Nothing in this short article is an attempt to provide legal advice. The author is not an attorney and is not suggesting the use of one type of real property conveyance versus another. The article is directed to real property appraisers and discusses the valuation of long-term lease interests.
Long-term leases are often negotiated between parties when securing a fee interest is not possible, or when there is some advantage to both parties to not convey a fee interest, and appraisers are often asked to value either the leasehold or the leased-fee interest.
The leased-fee interest is the interest that the owner of the real property retains once a lease has been given. While use and occupancy is generally conveyed via a lease the "leased-fee owner" generally gains an interest in the benefits of the lease and retains his or her interest in the remainder. Once the lease runs its course or is mutually cancelled the owner gets the real property back free and clear of the lease.
A long term lease is often favored when a landowner wants to benefit from an expected strong appreciation of real property. They ask, why sell when a lease will give them the benefit of the property's strong appreciation? Leases of this type can have a number of provisions. They may call for cost of living / consumer price index adjustments. They may have preset increases that have been established based on historical appreication, they may call for periodic re-appraisal dates or they may call for adjustments based on changes in the gross income produced at a property.
The tenant on the other side of a long-term lease can benefit from not having to pay full value for the real property. A long-term lease can allows for an investment in a property that many banks will share in, since there can be sufficient time to garner a return from an investment in improvements before lease expiration.
An appraiser must remember that appraising a long-term leased-fee interest is in fact appraising a partial interest in real property that has primarily to do with the income that may be gained over time and with the value of the fee once the lease expires. Its also important for appraisers to consider the risk associated with the leased-fee owner's receiving the benefits established by the lease.
For some appraisers its hard to imagine that a poorly crafted lease could destroy a landlord / owner's reasonable return from a property, but I have personally evaluated long-term leases that provide the leased-fee owner a return that is 1/10th or less of the market rate that will continue to provide a similar below market return for decades while landlord expenses (like taxes) continue to increase. So a leased-fee interest can be relatively small while the fee interest can be very large. An example of this relationship are the leases established in Las Vegas on the Strip and Downtown many years ago that started from fixed rates with poor adjustment terms that did not consider the growth that would occur.
The opposite extreme can exist, if lease terms dictated a constant percentage increase like 10%. When real property values fall or when there is little appreciation a lease rate increase of 10% each and every year dooms the tenant to failure. That's why so many leases use the Consumer Price Index (CPI) as a method to adjust the rental rate over time. Since the CPI over time doesn't always track the value of real property, its my opinion as an analyst that re-appraisal during the term of a lease is one of the best ways of keeping a lease rate fair.
For more appraisal information contact Glenn Rigdon
MA, MRICS, ASA is a Las Vegas / Henderson Nevada appraiser who can be contacted via email or via his business website Appraiser Las Vegas
), or you can also click on “Contact Us” on the home page of this website or visit my public profile at LinkedIn at http://www.linkedin.com/pub/glenn-rigdon-ma-mrics-asa/1a/30b/879/
Article source: http://www.appraisalarticles.com/General-Appraisal-Articles/4314-Appraising-the-99-Year-Lease.html