Highest And Best Use Issue

[SanDiegoBrian]

Hello everyone, interesting assignment for a commercial property in a major city. The assignment is to appraise the leased fee position: major restaurant tenant with 20 years remaining on the lease at a rate well below market.

In looking at HBU, the site is not developed to its maximum FAR and the lease allows for the owner to extinguish the lease. Should the assignment still focus on leased fee or HBU indication (rebuild and lease at market rents; less costs to cancel lease and demolition costs)?

 

[Gobears81]

If the lessor has a termination clause, it sounds like a savvy investor would purchase with the intent to terminate the lease, so the relevance of the leased fee value would effectively be in the highest and best use analysis. But, this is one that I'd discuss with the client before going much further.

 

[Howard Klahr]

Is there sufficient demand to support re-development of the property today or would this be based on a point out in the future? The H&BU might be for an interim use as opposed to re-development at this point in time.

 

[DREA Dean]

That is an interesting case. I would discuss with the client, but in your H&BU analysis, make sure to account for all aspects of canceling the lease: lease buyout, demolition, downtime between tenants, marketing, planning and approvals for new use, any on- and off-site costs for new use, any site and building construction for new use, etc. And I would certainly think the cap rate should be a lot higher for a re-use due to higher risk and unknowns compared to the current tenant/use.

 

[nstanbru]

this is one that I'd discuss with the client before going much further.

Agreed. This would be one of the 1st things I would do. What is the intended use of the appraisal?

 

[Michael P Jacobs MAI]

In looking at HBU, the site is not developed to its maximum FAR and the lease allows for the owner to extinguish the lease.

Done! Nice that you zero'd in on the issue before spinning your wheels on the "extinguishable" leased fee estate. I understand from your post that there is an alternative lease market ("below rent").

 

[glenn walker]

San Diego California - once you go into planning department and find out the costs and feasibility to tear down a building and rebuild I think you will realize not only about impossible but extremely costly - Environmental reports -demo costs - entitlement fees - impact on traffic-existing market area - and that's why many simply remodel the existing structure . Just a $500,000 consideration : ) LOL

 

[jay trotta]

Hello everyone, interesting assignment for a commercial property in a major city. The assignment is to appraise the leased fee position: major restaurant tenant with 20 years remaining on the lease at a rate well below market.

In looking at HBU, the site is not developed to its maximum FAR and the lease allows for the owner to extinguish the lease. Should the assignment still focus on leased fee or HBU indication (rebuild and lease at market rents; less costs to cancel lease and demolition costs)?

According to the Question, it would appear you are looking to alter/change the assignment ? Is the Lender in agreement ?? It would appear Howard has provided some good input, don't you think ?
I do not do commercial, but thought a comment was appropriate for your thoughts.

 

[SanDiegoBrian]

Is there sufficient demand to support re-development of the property today or would this be based on a point out in the future? The H&BU might be for an interim use as opposed to re-development at this point in time.

Development could be today but would take a few years; the lease runs to 2038 and the cost to cancel does not decrease. The report is to be used for tax purposes. If the scope of work/engagement says to appraise the leased fee position, is extinguishing the lease and creating a fee simple interest going outside the appraisal question?

BTW. This is not in San Diego. Think bigger.

 

[Michael P Jacobs MAI]

...The report is to be used for tax purposes. If the scope of work/engagement says to appraise the leased fee position, is extinguishing the lease and creating a fee simple interest going outside the appraisal question?

Well, it's leased so you are appraising the leased fee estate of course. But, under the parameters of your OP the current lease does not meet HBU criteria - you state that the lease is below market, so it is a fact that this lease is not Maximally Productive... there must be a "higher" attainable more economically feasible market rent, correct?

Extinguishing the lease is the HBU in this case. Is your engagement to appraise the property regardless of the HBU of the property?

Under their brief requirements a "Qualified Appraisal" for the IRS (like any other USPAP appraisal) would require an appraiser to employ a hypothetical condition to base market value on a below-market temporary lease. They know what this is all about and the appraiser will be blacklisted for it. There is no question that they are watching for just this kind of "trick" to reduce market value for a lower real estate value basis.

The appraisal is straightforward - ideally realty occupied by a "major restaurant tenant with 20 years remaining on the lease at a rate well below market" but otherwise (and more likely) something else with a negligible leasehold, vacant or owner occupied. If you have other issues like surplus or excess land so be it, but don't get in trouble here clouding the issue trying to do your client a "favor" because it will backfire. It's not worth it.