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

[leasedfee]

SHaxton,

The challenge is that rarely do we ever appraise a pure fee simple estate. Take a development pad site somewhere, there are numerous minor utility easements, access and cross easements, annexation or developer's agreements recorded against the land, and the platting creates private covenants and restrictions (uses, heights, architecture, density, etc.). Nonetheless, at loss of purity, we'd still call it a fee simple parcel that can be fully developed with a building. .... In my first post a gave some reasons why a small leased fee interest may be sufficiently minor over the economic life of 50 years or so. We agree that the definitions are pretty clear and I argue in favor of the lexicon. At the same time, some grayness should exist lest our OCD hampers our ability to do any appraisal at all. In my earlier political days, there was a maxim, "don't make the perfect the enemy of the good" -- but where does that line fall? ... I once had a report turned into the state because another appraiser thought my market rent conclusion at 50-cents/sf higher (about 5% higher) than the current lease rate, having 18 months remaining, was too high. This person also felt that a leasehold wasn't properly handled (the LH ranged from $0 to $3000 on a $700,000 property) correctly. Sigh, I hate my profession (as have a number of my prior colleagues admitted to me in private).

 

[shaxton24]

Thanks Tim.

That is good advice. I will humbly take it to heart!

That was harsh getting turned into the state like that. Wow. Interesting story though!

 

[Ken B]

So I was sitting on my back porch last night watching the sun set and enjoying an adult beverage when I had an epiphany. The value of the fee simple interest in a leased property isn't hypothetical. The interest is simply theoretical.

Deed books are full of transfers the fee simple interest in leased property. Naturally, that interest is subject to existing leases and various other encumberances. Deeds do not report that the "hypothetical" fee simple interest in these properties is being transferred.

So why, in our analysis, do we need to try to confuse the issue by asserting that fee simple interest in leased property can not exist and thus must be valued as a hypothetical condition? Market rents are not hypothetical. I suppose if we asserted that market rent was something other than what it is and utilized that asserted rent in our analysis, we would need to state that as a hypothetical condition.

If, using market rents to value a leased property, we did not refer to the interest appraised as the "fee simple interest", how would we differentiate the valuation of the property utilizing market rents versus contract rents? It wouldn't be the hypothetical value of the interest. It is the value of a theoretical interest.

Conversely, utilizing market rents to value the leased fee interest would require a hypothetical condition that market rents represented contract rents. I think that would create the potential for more confusion than simply identifying that the interest appraised when using market rents is the fee simple interest, even though that may be a theoretical interest.

 

[leasedfee]

Sometimes relying on appraisal definitions written by appraisers creates an echo chamber affect, so I grabbed West's Business Law, 4th Ed. (1989) to get more of a lawyer's perspective. While this is not authoritative as specific state statutes, it helps me try to "mirror" the lawyer's understanding of the world.

Rights of ownership in real property, called estates, are classified according to their nature, interest, and extent. (p. 910)
...
Free Hold Estates
The Fee Simple Absolute. In a fee simple absolute, or fee simple, the owner has the greatest aggregation of rights, privileges, and power possible.... The owner of a fee simple absolute also has the rights of exclusive possession and use. (p. 910; book's emphasis)
...
Nonfreehold Estates...
These estates include:
1. A tenancy for years.
2. A periodic tenancy.
3. A tenancy at will.
4. A tenancy at sufferance.

All, except a tenancy at sufferance, involve the transfer of the right to possession for a specified period of time. The owner or lessor (landlord) conveys the property to the lessee (tenant) for a certain period of time. In every nonfreehold estate, the tenant has a qualified right to exclusive possession (qualified by the right of the landlord to enter upon the premises to assure that no waste is being committed). This is called a leasehold estate. ... (p. 912, book's emphasis)​

It goes on to discuss conveyance by types of deeds and warranties of title (p. 914):

A covenant against encumbrances guarantees that the property being sold or conveyed is not subject to any outstanding rights or interests that will diminish the value of the land, except as stated. Examples of common encumbrances include mortgages, liens, profits, easements, and private deed restrictions on the use of land. [my underlining]​

Deeds will often have schedules taken from the title commitment attached in the addendum, sometimes just a generic clause, or sometimes reference to prior deeds or even leases.

Chapter 53, Landlord-Tenant

.... In most states, statues mandate that leases be in writing for some tenancies (such as those exceeding one year). (p. 927)
​

It writes about how the tenant (leasee)-landlord (leasor) relationship is established, and the various rights. A few of which include "Landlord's Duty to Deliver Possession", "Tenant's Right to Retain Possession", and "Covenant of Quiet Enjoyment"

"After obtaining possession, the tenant retains it exclusively until the lease expires,...."(pp. 928-929).​

Rent is the tenant's payment to the landlord for the tenant's occupancy or use of the landlord's real property. (p. 933)
​

The Language of Real Estate, 3rd Ed., John Reilly, describes the leased fee estate in familiar:

The interest and rights of the lessor in real estate that the lessor has leased. The lessor has a right to receive rental income and a right to possess the property at the end of the lease.
​

In my opinion: If there is a leased fee estate, the estate has been partitioned. Thus, the fee simple value is the hypothetical condition that that specific lease encumbrance is not in place and that the owner has full rights. Practically it would seem that'd mean the owner would (another possible assumption) lease an income property at market rent OR the assumption that the owner enjoys full utility in lieu of cash rent. The owner is still the owner and can transfer title of the current estate via deed.

 

[Ken B]

If there is a leased fee interest, there is a corresponding leasehold interest. How would one develop an opinion of value for a leasehold interest?

 

[shaxton24]

If there is a leased fee interest, there is a corresponding leasehold interest. How would one develop an opinion of value for a leasehold interest?

And how about this:

My AI coursebook says that: V (overall) = Value LF + Value LH
So this begs the question: what is Vo? Is it the theoretical "Value if leased at market"?

And does the value of the LH estate include a big discount for the actual sale price of this hard-to-sell interest to a 3rd party? Or is it valued at just what it is worth to the tenant - which would be Investment Value, not Market Value?


*****

--I'm still thinking through Ken's back porch theorizing. Good points worth thinking over.

I will admit that my opinions have been based on the Appr Institutes's textbook "The Appr of RE" (although not on their courses which don't seem to opine on this matter). However, Tim is right that the true basis is Law. Wow, he did some good research there! Does the Appraisal Foundation offer the final Law on the matter?

Whatever the conclusion is, it should be a concrete one. Because how do you value something you can't define?

 

[leasedfee]

The deeper down the rabbit hole you go into valuation theory the more you realize the holes. Pun not intended, or maybe it is. . . . . . . Take for example: the "pure" fee simple vs. the "typical" fee simple pad site. Would you have to use "pure" fee simple comps, presumably agricultural parcels outside of the path of human beings. So does the granting of minor utility/access easements, platting, etc. -- rather than taking away from the bundle of rights -- really create a network effect, which thereby increases value? .... There are more "deep" issues but for today .......
:new_all_coholic:

 

[Ken B]

I thought my question regarding developing an opinion of value for the LH interest was weak as I was typing it. 310 was a long time ago (recognizing that time is relative), but I thought I remembered it was taught that the value of the LH was calculated by deducting the value of the LF from the value of the FS. I recognize that is a bit too simplistic.

 

[shaxton24]

Land... and Fee Simple

Example: Land with utility/access easements, platting, required HOA's, required landscaped common areas, setbacks, etc.

I don't see any problem with Fee Simple defining this land. FS includes zoning-type rights being taken from an owner via police power resulting from local laws.

 

[shaxton24]

But say private easements/access agreements attached to land. That is not police power, but I suppose that is getting too technical to worry about defining it as something other than Fee Simple.