Valuing Leasehold Interest on Ground Lease

[UpstateNY]

OK, I've searched the forum for this subject, and found some ideas, but I'm a little dense this morning and don't want to re-invent a wheel that I'm sure some of you have already invented. I am valuing a building sitting on a ground lease with 30-years remaining on the lease. In assuming a 10-year holding period on a DCF there is of course a value of the reversion included in the calculation. But, if a buyer is sought after 10 years, with an eventual value of zero after the remaining 20 years, would the value to this buyer be the sum of the discounted cash flows for the last 20 years? I know we're not swamis here, but the bank would like to know what the prospective value might be in 10 years if the borrower goes belly-up and they look for a buyer.

I need more coffee...

 

[UpstateNY]

I'm getting caught up between the return ON investment and the return OF investment...

 

[Vernon Martin]

Appraisal of ground-leased property

I think you have unwittingly presented a case for doing a 30-year DCF model, not a 10 year model, with a reversion of zero.

You must account for every bump in the ground lease payment over the remainder of the lease.

It is not unusual for the leasehold value to go to zero long before the expiration of the ground lease, if the building fails to produce enough positive cash flow to make the ground lease payments. This has often happened in Orange County, CA and Hawaii, in areas of appreciating land values.

If and when Building NOI falls below the ground lease payment, then that should probably be the last year of your DCF model.

 

[hastalavista]

Another thing to consider is that while there may be no reversion there could be a demolition cost.

Many ground leases require the lessee to demo the improvement and return the site to a vacant condition, ready to develop to whatever the H&BU is at that time.

 

[C. Kevin Bokoske MAI]

I have a stored DCF I created for a similar scenario. It may save you a few minutes anyway. If the OP sends me a PM, I will email it to him/her.

 

[UpstateNY]

Mr. Bokoske - I tried PM'ing you but the system said you couldn't receive PM messages.

 

[C. Kevin Bokoske MAI]

You can always find an MAI e-mail by clicking on Find an Appraiser on A.I. webpage. I'll save you the trouble though. I'm at kbokoske@broward.org.

 

[stephenbullock]

I agree with Vernon and Denis, probably best to do a 30-yr. DCF with reversion either zero or a negative value equal to demolision costs if this is stipulated. True, leasehold value may be zero or negative before end of lease term but I would not use this assumption unless it's an older property and you think NOI will be insufficient to cover ground lease payments at some point before the end of the ground lease. You cannot determine market value ten years from now (you don't know what IRR's or reversionary cap rates will be in 10 years). At best you could only provide a "hypothetical" forecast subject to numerous assumptions but you should try to avoid doing this.

 

[Yukon32]

I have a ground lease on a property I am appraising. Subject is multifamily apartments, no excess land, 17 years remaining on lease which was a 49 year lease and has been set at a fixed $6,000 per year. I have estimated the current land value at $680,000. So my question is, can I estimate the FV based on a 3% annual compound rate, 17 year term. Then discount the FV back to NPV with an appropriate discount rate, and account for the $6,000 expense by subtracting it from the operating expenses. If the discounted land value was $220,000, the difference between the present market value of the land ($680,000) would be the value of the leasehold and therefore the capitalized value minus the $220,000 would reflect the value of the property with leased land and would appropriately address the leasehold interest?

 

[stephenbullock]

Multifamily on leased land

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