Fee Simple Cap versus Leased Fee Caps

[Matthew Jehs]

Hello All,

I am working on an owner-user office/warehouse building. In my analysis I have comparable sales of similar buildings, both bought for leased fee and fee simple (owner-occupancy). The leased fee buildings were very similar and had market level rents and expenses. However, when I tried to extract out a capitalization rate from the owner-occupancy buildings on a pro forma of market rent and expenses using similar vacancy allowance and expenses, I am arriving at lower derived cap rates.

In my market there is high demand for owner-user buildings right now.

My question is: can the fee simple cap rate in a market be lower than the leased fee cap rate even if the leased fee buildings are at market levels?

In thinking about this, the buyer of an owner-user facility would not have to pay management, worry about vacancy/collection loss, pay leasing commissions, or tenant improvement allowances. Further, even though the leased fee building may be at market, it could be below feasibility rent.

While I have always operated under the notion that leased fee and fee simple capitalization rates at market rent levels were equal, is it possible that they could be different?

 

[Fred]

I am working on an owner-user office/warehouse building. In my analysis I have comparable sales of similar buildings, both bought for leased fee and fee simple (owner-occupancy). The leased fee buildings were very similar and had market level rents and expenses. However, when I tried to extract out a capitalization rate from the owner-occupancy buildings on a pro forma of market rent and expenses using similar vacancy allowance and expenses, I am arriving at lower derived cap rates.

Because property users can pay more than investors? I think you will also find that the implied cap rates of SFR sales are lower than the sales of apartment buildings.

 

[ccooper]

I would think that you would need to use the leased fee cap rates in your income approach. Admittedly, yours is owner occupied. The purpose of the income approach is to indicate a value if it was to be rented, however. Hypothetical. Use market rents and market derived (leased fee) cap rates.

Sure, there may be a difference between owner occupied caps and rented cap rates. That is not the question.

If your highest and best use is for owner occupied and there are not similar properties selling as rentals, then your income approach would no longer be an accurate indicator. If, however, there are some rented sales (which there are per your description), then the income approach is a valid indicator and should be completed IMHO.

 

[Paul Ness MAI]

There could be other reasons for the difference. Did you re-create the NOI for the leased fee sales yourself? Did you have actual expenses or use market-derived expenses for those sales? How did you treat structural reserves, management fees and leasing commissions? Remember, what's important is the method the buyer used to determine a cap rate because that's what they used in the purchase decision. Also, remember a cap rate is a snapshot of one year, and the remaining terms of the leases may have had an impact on the cap rate. You would need to know the remaining term and escalations if any, to adequately determine the impact of the lease on value. Another possible item that would impact cap rate is the presence of any deferred maintenance. My point is that there may be more than meets the eye and it may require more than just saying "leased comps are going to have higher cap rates".

 

[David Bodtcher]

Doesn't that depend on whether the purpose of the appraisal is to find the market value of Fee Simple interest, or Leased Fee Interest? I would think that if you are trying to determine the market value of the Leased Fee Interest of the subject, you would use the leased fee cap rate rather than the fee simple (owner occupied from sales) rate and vice versa if trying to determine the market value of the fee simple interest of the subject.