Fee Simple vs. Leased Fee Interest

[PL1957]

My head is spinning from all the bs …

To figure out whether to appraise the property fee simple or leased fee ASK YOUR CLIENT. They can have legitimate reasons for either value, depending on loan structure, underwriting, etc. Once they tell you what they need, you can proceed from there. There is no right or wrong answer - either fee simple or leased fee values can be appropriate, depending on the clients need.

 

[Zoe]

My head is spinning from all the bs …

To figure out whether to appraise the property fee simple or leased fee ASK YOUR CLIENT. They can have legitimate reasons for either value, depending on loan structure, underwriting, etc. Once they tell you what they need, you can proceed from there. There is no right or wrong answer - either fee simple or leased fee values can be appropriate, depending on the clients need.

Leased fee is more risky unless you have leases in place. No way your going to do leased fee on a 1 year lease. I don't think they realize what that ff&e is worth.


I can't put it together without knowing more. If buyer has a 5 year lease? Idk. I don't even know H&B use.

 

[PL1957]

Leased fee is more risky unless you have leases in place. No way your going to do leased fee on a 1 year lease.

You can’t have leased fee unless you have leases in place. The length of the lease is immaterial - if there’s a lease in place and you are giving it consideration, you‘re appraising a leased fee interest. Apartments are appraised leased fee all the time with leases that are less than a year.

 

[Russ Kitzberger]

Value the interest you were engaged to value. If the client left it open, and they cannot encumber the property title in the fee simple, then you will value the leased fee. If they can encumber the property in fee simple, value the fee simple.

Example: Mortgage financing transaction:
Mortgage can encumber the property and lessees will subordinate to the mortgage: Fee Simple
Lessees will not be subordinate to the lease: leased fee.

Have a conversation with the client on what interest you are valuing.

The capitalizing of contract rents has the propensity of extending into perpetuity the positive/negative leasehold,

Only if using a cap rate (and not adjusting for tenant/lease terms risk), if you use a DCF, it will account for changes to market rent at the end of lease term.

Using contract rents and adjusting cap rate or using DCF is the property way to value the leased fee interest.


I had this example years ago: provided opinions of value for both interests. In that case, over-market leases had a significant positive value effect on the leased fee from fee simple.

 

[PL1957]

Using contract rents and adjusting cap rate or using DCF is the property way to value the leased fee interest.


I had this example years ago: provided opinions of value for both interests. In that case, over-market leases had a significant positive value effect on the leased fee from fee simple.

A useful sanity check for above/below market situations is to do a back of the napkin fee simple valuation, using market rents, then adding/subtracting the above/below contract rent for the duration of the lease term, discounting if appropriate. This should give you a value in the same ballpark as your DCF or adjusted cap rate analysis. If not, you need to revisit assumptions.

 

[Russ Kitzberger]

A useful sanity check for above/below market situations is to do a back of the napkin fee simple valuation, using market rents, then adding/subtracting the above/below contract rent for the duration of the lease term, discounting if appropriate. This should give you a value in the same ballpark as your DCF or adjusted cap rate analysis. If not, you need to revisit assumptions.

Good tip. Keep in mind you are valuing the tenant/landlord relationship in the leased fee analysis.

Say your lessee has $10 mil (depreciated value, useful life of 20 years remaining) in equipment in a $2 mil fee simple building that would cost $5mil to move and shutdown cost/lost production of $1 mil. Three years remaining in the lease, at above market rates.

The landlord has $6mil/17 years leverage over the tenant in the leased fee.

If you are valuing the leased fee, Do you discount the rent at the end of the DCF or increase it based on the leverage of the landlord of $6 mil of the 20 years remaining useful life?

Also, this was a real world example of a manufacturing company's lease situation. The end result was the company worked out a renewal for a total lease term of increments of 5 years for total of 20 years at above-market rates; after the landlord refused to sell them the building.

 

[PL1957]

Good tip. Keep in mind you are valuing the tenant/landlord relationship in the leased fee analysis.

Say your lessee has $10 mil (depreciated value, useful life of 20 years remaining) in equipment in a $2 mil fee simple building that would cost $5mil to move and shutdown cost/lost production of $1 mil. Three years remaining in the lease, at above market rates.

The landlord has $6mil/17 years leverage over the tenant in the leased fee.

If you are valuing the leased fee, Do you discount the rent at the end of the DCF or increase it based on the leverage of the landlord of $6 mil of the 20 years remaining useful life?

Also, this was a real world example of a manufacturing company's lease situation. The end result was the company worked out a renewal for a total lease term of increments of 5 years for total of 20 years at above-market rates; after the landlord refused to sell them the building.

This really doesn't have anything to do with a market rent level which is predicated on "typical" landlords/tenants. It does come in to play on the tenant renewal probability which increases as the costs to the tenant to move increases. An astute landlord would take advantage of the situation to a certain degree, but again, it wouldn't increase the market rent. The degree that the above-market rent affects the value is dependent on the underlying credit of the tenant.