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Lease values

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Jeff Horton

Senior Member
Joined
Jan 15, 2002
Professional Status
Certified Residential Appraiser
State
Alabama
I posted this in the Education Forum by mistake.
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I need a quick refresher here. Friend of mine asked me to take a job to appraise some acreage, undeveloped land so pretty straight forward job. However there is a small section of the land involved in a 99 year lease. It brings in approximately $1300 anually and there is something like 80 years left on the lease. I don't know any more details.

Some where in my book case is info on lease fee and valuing income streams. However I dont have time to dig in and find it right now. Have a job I need to get out and I need to give her an answer in the morning. Could someone give me a brief reminder of what is is involved so I can decide if I want to take the job and how to price it.

Actually I want to do it, just got to re-educate myself on how to do this. I love doing something different and don't get that many chances too.
 

Restrain

Elite Member
Joined
Jan 22, 2002
Professional Status
Certified General Appraiser
State
Florida
Realistically, you have a discounted cash flow analysis. Your rate is essentially the "safe" rate as you have a 99 year lease with virtually no risk. If the rent is flat over the 80 year remaining life, look at the probable holding period of the land, use the rent and discount it at the safe rate over the holding period.
 

Jeff Horton

Senior Member
Joined
Jan 15, 2002
Professional Status
Certified Residential Appraiser
State
Alabama
That is basically what I was thinking. I have been reading on safe rate. I found the following definition I am thinking of using in the report:

Safe Rate. -- The safe rate reflects a rate of return that an investor could expect on an investment of minimal risk. This rate is developed through weighted averages of interest rates offered on five-year United States Treasury Bills for the five years immediately preceding the appraisal date.

Now the next dumb question. Where is the best place to get information to determine my "safe rate"?
 

Jeff Horton

Senior Member
Joined
Jan 15, 2002
Professional Status
Certified Residential Appraiser
State
Alabama
Got the contract on my lease they have thrown me a curve. Lease is for 99 years but is renewable ever 5 years. They can pull out with 90 days notice. Now I am confussed over what to do. Won't start on this one for a few days but sure could used some opinions on how to hadle this.

BTW the lease for MCI substation. From what I gather they have some sophisticated computer equiptment in the substation monitoring one of their phone lines. My thinking is that the way technoloogy changes the chance of this lease running full turn is slim. At some point it will be obsolete and no longer needed.

More questions than answers on this one!
 

Restrain

Elite Member
Joined
Jan 22, 2002
Professional Status
Certified General Appraiser
State
Florida
The "normal" holding period of a home is 8 years, with commercial properties generally having a holding period of 10 years. The probability is that the actual time frame will well exceed 10 years. However, using a DCF over 10 years will show that after the 10 year period, the discounted cash flow approaches $0, so it really doesn't do any good to go beyond 10 years. Second, if you look at commercial cap rates, it hasn't mattered very much as to what the rates, etc do. If you cap the net return at 10%, this indicates a good rough estimate of value. 10% - 10 years. Good luck.
 

Jeff Horton

Senior Member
Joined
Jan 15, 2002
Professional Status
Certified Residential Appraiser
State
Alabama
Finally working on this lease's value today. Just created a spread sheet in Excel and started punching in numbers. I am amazed that this lease has no little to no value.

When plugging in numbers I notice that if I plug in my amortization in years as opposed to months I show some value. Am I correct in assuming that I should amoritize this by months?

I dont think many investments amortize yearly anymore. :wink:
 

David C. Johnson

Senior Member
Joined
Jan 15, 2002
<span style='color:darkblue'>Jeff,

I could be wrong, but I do not think "amortization" is the best term to use in this case. For the calculation, you are looking for the net present value of an annuity with 80 remaining (yearly) periods plus the reversionary value (i.e., also discounted back to present value) of the property, which is the land (and also the improvements -- but which may have a slight negative impact on the land's value at that time for the reasons that you suggested). My guess would be that payments are scheduled to be made once a year rather than monthly; if not, you would likely divide the $1300 per year into 12 equal pieces for monthly lease payments for the discounted cash flow analysis suggested by RStrahan.

By the way, such an exercise may be warranted depending on the contractual terms of the lease when taking into consideration such factors as yearly real estate taxes, and possibly liability insurance (e.g., some kid breaking his arm after falling from climbing on the equipment or tower), and possibly maintenance costs if the landowner is responsible for keeping up access to the "facility" via a private road through the remainder of his property.
If there is a significant difference in values based on annual versus monthly lease payments, this may indicate a problem with how the equation is set up. For one, it may be calculating at 960 periods (12 X 80) rather than 80, where the rate is not divided by 12 for application to each of the larger number of periods. However, as RStrahan indicated, one of the reasons holding periods rarely exceed 10 years for DCF calculations is due to the discount rate's extreme effect on the present value of subsequent years income, and on the reversionary value. It approaches zero pretty quickly. For this reason, even another 800 periods or so might make little real difference even if the rate was not devided by 12. So, my guess is that the equation may need some "twinking."

Capitalization rates on raw land often seem to be about 6 or 7 percent, so far in my experience. Capitalization rates include the value of the reversion as being implicit to this number; and I believe, such rates are largely unaffected by the term of the lease. Conceptually, this is because at the end of even a very short lease, it can then simply be release on similar terms as before, and generally the tenant will not have "trashed the property" as their is nothing to trash -- except maybe for leaving trash itself. I believe at least a starting point (if not a reasonable estimate of value for this section of the property) might be by the following type math:

$1,300 / .065 = $20,000

Actually, my valuation concern would be the effect of the lease on the value of the remainder of the property. The substation may be a liability to development (or development options) of the overall property assuming highest and best would have included development of the whole property at some point in time while the lease of this part of the overall property is in effect. The five year renewal increments into near perpetuity could present a significant problem for the purposes of planning on the part of the landowner. And, while I have not really thought this through real well, I guess I could see the possibility of the leasehold estate owner deciding to retain control over this piece of land long after its economic utility for substation use had ended solely for the possibility of maybe being "bought out" of his leasehold interest at a premium in order for the land owner to most profitably develop whole tract!

On the other hand, and depending on maybe more likely circumstances, it probably has minimum impact on the remainder of the property. Otherwise we would have to be making the assumption that the owner was a bit of a dummy. And if he was a dummy, how would he have the land in the first place? Well, there is always inheritance! Anyway, to make your job a little easier, hopefully he was not penny wise (i.e., 130,000 of them per year), but dollar foolish.

NOTE: Guru's, semi-gurus or even neophytes will not hurt my feelings by challenging anything I have had to say in this post. In fact, if I am missing something, please do pipe up.

____________________

dcj</span>
 
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