Ground Lease Valuation Assistance - A Little Lost

[REApp32]

New to the forum and relatively new to the profession. I switched over to appraising after practicing law for the past few years. I have run into my first issue with what I find to be a somewhat complicated appraisal. I have already placed a Fee Simple value on the land but need to value the Leased Fee Interest as well. Here are the numbers.

Investment group pays $360,000 for land.

They immediately enter into a 15 year Ground Lease with national company that pays them $3,000.00 per month, or $36,000 per year in rent. The tenant covers all expenses and the lease lasts 15 Years. Tenant is responsible to remove all improvements at expiration of lease if Landlord opts to exercise that provision.

How do I value the Present Value of the Ground Lease? What steps do I need to take to complete the "Income Approach" analysis. I appreciate the help. I completed a DCF and am still not sure if I have approached this valuation in the correct manner.

 

[Gobears81]

First issue that catches my eye is that the ground lease is only for 10-years, although it says in the following sentence that it is a 15-year lease? Either way, if it is a new building, I'm guessing that there are a decent time frame in renewal options?

 

[REApp32]

First issue that catches my eye is that the ground lease is only for 10-years, although it says in the following sentence that it is a 15-year lease? Either way, if it is a new building, I'm guessing that there are a decent time frame in renewal options?

It is 15 years, that was a typo on my end. There are renewal options, in this case three, three year renewals after the initial 15. I am not sure those would matter though?

 

[Gobears81]

It is 15 years, that was a typo on my end. There are renewal options, in this case three, three year renewals after the initial 15. I am not sure those would matter though?

If they paid $360,000 for the land, it sounds like it is a new building, correct? If so, the ground lessee only has 24-years of life in the building before it reverts to the ground lessor?

I recognize that there is a provision for the tenant to demolish...what type of property is this? The reason for asking is that a 24-year building life is quite short for most property types, which could very well make a difference in how you value it.

 

[REApp32]

If they paid $360,000 for the land, it sounds like it is a new building, correct? If so, the ground lessee only has 24-years of life in the building before it reverts to the ground lessor?

I recognize that there is a provision for the tenant to demolish...what type of property is this? The reason for asking is that a 24-year building life is quite short for most property types, which could very well make a difference in how you value it.

There is no building. Just some concrete for a fueling station.

 

[hastalavista]

Now this begins to make some sense.

I'm assuming this is a non-retail fueling station?

The renewals (terms/options) can make a difference. Depending on the tenant/property, you'll have to consider the likelihood of those renewals being enacted over the life of the lease. If the probability is high, then you'd want to factor that it. The terms of the renewal (are they reset at market, etc.?) can impact the DCF (although in the out-years, their impact would expected to be moderate to minor).

You might get some general input on how to address this on the forum, but you should be working with your supervisor closely on this.

 

[hastalavista]

Welcome to the forum, BTW.

 

[Gobears81]

There is no building. Just some concrete for a fueling station.

Oh OK. I find DCF to be a useful tool in ground lease valuation, but many prefer direct cap. If the market suggests a cap rate of between say 7% and 8%, DCF can often help ascertain where in that range to go. But remember that you always want to do a check at the end of the DCF and figure out what the value implies for that cap rate because that is what investors are quoting. If the market indicates cap rates of 7% - 8% for your property and the DCF indicates a value of $400,000 in your case, I'd be reviewing your inputs or understanding why the implied cap rate on your property varies from what the market is suggesting. FWIW, I am not actually suggesting that your cap rates should be 7% - 8%, just making up numbers.

Also, there is an oft-quoted model of Vfs=Vlh+Vlf. While that model might work in some cases, it often holds no weight, particularly in ground lease valuations (in my market, although there are several documented circumstances in which this model falls apart).

 

[REApp32]

Welcome to the forum, BTW.

Thank you. I was advised to disregard the renewals on the initial valuation. What would be the best bet to go about this? I have the cap rate as 10%? 3600/36000. Is that the correct approach? What do I apply the cap rate to to develop the valuation? The NPV of the land after the DCF is completed?

 

[REApp32]

Oh OK. I find DCF to be a useful tool in ground lease valuation, but many prefer direct cap. If the market suggests a cap rate of between say 7% and 8%, DCF can often help ascertain where in that range to go. But remember that you always want to do a check at the end of the DCF and figure out what the value implies for that cap rate because that is what investors are quoting. If the market indicates cap rates of 7% - 8% for your property and the DCF indicates a value of $400,000 in your case, I'd be reviewing your inputs or understanding why the implied cap rate on your property varies from what the market is suggesting. FWIW, I am not actually suggesting that your cap rates should be 7% - 8%, just making up numbers.

Also, there is an oft-quoted model of Vfs=Vlh+Vlf. While that model might work in some cases, it often holds no weight, particularly in ground lease valuations (in my market, although there are several documented circumstances in which this model falls apart).

Would it be possible to PM you directly? I have the cap rate at 10% and my DCF was setup to show Year 0 = -360,000.00 and Year 15 with 1.5% increase per year in land value to be X. I then add the NPV of all 15 years of rent + land value after Year 15 minus Year 0 land value to come up with Y. Do I apply my 10% cap rate to Y to get NPV?