Income approach and property rights appraised.

[Frederick R. Ruffell]

After reading a rather long and in depth debate over on the Commercial forum ((see: Can the income approach (when based on market-derived economic rent, expense and cap rate data) be used to estimate the fee simple interest of a non-leased property?)) and starting yet another 2-4 unit residential appraisal I now have a couple of questions concerning the Income approach and property rights appraised. What I am looking for is the typical residential appraisers (my peers) indicate on the 1025 form.

OK,
1.) 2units 2 buildings, 1 vacant, 1 owner occupied. Am I appraising fee simple interest or leashold interest?

2.) 2units 2 buildings, 1 vacant, 1 tenant occupied. Am I appraising fee simple interest or leashold interest?

3.) 2units 2 buildings, both owner occupied. Am I appraising fee simple interest or leashold interest?

4. 2units 2 buildings, both tenant occupied. Am I appraising fee simple interest or leashold interest?

 

[Paul Ness MAI]

It depends on whether or not there are actual leases in place. By definition, a leased fee interest does not exist unless there is a lease contract in effect. If there is no lease, there is no leased fee interest.

If there is a lease, you would only be appraising the leased fee interest if you apply the contract rent and terms from the lease in the valuation. In a 2-4 unit situation, if the leases are yr-to-yr or mo-to-mo, the question is probably academic.

If only a portion of a property is leased, but you appraise the property based on the terms and conditions of that lease as they apply to that portion of the property, you are still appraising the leased fee interest, as the bundle of rights has been divided and a purchaser would be acquiring less rights than those acquired with the fee simple interest.

 

[bradellis]

Paul,

Here is a question that has bothered me for a long time now, and I'd like your take on it:

In theory at least, a classical leasehold interest in a property occurs when there is value to it. In other words, the lessee has the rights at say, $18/foot, but the market would pay $20/foot and the lease allows for subletting. In that scenario, the lessee has an estate worth $2/foot capitalized at an appropriate rate.

What I am wondering really has to do with residential forms. If the property is under lease, BUT the lease is at market or economic rent levels, is there actually value to the leasehold estate?

I ask this for a basic reason. The condo form allows for one to designate only 2 estates- fee simple or leasehold. (I do NOT want yet to get into a discussion of whether or not condo ownership is actually fee simple- it is a different question).

It had always been my opinion that the leasehold box was there for co-ops. But last year, my wife did an appraisal of a condo on leased Indian land. Whole complex was on that land and all paid the same amount for the lease annually. Actually, the lease is paid out of asociation dues, but each owner is on the hook in severalty.

She did this for the company I worked for. My boss, also an MAI, insisted that the leasehold box had to be checked. I argued that- no- the leasehold box should not be checked. My reasoning is that since there is no value to the leasehold- all rents for the land are at market, that reporting value of this as leasehold would be wrong.

We compromised. She checked leasehold and then wrote a paragraph explaining it all so that no one would be mislead.

What is your opinion?


Brad Ellis, IFA, RAA

 

[Paul Ness MAI]

Very interesting. At first glance, I would have to agree that the leasehold box must be checked. The bundle of rights is legally divided by the lease contract, and the condominium association could possibly still sell the leasehold interest in the land (unless subject to other contractual restrictions). Even though the land rent is at market today, there still may be value to the leasehold interest (i.e. if the contract rent is level). However, if the contract rent is level, I don’t think the condo association would want to sell the leasehold interest.

 

[Frederick R. Ruffell]

Thanks Paul and Brad, for your answers (i think) but I am still not sure what box to check. Paul assuming that the tennants occupy under the terms of a current lease, I check the leashold box, and I use Market rents (which raises another question if the current rents are at or above market?).... what, in the income approach is different? than if it was all owner occupied. Other than the differences in definitions, is there anything I should be doing differently, in practice, for owner vs tennant occcupied 2 to 4 unit properties. Please try to keep the answer simple initially and then we can explore the permutations after that.
Thanks again

 

[airphoto]

Let me add two pennies, and reveal my ignorance:

Isn't the leasehold interest held by the person/entity leasing the property (a portion of the bundle of real property "rights."?)

Isn't that portion quantified by the terms of the lease/rental? Hasn't the owner exchanged a portion of his bundle of "rights" for the income flow? Doesn't his ownership consist of the additive total of those components?

I realize that above you all refer to a building on leased land .. that's a different item from trying to figure out where an owner occupied 1-4 unit comes in ..

 

[George Hatch]

$.02

Fee Simple - Owner's interest with no lease encumbrances; month-month occupancies don't count as leases.
Leased Fee - Owner's interest with a lease encumbrance
Leasehold - Tenant's interest as a result of a lease
Sandwich interests - Lets not go there; you wanted sinple.

Usually, a short term lease (less than a couple years) does not represent enough of an encumbrance on the long term income stream to affect the property's value. In these cases, the fee simple and leased fee values will be similar, if not the same. I wouldn't appraise a residential property as a leased fee interest unless there was a long term lease encumbrance. Oh yeah, and life estates, too.

You probably wouldn't have occasion here on the left coast to use the "leasehold" box on the FNMA forms unless there is a land lease involved. Brad's example of properties on indian leased land illustrates one example of this. There are some projects like that here in SoCal, mostly out in the Palm Springs area. The only other possibility I could see for using that box would be if you were appraising the tenant's interest as a result of a long term lease, assuming it was even marketable. I'm sure our friends out in New York probably do this from time to time, but I've never seen it out here.


If the box was intended to include condo projects solely because of their common interests, the box would not be necessary on the condo form nor would it be an adjustable item on the grid because it would apply to all of the projects equally.


George Hatch

 

[Paul Ness MAI]

Fred, I think we're all on the same page, but I think you are now confusing your first questions about a 2-4 unit, with the leasehold condo question brought up later by Brad.

In a 2-4 unit situation, you wouldn't check the leasehold box as you are presumably appraising the interest of the "property owner" and not the tenants. If you are using market rent (as you indicated), then you are really appraising the fee simple interest and not the leased fee interest. As a few of us stated here, unless you have a lease with a remaining term longer than a few years with rent significantly above or below market, the leased fee and fee simple interests are going to be the same. On such small residential properties, don't sweat the ownership interest issue unless there is a long-term lease in place.

 

[Frederick R. Ruffell]

Thanks again all,

I had it stright all along but got confused after reading the commercial forum on this subject. Just one question remains.... When would a residential appraiser encounter an assignment that would require the Leashold interest to be appraised. Does it ever come up in mortgage origination i.e. FNMA 1025?

 

[Larry Lyke]

Frederick --

When somebody else owns the land and somebody else owns the improvements or rights to the latter.