Leased Fee Interest Valuation
Leased Fee Estate is the ownership interest that the landlord or lessor maintains in a property under a lease with the rights of use and occupancy being conveyed or granted to a tenant or lessee. The ownership interest in a leased property.
Fee simple or leased fee interest? It comes up daily for commercial appraisers and financial institutions. The current generally acceptable methodology is, if there’s a lease, you must present the leased fee interest. There’s not a lot of discussion and interpretation surrounding this method. However, as an appraiser it often generates questions such as, “shouldn’t we be determining how a typical buyer would view the lease and its impact on value? Should you really present the leased fee interest if there’s only 30 days remaining on a lease? What about three months? What about eight months?” Lots of questions, few consistent answers. And it seems everyone would be served better with some consistency.
A Problematic Issue
The issue must be problematic enough for the Appraisal Institute to draft the Property Rights Symposium Discussion Paper dated December 21, 2017. The purpose of the paper was to generate broader discussion and feedback. The paper indicates valuation standards require that the interest or rights be identified and reported in the valuation report. Typically these include a discussion of fee simple, leased fee or leasehold interests. One issue is if the assignment is to value the fee simple estate and the property type is typically leased and sold as leased, the question arises as whether it should be valued as though occupied or as though vacant. Notwithstanding eminent domain and property taxation where the law or regulation generally requires the fee simple estate (even if a lease exists), this issue often comes up with financial institutions, specifically when the lease income is needed to repay a loan. What about the risk of unexpected vacancy, potential lease-up costs, retrofit and maybe the loss of a national tenant replaced with a “mom and pop” tenant with much lower rent and higher capitalization rate?
The paper brings up the issue: does fee simple mean vacant and available for lease or occupancy? If so, should deductions be made for lease up time and cost? Does fee simple imply a “go dark” scenario? Also, how does the interest valued relate to your selection and adjustment of your comps and selection of an appropriate capitalization rate? Some of the suggestions indicate tweaking the fee simple definition and whether leased fee and leased fee estates should continue to be included in valuation practice.
Back in the Day
“Back in the day,” we always reported the fee simple interest even if it was subject to existing leases. We knew as appraisers to use our local knowledge of how typical buyers of a particular property grade would consider leases and their impact on value. It seems like the current climate of rigid definitions and lack of appetite for interpretation by the appraiser hired is causing valuation issues and disagreements. Some of it may come from the declining trust in appraisers, often regulated to the discussion sidelines due to Dodd Frank. I think we’ve lost some of our common sense along the way. That said, asking for industry feedback is productive and keeps appraisers in the valuation discussion. We need to communicate clearly to our clients about this issue. If you would like to chime in on this or any other topic as a guest writer, please feel free to reach out to me.
