"leases In Place" As An Intangible Asset

[Timbo813]

Good morning everyone,

I am reviewing an appraisal where the appraiser included a lease-up expense in the income approach to account for "leases in place" which he calls an intangible asset. He explains it as follows:

In place leases have value because an investor would pay more for a property with tenants versus a vacant property. The existence of tenants in-place allows the owner/buyer to avoid the costs that would typically be incurred if the building were vacant (lost rent, lease-up costs, commissions, etc.).

The appraiser argues that unencumbered fee simple market value assumes a vacant building, thus, on an occupied building, appraiser's should account for the "leases in place" by including a lease-up expense in the income approach, even if the property is 100% occupied. He says leases in place are an intangible. He defends this approach by pointing out that the IRS allows taxpayers to account for leases in place as an intangible. But I haven't found a single reference in appraisal text for doing that as part of a real estate appraisal.

Do you think leases in place are an intangible asset or part of the real estate?

Thanks in advance for your thoughts.

 

[Gobears81]

This is really a highest and best use perspective. There are cases where fully leased properties result in value enhancement. The lease-up costs are real and in some cases, significant. But, I have seen a few retail strip centers in Illinois sell recently where the depreciated cost is nowhere near what the value of the property is, due to the length of the leases and the strength of the tenants (aside from the above-market rents in some cases).

The highest and best use analysis considers the most likely purchaser. If a property is suitable for a national user, then the most likely purchaser will probably be a passive investor. Those are typically the cases where value enhancement is noted, although what are vacancy levels on those properties? Slim to none in most cases. If it is fully leased, passive investors don't consider leaseup costs, and in most cases, assume zero expenses. Use of sales that are typically purchased by owner-users will indicate a different value than that suggested by properties that are typically purchased by investors. Attempting to tie the two in does not fly. With that said, isn't the original appraisal based on leased fee interests considering that it is leased?

 

[Terrel L. Shields]

Do you think leases in place are an intangible asset or part of the real estate?

I would say the property value would include the intangible asset, but I don't think of intangibles as "real estate", but is part of the "property". I agree that an empty building / apartment, etc. would have a lesser value than one that is rented up due to the risk of that lease up and loss of income that would apply.

 

[Michael S]

Good morning everyone,

I am reviewing an appraisal where the appraiser included a lease-up expense in the income approach to account for "leases in place" which he calls an intangible asset. He explains it as follows:

In place leases have value because an investor would pay more for a property with tenants versus a vacant property. The existence of tenants in-place allows the owner/buyer to avoid the costs that would typically be incurred if the building were vacant (lost rent, lease-up costs, commissions, etc.).

The appraiser argues that unencumbered fee simple market value assumes a vacant building, thus, on an occupied building, appraiser's should account for the "leases in place" by including a lease-up expense in the income approach, even if the property is 100% occupied. He says leases in place are an intangible. He defends this approach by pointing out that the IRS allows taxpayers to account for leases in place as an intangible. But I haven't found a single reference in appraisal text for doing that as part of a real estate appraisal.

Do you think leases in place are an intangible asset or part of the real estate?

Thanks in advance for your thoughts.

If a property is fully occupied, I don't see any reason to deduct lease up expenses. If it's below stabilized occupancy it would be property to deduct those costs as a typical buyer would not pay as much for a building at 70% occupancy as they would one at 95% occupancy. The former will incur lost rent at a minimum, and likely leasing commissions, and or tenant improvement costs. In the case of an apartment complex or self-storage facility lease-up costs would be minimal as there's typically just lost rent to consider as you don't have commissions or TI.

 

[Gobears81]

I am curious to know a little more about the back story, and that might give us a little better understanding of why the original appraiser did what he did (or whether it was done incorrectly). There was a somewhat plucky review appraiser (though a nice guy) that I dealt with a few times over the years that was big on deducting leaseup expenses in the income approach. We certainly agreed to disagree in that case. But the statement that fee simple is equal to a vacant property really reduces the percentage of times that the leased fee and fee simple values would be equal.

 

[NachoPerito]

When I value a 'fee simple' interest of a multi-tenant office building I assume stabilized occupancy at market rates. I don't deduct for lease-up for the fee simple interest. I know of one client that has appraisers assume the building is vacant for the fee simple interest and has appraisers deduct for any lease-up costs associated with that, but otherwise I have always had the mindset that if the rents are at market than the fee simple and lease fee interests are the same value. there is intangible value if there is an above market lease in place that adds to the market value of the real estate.

 

[Pittsburgh Pete]

When I value a 'fee simple' interest of a multi-tenant office building I assume stabilized occupancy at market rates. I don't deduct for lease-up for the fee simple interest. I know of one client that has appraisers assume the building is vacant for the fee simple interest and has appraisers deduct for any lease-up costs associated with that, but otherwise I have always had the mindset that if the rents are at market than the fee simple and lease fee interests are the same value. there is intangible value if there is an above market lease in place that adds to the market value of the real estate.

But which would you shell out for first, a building with leases at market or a vacant building? There is a significant cost associated with getting a building from empty to full, even if those leases are all at market.

I would recommend the Advanced Concepts and Case Studies offered by AI.

 

[NachoPerito]

But which would you shell out for first, a building with leases at market or a vacant building? There is a significant cost associated with getting a building from empty to full, even if those leases are all at market.

I would recommend the Advanced Concepts and Case Studies offered by AI.

I have taken the courses, but I admit to not remembering all of it.

If a typical buyer is an owner/user then the building has a higher value as vacant.
If a typical buyer is an investor then the building has a higher value at stabilized occupancy.
If a typical buyer is either one then the two are equivalent assuming the building is turnkey.

 

[Pittsburgh Pete]

May be true for smaller one tenant type buildings. Larger buildings, multi-tenant Class A & B, and others would be an entirely different ballgame!

 

[NachoPerito]

May be true for smaller one tenant type buildings. Larger buildings, multi-tenant Class A & B, and others would be an entirely different ballgame!

True, just by the fact that the buildings are multi-tenant suggests it wouldn't be appealing to an owner user. It would be unlikely scenario that an owner/user would be combine all the spaces in a multi-tenant building for their own use. So for a multi-tenant building it would be a loss in value with any vacancy.