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Proper Methodology To Appraise Partial Ground Lease On Property

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Thebookdoesnthaveit

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Wyoming
I have been asked to provide an opinion of value on a 30,000 sf site of which 20,000 sf is improved with a restaurant and the remaining 10,000 square feet is a ground lease with a remaining lease term greater than 50 years. I have appraised ground leases before; however, have never encountered a "blended" property. What is the proper method(s) I should use?

My gut says that I can capitalize the income generated from the ground lease and add to the NOI of the restaurant and apply a cap rate; however, I could also possibly estimate the fee simple value of the 20,000 sf site with the restaurant and the value of the ground lease separately and add the two together??

Thoughts???
 

Howard Klahr

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I have appraised ground leases before; however, have never encountered a "blended" property. What is the proper method(s) I should use?
It sounds like the lease parcel represents the parking area for the restaurant use. Is the lease site area necessary for the other area to be a restaurant of the size that exists?

Due to the length of the remaining term, you could just deduct the land lease payment as an operating expense in calculating your NOI and the cap the result. The remaining terms of sufficiently long enough that the differential between fee and leased fee is minimal. How doe the land lease account for rent increases?
 

Gobears81

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One benefit of considering the land lease payment as an operating expense is that it could mirror the actions of the market. An argument for analyzing it separately is that if the payments are considered as an expense, the capitalization rate for leasehold interests is, in theory, greater than that of the fee simple/ leased fee interests. Supporting a blended rate might be a tough go. Personally, I'd do a DCF on the ground lease interest separately, but particularly given the length of the lease, a direct cap model probably would not yield a significantly different answer unless there are unusual terms, escalations in the near term, etc.
 

Thebookdoesnthaveit

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Thank you for the responses. I guess I should have been a tad more specific. The property is owned by the restaurant that leases the ground to a bank, which has subsequently constructed a building. The restaurant owner wants to sell the property, so I need to provide them with the value of the entire property. Given the owner is the leased fee holder of the ground lease, there are no operating expenses related to the ground lease, just income. So sorry for the confusion.
 

hastalavista

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Thank you for the responses. I guess I should have been a tad more specific. The property is owned by the restaurant that leases the ground to a bank, which has subsequently constructed a building. The restaurant owner wants to sell the property, so I need to provide them with the value of the entire property. Given the owner is the leased fee holder of the ground lease, there are no operating expenses related to the ground lease, just income. So sorry for the confusion.

So the site is a single parcel?
Who is the buyer for a mixed-use property such as that? Is this a viable restaurant site on its own that can be leased to an operator?
The land lease component's buyer is an investor.
The restaurant component's buyer may be an owner-user.

A 50-year lease to a bank? That's a cap rate problem in my book.
 

Thebookdoesnthaveit

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Wyoming
Site is a single parcel. At this point the owner wants to list the property; however, the Realtor feels the asking price is unrealistic (I have not been privy to what the owner wants to list the property at). The restaurant is very viable and has been in operation for many years. I would think if an investor purchased the property, they would possibly lease back the restaurant to a tenant.

Please expand on the cap rate problem regarding the lease to a bank. Not quite following...
 

hastalavista

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Please expand on the cap rate problem regarding the lease to a bank. Not quite following...

Not sure how long-term bank NNN land leases work in your market, but in my market, no buyer would do a DCF on a 50-year lease for a credit-tenant like a bank. They trade all day long based on cap rates. Differences in the lease terms (if they exist) are addressed in the individual rates.

If an investor is the likely buyer (which I would tend to agree if the restaurant site is viable on its own) then, IMO, the way to solve it in the sales comparison approach is to allocate the values: identify the restaurant component and value that component using the traditional sales comparison approach. The contributory value of the NNN income from the land lease is then added to that result.
For the income approach, I'd allocate it as well as the two income streams will have different economic profiles with, presumably, the NNN land lease having the lowest risk/cap rate and the restaurant component having a different set of income, expense, and risk dynamics.
 

Thebookdoesnthaveit

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Wyoming
Thanks. So would it still be appropriate to add the two values in the income approach to arrive at the final value of the property? I do not want to be misleading..
 

hastalavista

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Thanks. So would it still be appropriate to add the two values in the income approach to arrive at the final value of the property? I do not want to be misleading..

I don't see anything misleading here.
The subject is composed of two different value components. From what you describe, they act independently of one another. I don't need the restaurant to get the income from the bank lease, and I don't need the bank to operate the restaurant.
Those different value components are valued differently in the market.
If both components (combined) would primarily be purchased by an investor, then an investor is going to evaluate those income streams separately but the value of the whole to an investor is the value of the sums (it is all income).

Where I think it gets problematical is if one of the components would appeal more to an owner-user; the only component that might fit that bucket is the restaurant. If so, what I would expect to see is that the comparable sales of restaurants are all owner-users and they would pay more than an investor (Right? Otherwise, it would be an investor property). In that case, the sales comparison approach (unless adjusted for the difference in rights) would show a higher value of the restaurant component based on what owner-users pay vs. what the subject is presumed to be (an investor property).

That is why it is key to identify the likely buyer and then to ensure that the comparables used sell to the same buyer-type. We know that the NNN lease is an investor-profile, so the only question is the restaurant. If the restaurant meets the investor-profile, then the comparables should be similar. But if the restaurant does not meet the investor-profile, then it could be the comparables will be dissimilar.
If that is the case, that has to be considered and addressed. Because in that case, adding the two value components would be incorrect (still not sure it would be misleading); we would be adding an owner-user component's value and an investor-component's value together and expect it to sell to an investor for that price.

Ideally, a difference such as I described would be addressed in the specific approach by applying an adjustment.
However, it may be possible to adequately address it in the reconciliation: if our subject is an investor property, then the income approach (the cap rate of which should be based on investor requirements and not pro forma estimates from owner-user properties) would implicitly consider the market's investor-requirements.

At least, that is how I see it. Others may look at it differently.

:cool:
 
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