buying, which would be the leased fee. If I am a lender, I want the value estimate of the interest I would receive in foreclosure….round-and-round…
 
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