Why do appraisers say Leased Fee Value = Fee Simple Value, when leases are at market?

[shaxton24]

I still don't see how a property with even month-to-month leases can be appraised as Fee Simple, unless hypothetical. Why conflict with the definition of Fee Simple?

My issue is not with technicalities, but in the real confusion this causes.

(I do appreciate all the different views and commentary here!!)

 

[leasedfee]

I still don't see how a property with even month-to-month leases can be appraised as Fee Simple, unless hypothetical.

It isn't hard, in many markets, to end those leases and for the owner to get to the fee simple rights. I have addressed the bundle of rights on some other posts.

A few months isn't very significant. Part of it is accounting convention of current assets vs. long-term assets. Part of it is that a few months isn't much time. Here we are June is almost one-half over and the year is half over -- time really flies. The property owner will get it under full control with no noticeable impact on value from far above or below lease rates versus the economic rent. Part of it is that the time value of money (present value of $1) isn't that much for a few months impact. Part of it is that for the owner to take control of the property, go through zoning, platting, architectural plans, space-design plans, bidding, TI build-out, or new construction permits, there is more than enough time for a few months of the old leases to burn-off or for month-to-month tenants to vacate.

My colleague and I call most of our apartment buildings fee simple for this reason. Upon acquiring the property, as of the effective date, the new owner will have the rights to condominiumize, demolish, or convert in a very short time. With all of the subjective qualitative aspects of appraisal it is simpler not to get bogged down by fairly minor nuances. I'm looking for bigger problems. Many in this forum, though, would call this fee simple or fee simple subject to leases -- though I would call "fee simple subject to leases" a leased-fee estate .... If you want to call month-to-month leases a leased fee estate, I wouldn't hold it against you.

 

[shaxton24]

Timothy -- Ok. I can believe that. And even if a lease doesn't contractually allow the owner to end it, the owner could likely buy a tenant out.

Yes. "Fee simple subject to leases" is a leased-fee estate. I agree your apartment example is one where the FS and LF estate is worth basically the same. But for most apartments, a few months left on the leases of a hundred tenants is very meaningful and valuable - because many tenants will stay and renew their leases.

Back to my 20 tenant retail example:
There can always be H&BU exceptions, but most often a multi-tenant property under leases is worth more than Fee Simple vacant. Even if there is 1 day left on all 20 tenants' leases, there is more value to the LF estate - because it is likely that many tenants will renew leases. If the property was vacant, it would incur complete costs of tenanting a vacant building - lost rent, lc's, ti's etc. To me this is simple and articulate - something important in the valuation process.

Also, Fee Simple means more than just some theoretical maximum "bundle of rights" to the owner, it also happens to describe the "positional circumstance" of the property. In the case of Fee Simple, it would mean there are no tenants.

I suppose there is a situation where an owner could have paying and occupying tenants, but no leases. This would be a Fee Simple estate.

 

[jdbiggers]

Wow. That's all I can say.

TITLE is all it comes down to.

Rented or not, if I have an apartment complex, I can sell it. The tenants cannot. I can give notice and kick my tenants out if it is no longer economically viable as a rental property and turn it into condos if that is more economically viable and my tenants as soon as their leases expire or unless there are some BS local rental statutes. Even then, there are ways to get them out. I can encumber the property. I own the apartment complex: they have a contract giving them limited rights to a portion of it, but I own it's entirety. I can encumber EVEN the portions that is leased. When I rent a unit in an apartment, I am NOT giving them a leashold estate, I am writing them a contract giving them limited USE LICENSE of a portion of MY PROPERTY. The apartment complex is held by me in FEE SIMPLE interest and my tenant have only rental agreements, not TITLE. I hold the ONLY TITLE to the property.

Even in states which have very strict rent control laws, the tenants do not have TITLE to the property: they simply have a contract that must adhere to some statues or ordinances giving the tenant a lot of power in terms of lease length and fees, BUT NOT TITLE.

Now, leasehold is entirely different. A leasehold estate is NOT a standard MTM, 1 year, 2, year, or even 10-year lease agreement. It is giving the holder ALL the bundle of rights applciable VIA TITLE for a given amount of time, even the right to encumber. TITLE is transferred which is reversionary at the end of the lease period.

If I grant someone a leasehold estate, I hold LEASED FEE title, they hold LEASEHOLD title, at the end of term, it reverts to FEE SIMPLE title.

No title transferred, then only the FEE SIMPLE estate exists.

There are numerous court cases on this where judges get very frustrated at people not understanding the whole title issue and THAT is what determines the estate, not who occupies the property or what financial arrangements have been made for use.

 

[Ken B]

Bzzz.

No cigar for you.

 

[Pittsburgh Pete]

Wow is all I can say--and for a totally different reason!

 

[leasedfee]

Shaxton,

Let's say there is a 20 bay retail building on one corner and on the other corner is a 20 bay retail building. They were built in the same year, by the same builder, with the same architectural floor plans, with the same micro-locational characteristics, etc. Property A is fully occupied by local tenants averaging 7 year leases. Property B is vacant.

The most likely owner is an income investor who will value the cash flows on A and discount accordingly for the lease-up costs, etc., for B. In most markets, we agree that the A will be more valuable than the B. Especially in the last several years having tenants is much more desirable than not having tenants. I'd agree with you that, in most markets, even if the tenants have one day left on their leases or are month-to-month, property A due to renew probability is more valuable than B.

Now let's say that this property is circa 1995-2005 in gentrifying or rapidly renewing central Denver neighborhood. Which would you rather have? Property B's building can be gut renovated and re-tenanted with a higher rent tier business. You don't want any tenants in the building getting in the way of a quick and efficient renovation. At a certain point the most likely owner, the income investor, will switch from A to B as the most valuable investment. Property A-7yr is stuck with local tenants and cannot avail of the upswing in H&BU. Due to the time value of money the first 10 years constitutes a noteworthy portion (roughly one-third of the present value of an annuity factor occurs over the first ten years versus the capitalized into perpetual factor).

For example, Denver's most chic shopping district something exactly like this happened. The tenant sued the property owner who wanted to tear down the parking structure, and ultimately the entire shopping center. The court ruled for the tenant. Years later, soon after the tenant vacated, the developer constructed a mid-rise mixed-use building.

In the prior post I mentioned other examples like demolition. Another example would be if A's 7 year leases are severely below market. The fee simple might be much preferable to the positive leaseholds.

You are right that there are many circumstances where the property owner has paying tenants or their own company and can get to the FS rights quickly. .... going off-topic, it's interesting that there is "allodium FS" or "crown FS", often held by the government, not subject to the four powers of government. ...my first 4-5 years in R/E was dealing with title work for the gov't...

I think you are confusing correlation with causation. Occupied vs. unoccupied is not the same as leased fee vs. fee simple, even if the correlation is high.

Sincerely,

Tim

 

[shaxton24]

Tim,

Very good points. Glad you agree on the one-day-left-on-lease example. Your renewing neighborhood is a good example too - I agree.

"Occupied vs. unoccupied is not the same as leased fee vs. fee simple, even if the correlation is high". I agree with this as well. That is a good way to put it.

Now since you did title work for the gov't maybe you can tackle jdbiggers above comments about TITLE ... "No title transferred, then only the FEE SIMPLE estate exists."

I am not a lawyer or expert on the definitions of FS or LF or "title”, but the Appraisal Institute's "The Appraisal of Real Estate" (Eleventh Edition p. 138) doesn't seem to mention that title has to transfer to tenant in order for LF and LH estates to be created. It does say that LF and LH estates are created by a lease - which is a contract subject to contract law. And... "The divided interests resulting from a lease represent two distinct, but related, estates of property - the leased fee estate and the leasehold estate. (It is noted that the Appr Inst book is not a legal authoritative book)


Regarding the court cases that jdbiggers mentioned:

Maybe these judges sourced different definitions of the terms. And, maybe there are also cases that contrast with these ones and sided with the same/similar definition as found in the Appraisal Institute book.

Anyway…thanks for the helpful input Tim. I hope to not patronize you anymore.

 

[Ken B]

I'm a great fan of Occam's Razor. So...

If we are going to start referencing AI's The Appraisal of Real Estate, get your hands on the 13th Edition and read the information in the box in the bottom right corner of the opening page of Chapter 6 (page 111) and in the box at the top of page 473. Since you might not have the 13th Edition handy, allow me to quote the most appropriate text.

"...true fee simple ownership seldom exists because nearly all properties are encumbered to some degree by easements, reservations, or private restrictions...once a partial interest is created by a lease or mortgage, the fee simple interest becomes largely theoretical. Even so, many assignments call for the valuation of the fee simple interest." (page 111)

"To a certain extent, the interest being appraised determines how rents are analyzed and estimated. The valuation of fee simple interests in income-producing real estate is based on the market rent the property is capable of generating...To value the leased fee estate, the appraiser considers contract rent for leased space which may or may not be at market levels." (page 473)

So when an appraiser reports that the interest valued for a property encumbered by a lease (or leases) is the fee simple estate, you know that market rents were considered in the valuation. If the appraiser reports that the leased fee interest is valued, you know that contract rents were considered in the valuation. Valuation of the fee simple interest considers the potential income; valuation of the leased fee interest considers the contract income. If contract rents are representative of market rents, the value of the leased fee interest is comparable to the value of the fee simple interest in the property.

Good talk.

 

[shaxton24]

Ken,

I do appreciate all your points - all good. Including my using the older 11th edition. Funny and true.

I have no problem with appraising as a Fee Simple estate when there are easements, reservations, liens, etc. present. Because these are common items that are assumed not present, and stated as such in our standard assumptions and limiting conditions.

But it would have to be a hypothetical FS estate to analyze a property as Fee Simple when there are known tenants/leases in place. Thats my stance.

I had to read this carefully. I think I can agree with it fully:
"To a certain extent, the interest being appraised determines how rents are analyzed and estimated. The valuation of fee simple interests in income-producing real estate is based on the market rent the property is capable of generating...To value the leased fee estate, the appraiser considers contract rent for leased space which may or may not be at market levels."


But I don't know if you are in general agreement with me or not. But thats ok. Thanks for your comments.