If you mean the text statement, I think it suggests capitalization, which was the one word answer I originally gave to the OP question of proper method.
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valuing a property rented below market rates
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PropertyEconomics
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Abester
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Maybe the "benefit" is value?
Maybe it's suggesting a methodology to calculate the benefit is to calculate the value of income throughout the lease (present value of the cash flow?) and to calculate the reversion at the end of the lease? The methodology does not distinguish between below market rent, market rent or above market rent. Perhaps I'm reading too much into what seems relatively straightforward...
Maybe it's suggesting a methodology to calculate the benefit is to calculate the value of income throughout the lease (present value of the cash flow?) and to calculate the reversion at the end of the lease? The methodology does not distinguish between below market rent, market rent or above market rent. Perhaps I'm reading too much into what seems relatively straightforward...
Russ Kitzberger
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PE has it right for the DCF, but you should develop the cap rate for sales of properties with below market leases to add credibility.
Due to the below market lease there may be less risk to the leased fee estate holder. Less risk in the tenant leaving for more favorable terms elsewhere and less risk of difficulty in subletting the property if they need to vacate. Only the market will determine if there is any difference in your area and that submarket.
I recall a small strip center and the leases were 10 year with 5 year renewal at 20% below market. By the time the leases were up, the strip would need complete facelift, parking lot, roof, etc.
It is all fun and games until the lease comes out from the file cabinet.
Good luck.
Russell Kitzberger
Pointer Appraisal Services LLC
Northeast Ohio Real Estate Appraisal
www.PointerAppraisal.com
Due to the below market lease there may be less risk to the leased fee estate holder. Less risk in the tenant leaving for more favorable terms elsewhere and less risk of difficulty in subletting the property if they need to vacate. Only the market will determine if there is any difference in your area and that submarket.
I recall a small strip center and the leases were 10 year with 5 year renewal at 20% below market. By the time the leases were up, the strip would need complete facelift, parking lot, roof, etc.
It is all fun and games until the lease comes out from the file cabinet.
Good luck.
Russell Kitzberger
Pointer Appraisal Services LLC
Northeast Ohio Real Estate Appraisal
www.PointerAppraisal.com
Groover
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Hello Associated;
Assuming your appraisal is to estimate the market value of the property, and you have below market rents, then you have a lease fee issue. The lease fee is the value based on the current rents, the value based on market rents would be the market value, and the value of the difference is the leasehold. The leasehold may or may not be marketable, based on the remaining term of the lease and your local market. If your market is stable you will use direct capitalization, but yield capitalization might be used in a rapidly changing market.
Typically, if you have a below market rent, you should reflect the value of the lease fee, the value at market, and the leasehold. Additionally, you should reflect whether the lease fee is a marketable interest. There is a lot of information to be considered with respect to your question, but typically I would try to use direct capitalization rather than yield cap in this case.
Assuming your appraisal is to estimate the market value of the property, and you have below market rents, then you have a lease fee issue. The lease fee is the value based on the current rents, the value based on market rents would be the market value, and the value of the difference is the leasehold. The leasehold may or may not be marketable, based on the remaining term of the lease and your local market. If your market is stable you will use direct capitalization, but yield capitalization might be used in a rapidly changing market.
Typically, if you have a below market rent, you should reflect the value of the lease fee, the value at market, and the leasehold. Additionally, you should reflect whether the lease fee is a marketable interest. There is a lot of information to be considered with respect to your question, but typically I would try to use direct capitalization rather than yield cap in this case.
Joyce Potts
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Who cares if the subject is rented at below market rent. If the intended use is for market value, then who cares? Disclose it and then value it based on the current market rents. The subject's rents concern anyone in this assignment?
Joyce, I tend to agree with you, except that below market rents may make the income stream more likely to be collected in full with some tenants, but as I pointed out to PE, not with all tenants.
As you can see, some get into all this positive-negative leasehold leased fee v fee simple hypothesizing and adding or subtracting premiums from irrelevant approaches. Geez. It's an appraisal, not a balance sheet.
aussie ken
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Joyce.... my old mentor always told me that the ultimate question any valuer[appraiser] should ask is would you privately and happily,using your own money, buy the property you have just valued at your valuation amount?............Accordingly your observation is astute but if I was personally buying this property with its below market rentals I would nevertheless want a rational adjustment that recognises I'm not going to get my full market rental until sometime in the future............either, by way of a rent review to market if available within the terms of the lease or on re-negotiation on termination of the lease.
Jungle Boy
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10 years is a drop in the bucket, relatively speaking.
But so are our lifetimes.
But so are our lifetimes.
Russ Kitzberger
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Joyce,
Respectfully, The appraiser is telling us in that market area that the income from an income producing properties lease is considered by purchasers and has everything to do with the market value.
This property is encumbered by lease for 10 years. Which may or may not be a significant amount of time in that submarket.
Also, what the appraiser is telling us is that he is concerned the below market lease rate will effect the market value due to the rate and the encumbrance.
The fee simple estate has been divided and the theoretical perspective owner of the property is purchasing is an encumbered fee simple property. Encumbered by the respective lease. They are purchsing a leased fee interest for a period of time and the right to do what they wish with the property at the expiration of the lease. The tenant conversely has purchased a leasehold interest for a period of years from the bundle of fee simple rights and the owner.
I say theoretical sale because the definition of market value typically used assumes the property is transferred as of a specified date.
Because the seller has granted some of their rights to occupy the property for a period of years, the fee simple estate has been encumbered. The market value will depend on the typical purchaser's reaction to the encumbrance. This is of course, unless the appraiser disregards the encumbrance, which is not typical in long term leased property and would obviously be a hypothetical condition.
The market value is derived from the leased fee interest, since that is what would be purchased in this appraisal's theoretical sale, and the residual. Another method is to develop a cap rate for properties leased at below market rates then utilize the below market rent and the actual rental rate (below market) to develop a value of the below market income stream.
This relationship is explained in the AI course advanced income capitalization on section 1.19. As well as earlier more basic income property courses.
See this article about cap rates derived from below market rents and their influence on value conclusions:
http://nreionline.com/commentary/taxnotes/real_estate_improper_cap_rates_0411/
Russell Kitzberger
Pointer Appraisal Services LLC
www.PointerAppraisal.com
Respectfully, The appraiser is telling us in that market area that the income from an income producing properties lease is considered by purchasers and has everything to do with the market value.
This property is encumbered by lease for 10 years. Which may or may not be a significant amount of time in that submarket.
Also, what the appraiser is telling us is that he is concerned the below market lease rate will effect the market value due to the rate and the encumbrance.
The fee simple estate has been divided and the theoretical perspective owner of the property is purchasing is an encumbered fee simple property. Encumbered by the respective lease. They are purchsing a leased fee interest for a period of time and the right to do what they wish with the property at the expiration of the lease. The tenant conversely has purchased a leasehold interest for a period of years from the bundle of fee simple rights and the owner.
I say theoretical sale because the definition of market value typically used assumes the property is transferred as of a specified date.
Because the seller has granted some of their rights to occupy the property for a period of years, the fee simple estate has been encumbered. The market value will depend on the typical purchaser's reaction to the encumbrance. This is of course, unless the appraiser disregards the encumbrance, which is not typical in long term leased property and would obviously be a hypothetical condition.
The market value is derived from the leased fee interest, since that is what would be purchased in this appraisal's theoretical sale, and the residual. Another method is to develop a cap rate for properties leased at below market rates then utilize the below market rent and the actual rental rate (below market) to develop a value of the below market income stream.
This relationship is explained in the AI course advanced income capitalization on section 1.19. As well as earlier more basic income property courses.
See this article about cap rates derived from below market rents and their influence on value conclusions:
http://nreionline.com/commentary/taxnotes/real_estate_improper_cap_rates_0411/
Russell Kitzberger
Pointer Appraisal Services LLC
www.PointerAppraisal.com
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