Post on 27-Dec-2015
Chapter 9:Leased Fee and Leasehold Valuation
IntroductionLeases affect typical investment returns by
impacting:Net operating incomeReversionary value estimateFinancing optionsInvestment risk
Ownership interests subject to leases
Leased fee interest (leased fee estate)
Could be greater than, less than, or equal to the market value of the fee simple interest
Typical purchaser is a real estate investor
Value = PV of NOI considering existing leases + PV of reversion from resale of property at end of holding period
Discount rate used is that desired by the purchasers of leased fee interests
Ownership interests subject to leases
Leasehold interest (leasehold estate)
Typical purchaser is a tenant
Value = PV of rent differentials between the contract rent and market rent
Discount rate is the rate desired by purchasers of leasehold interests
Ownership interests subject to leases
Value of leased fee interest plus the value of the leasehold interest may or may not equal the value of the fee simple interest
Investors of leased fee interests operate in different markets than investors in leasehold interests.
Investment criteria may differInvestment horizons may differ
Cash-flow forecasting with existing leases: the lease agreement
Important considerations affecting cash flow in the lease agreement:
Date of agreement Date of execution of the lease Date the rental payments begin Date the lease expires Date of any renewal options Date of notice
Parties to the lease (check for arm’s length agreement)
Description of the leased premises
Uses allowed for the property
Cash-flow forecasting with existing leases: the lease agreementPayment amount and method of calculation of rent:
Contract rentFixedBased on price index
Percentage rentOverage rentExcess rent
Expenses:Gross leaseAbsolute net leaseNet leaseNet net net lease (triple net lease)Expense pass-through
Remaining lease provisions
Net operating income forecast
Contract rents
Absorption of unleased space
Vacancy and collection loss allowances
Income from other sources
Operating expensesExpense pass-throughFixed expensesVariable expenses
Resale proceeds forecast
MethodsActual dollar forecastChange in value over the holding periodTerminal capitalization rate
Leased fee NOI may change at a different rate than market NOI
Resale proceeds forecast
A significant change in NOI because of lease renewals may not induce an equal change in the value of the lease-fee estate over the same time period
Value of the lease-fee estate depends on both the NOI from the existing leases and the proceeds from resale of the property at the end of the holding period
The resale price of the property at the end of the holding period depends on the expected NOI in the years after the property is sold
Resale proceeds forecast
Terminal capitalization rate may have to be adjusted if leases have not expired at end of holding period.
Leased-fee discount (yield) rate
May be higher, lower or equal to fee simple discount rate
Depends on credit rating of tenants and whether leases are above or below market
Example: Market Assumptions
Gross building area: 24,000 sqft
Net building area: 20,000 sqft
Market rent: $15/sqft
Income: Increasing at 4% per year for 5 years
Vacancy: Level at 6% per year
Management: 5% of EGI
Property tax: $11,900 level for 3 years, increasing to $15,000 in years 4-6
Insurance: $0.20 per sqft of net rentable area, increasing by 3% per year
Utilities: $1.25 per sqft of gross area, increasing by 5% per year
Janitorial: $0.90 per sqft of net rentable area, increasing by 4% per year
Maintenance: $4,000 per year increasing by 3% per year
Example: Fee simple value estimate
Assuming a 5 year holding period, if I=12%, solving for NPV gives a value estimate of $2,142,209
1 2 3 4 5 6PGI 300,000 312,000 324,480 337,459 350,958 364,996Less vacancy and credit loss 18,000 18,720 19,469 20,248 21,057 21,900
EGI 282,000 293,280 305,011 317,211 329,901 343,096Less operating expense 82,000 85,024 88,138 94,580 98,021 101,616
NOI 200,000 208,256 216,873 222,631 231,880 241,480
Net resale proceeds2,414,80
0
Example: Market Assumptions
Gross building area: 24,000 sqft
Net building area: 20,000 sqft
Market rent: Increasing by 4% per year
Vacancy: 6% of released space; 0% during term of existing leases
Management: 5% of EGI
Property tax: $11,900 level for 3 years, increasing to $15,000 in years 4-6
Insurance: $0.20 per sqft of net rentable area, increasing by 3% per year
Utilities: $1.25 per sqft of gross area, increasing by 5% per year
Janitorial: $0.90 per sqft of net rentable area, increasing by 4% per year
Maintenance: $4,000 per year increasing by 3% per year
Example: Existing Leases Present
Tenant
Leased area(sqft
)
Current annual
rent
Contract rent/sqf
tRemainin
g term
Market rent/s
qft Comments
C&B Bank 10,000 $100,000 $10.00 4 year $15.00 Tax stop above $0.20 per sqft
Valley Mortgage 6,000 $69,000 $11.50 1 year $15.00
2-year option @$13 per sqft
Apex Insurance 4,000 $48,000 $12.00 3 years $15.00
2% annual increase
Example: Leased fee value estimate
Assuming a 5 year holding period, if I=12%, solving for NPV gives a value estimate of $1,962,344
Year 1 2 3 4 5Income C&B Bank $100,000 $100,000 $100,000 $100,000 $175,479 Valley Mortgage $69,000 $78,000 $78,000 $101,238 $105,287 Apex Insurance $48,000 $48,960 $49,939 $67,492 $70,192 Total $217,000 $226,960 $227,939 $268,730 $350,958 Vacancy @ 6% $0 $0 $0 $10,124 $21,057 EGI $217,000 $226,960 $227,939 $258,606 $329,901 Expenses Management $10,850 $11,348 $11,397 $12,930 $16,495 Property tax $11,900 $11,900 $11,900 $15,000 $15,000 Insurance $4,000 $4,120 $4,244 $4,371 $4,502 Utilities $30,000 $31,500 $33,075 $34,729 $36,465 Janitorial $18,000 $18,720 $19,469 $20,248 $21,057 Maintenance $4,000 $4,120 $4,244 $4,371 $4,502 Total expenses $78,750 $81,708 $84,328 $91,649 $98,022 Pass-throughs $3,950 $3,950 $3,950 $5,500 0NOI $142,200 $149,202 $147,561 $172,457 $231,879