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How To Value The "as Is" Value For A Leashold Position For A Proposed Hotel?

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Helpless

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The client is the lender. The project is a proposed hotel which will be subject to a ground lease. The site is currently a vacant parcel of land in an urban area.

The market value upon completion is a relatively simple matter. Modeled using a DCF with an appropriate discount rate and terminal cap rate.

The lender has requested an "As Is" value for the leasehold position. At first, I found this a little odd since the leaseholder does not own the land. Nevertheless, the lender says this is something they require internally.

Are the following steps a good methodology to get the "As Is" market value of the leasehold position:

1. Run out the proposed hotel cash flow for the 60 year term of the ground lease (with no reversion);
2. The above cash flow period includes 2 years of development (ground rent plus development costs);
3. Discount the above cash outflows and inflows to derive the As Is value of the leasehold position;

The ground lease appears to be at market rates. Thanks for any input.
 

Gobears81

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Illinois
How would you go about valuing the leased fee interest associated with the ground lease and how does that value compare to the fee simple value of the vacant site? The difference could be your answer but like Terrel said, if the rents are at market, theres a good chance the value is $0 or very close to it.
 
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Helpless

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California
^Thanks to you both.

@GoBears: Let's say there is a difference between the "leased fee" interest and the "fee simple" interest. Let's assume the fee simple interest is worth $1.0 million more than the leased fee interest. What if any value could be attributed to the leasehold value in that case?
 

Howard Klahr

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You have not provided any information about the ground lease especially as it pertains to the rent. How do you expect anyone to provide assistance beyond Terrels comment?
 

Meandering

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^Thanks to you both.

@GoBears: Let's say there is a difference between the "leased fee" interest and the "fee simple" interest. Let's assume the fee simple interest is worth $1.0 million more than the leased fee interest.


@GoBears:
What if any value could be attributed to the leasehold value in that case?[/QUOTE]

None,
I agree with Howard and Terrel.

The difference between the fee simple, and leased fee - the right to occupy, utilize, and build-out, has no bearing on the value of the leasehold, excepting the transfer-ability of the lease and it's terms to any new owner of the leased fee interest.

Heck, no one here is even sure if a land lease is the highest and best use of the land. Therein, may lie your value difference between fee simple and leased fee.

.

.
 

Gobears81

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Certified General Appraiser
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Illinois
^Thanks to you both.

@GoBears: Let's say there is a difference between the "leased fee" interest and the "fee simple" interest. Let's assume the fee simple interest is worth $1.0 million more than the leased fee interest. What if any value could be attributed to the leasehold value in that case?
Similar to what Howard said, I don't have enough information to offer much of an opinion, but if I understand your first post correctly, you have initially done (or are proposing to do) a form of a land residual by factoring costs into a DCF. For hotels, land is often a fairly small portion of the total value, so a minor change in inputs to the DCF could result in a large percentage change in the land value. Plus, if the hotel is not the ideal improvement to the site or the DCF assumptions are not synonymous with the appropriate timing for development, it could understate the land value. Just a thought, and again, I don't have all of the information, but what about isolating the valuation of the ground lease/ leased fee and comparing that to a fee simple land valuation via sales comparison approach?
 

Helpless

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Nov 12, 2014
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Certified General Appraiser
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California
Ok, I can see I really didn't start on a good footing. I will try again.

I have been asked to provide the "As Is" Value for the leasehold position. The property is currently a vacant site. The developer (the tenant) is planning to build a hotel. The neighborhood has seen several new hotels get built in the last few years...it is a very desirable location for a hotel. The developer is getting ready to break ground in the next few weeks.

The ground lease is for 50 years with two 10-year options. The ground rent is based on a base rent amount which increases with inflation.

I am going to contradict what I said earlier. The ground lease looks favorable to the tenant (i.e., under market). Most hotel ground leases in the area would be based on a percentage of total revenue (say about 5 to 7 percent); however, this lease has a base rent plus inflation (it is not tied to revenues). Based on projections the base rent is about 2 percent of total hotel revenues.

What is the correct process or methodology for valuing the "As Is" of the leasehold...?
 

Howard Klahr

Senior Member
Joined
Oct 4, 2004
Professional Status
Certified General Appraiser
State
Florida
What is the correct process or methodology for valuing the "As Is" of the leasehold...?
OK based only on what you have desribed, you would calculate the dcf of the rent differential between market lease terms and the contractual lease terms.

Keep in mind that the applicable discount rate is NOT the same as what you used for the hotel valuation and depending on the terms of the lease agreement there might be some expenses applicable as well.
 
Joined
Jun 2, 2007
Professional Status
Certified General Appraiser
State
Florida
Very straightforward: NPV of the favorable difference between the market and leasehold estate rents for 50 years. Use a low-risk discount rate marginally above a treasury rate - others may disagree. In theory they would need to invest at a savings rate to supplement the below-market rent, but please chime in everybody - I'm not going to think this through right now.

Hopefully you are not really "Helpless" and are supervised. If not, technically, I suppose that this forum counts towards competency, but it appears you may have accepted the assignment not knowing how to value a leasehold estate, and I might also assume if so that you did not inform your client. Well, you are on good footing now so be sure to supplement your workfile with this thread. Wait for a definitive answer from others on the discount rate though.
 
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