Valuing Leasehold Interest on Ground Lease

[Yukon32]

Dear Yukon,
In my opinion the answer is maybe. Your methodology might provide an accurate estimate but it might not. My question is why are you attacking this in such a convoluted manner? What interest have you been hired to appraise? If I know that I think I can advise on a more straightforward and accurate method. Regards, Stephen

I belive in using the most direct and straightforward solution whenever possible so it is not my intension to go out of my way to use a more convoluted methidology. I simpily have a complex appraisal problem that involves valuing a 34 unit senior housing complex which is located on leased land with a long term lease and has a "maximum annual investor return distribution as approved by VHFA of $8,800 as part of a Preservation Agreement and tax credit transaction".

I am first focusing on the leased land. I want the methidoligy to account for the lack of ownership of the land but also accunt for the favorable lease terms. To do this I have deducted the npv of the landvalue from the income appraoch, and deducted the $6,000 annual lease payment as an operating expense. I would be interested to hear what your sugestion might be? (17 years on remaining lease, fixed $6,000 annual lease payment, market info for land rent is limmited, current market value of land =$680,000±)

 

[Vernon Martin]

Appraisal of leasehold interest

If the assignment is to estimate the value of the leasehold interest, then I wouldn't focus on the leased land first. I would focus instead on the market for similar leasehold properties and find the appropriate discount rate for discounting the net income net of the ground lease payment. The present value of the cash flow stream should approximate the leasehold value if you are using market-derived assumptions. There should be no need to subtract the value of the leased land afterwards since the only thing that matters about it in the DCF analysis is what the building owner is paying in ground rent. What you are proposing is a double deduction for the value of the leased fee interest in the land.

 

[stephenbullock]

Valuing apartments on leased land

Dear Yukon,

Terminology has to be very precise when communicating this kind of situation. If I understand correctly, the fee simple land value is $680,000. The value of the ground lessor's interest is $6,000/year for 17 years discounted back plus the FV of land discounted back 17 years. If you subtract the estimated value of the ground lessor's interest from the $680,000 fee simple land the result should be equal to the apartment owner's leasehold interest in the land. Then if you value the apartment building via DCF with 17 year life and then deduct the $680,000 - PV of ground lessor's interest (Say $6,000 for 17 years discounted at 8% given very low risk = $54,730 + discounted FV of land, Say $680,000 appreciated 3%/yr. for 17 years then descounted back at 10% or $1,123,936 discounted back 17 years at 10% = $222,365. So $222,365 + $54,730 = $277,095. Next, value of apartment via DCf with 17 year life and no reversion but still subject to restrictions per VHFA and Preservation Agreement plus $402,905 ($680,000 - $277,095) is the value of the apartment building plus land leasehold ownership interest your valuing. If I am following correctly, wouldn't deducting the $6,000 as an operating expense be double counting? The $6,000 annual payments have already been accounted for in your valuation of the apartment owner's ground leasehold interest which your deducting from the fee simple land value. If the ground lease agreement stipulates that the apartment building leasehold owner must demolish improvements after end of lease term, I think this will work and help provide you with a SC approach value. If apartment building has contributory value in 17 years and if ground lessor comes into possession of the improvements, I think you have to add the NPV of the future projected value of the improvements to the $277,095 which will lower the $402,905 figure.

I guess my question is, if you have been hired to estimate the value of the apartment building owner's ownership interest, why not just do a 17 year DCF, deduct the $6,000 ground rent as an expense in calculating your net income over the 17 year period. Wouldn't the NPV of that 17 year income stream equal what you were hired to value? The apartment building owner has no ownership interest after the 17 year period. I would exclude the SC approach because it would be like comparing apples to oranges. I assume your comps would be comprised of fee simple apartment building sales and the calculations in the previous paragraph are done so you can provide a value estimate via SC approach? I think you have good cause to exclude SC approach unless mandated by client. Hope this helps and that I did not misunderstand the situation.

 

[Yukon32]

Right,
If the market information available reflected cap rates for sale properties with leased land, then I would go that route. This is an unushual type of property for the area and all other
cap rates available reflect the transfer of full unrestricted ownership of the property and the land. The owners of the subject have the option to buy the land for market value, but because they have such a great deal on the annual lease payment it is better for them to continue making the annual lease payments for the remainding 17 years at which point they would need to buy the land.

 

[stephenbullock]

Valuing apartments on leased land

Dear Yukon,

Terminology has to be very precise when communicating this kind of situation. If I understand correctly, the fee simple land value is $680,000. The value of the ground lessor's interest is $6,000/year for 17 years discounted back plus the FV of land discounted back 17 years. If you subtract the estimated value of the ground lessor's interest from the $680,000 fee simple land the result should be equal to the apartment owner's leasehold interest in the land. Then if you value the apartment building via DCF with 17 year life and then deduct the $680,000 - PV of ground lessor's interest (Say $6,000 for 17 years discounted at 8% given very low risk = $54,730 + discounted FV of land, Say $680,000 appreciated 3%/yr. for 17 years then descounted back at 10% or $1,123,936 discounted back 17 years at 10% = $222,365. So $222,365 + $54,730 = $277,095. Next, value of apartment via DCf with 17 year life and no reversion but still subject to restrictions per VHFA and Preservation Agreement plus $402,905 ($680,000 - $277,095) is the value of the apartment building plus land leasehold ownership interest your valuing. If I am following correctly, wouldn't deducting the $6,000 as an operating expense be double counting? The $6,000 annual payments have already been accounted for in your valuation of the apartment owner's ground leasehold interest which your deducting from the fee simple land value. If the ground lease agreement stipulates that the apartment building leasehold owner must demolish improvements after end of lease term, I think this will work and help provide you with a SC approach value. If apartment building has contributory value in 17 years and if ground lessor comes into possession of the improvements, I think you have to add the NPV of the future projected value of the improvements to the $277,095 which will lower the $402,905 figure.

I guess my question is, if you have been hired to estimate the value of the apartment building owner's ownership interest, why not just do a 17 year DCF, deduct the $6,000 ground rent as an expense in calculating your net income over the 17 year period. Wouldn't the NPV of that 17 year income stream equal what you were hired to value? The apartment building owner has no ownership interest after the 17 year period. I would exclude the SC approach because it would be like comparing apples to oranges. I assume your comps would be comprised of fee simple apartment building sales and the calculations in the previous paragraph are done so you can provide a value estimate via SC approach? I think you have good cause to exclude SC approach unless mandated by client. Hope this helps and that I did not misunderstand the situation.