Assessment of Present Market Value of Leasehold Property
A leasehold agreement conveys the rights of a tenant to use and occupy a landlord’s space for a stated term under certain conditions through a lease. The value of the agreement is generally determined by the terms of the agreement — specifically, the actual rental rate relative to fair market rental rates. If the actual rental rate is lower than fair market rental rates, the renter benefits, and if it is higher than fair market, the property owner benefits. Valuing the leasehold agreement can be done in several ways for each circumstance.
Calculate Fee Simple Interest
Think of fee simple interest as the fair value of the property. If you cannot obtain this from an appraisal report or online via the local tax assessor, you can use several methods to estimate the fair value of a property. It is always best for a qualified real estate appraiser to perform real estate appraisals, but in their absence you can obtain comparable transactions of properties as close to the subject property as possible. In the case of an income-generating property, net operating income is capitalized, or converted to value, to determine fair value. This may be slightly more difficult to perform, as you need to calculate net operating income using fair market rental rates and operating margins and also using an appropriate capitalization rate.
Calculate Leased Fee Interest
The leased fee interest equals the fair value held by the lessor, which you can think of as the value of the lease in the hands of the property owner. Estimate the values of both the leased fee and leasehold interests using an income approach to valuation. You may have to adjust the discount rate — which reflects prevailing costs of capital for local real estate investors in the relevant real estate type — upward to reflect any risk stemming from the relationship between contract rent and market rent.
Leasehold Interest Calculation
Calculate the leasehold interest using the same principles you used to value the leased fee interest. However, if you have already calculated the values of the fee simple interest and the leased fee interest, you should already have your leasehold interest value. Use the following formula to determine the fair value of the leasehold interest: Fee simple interest minus leased fee interest equals leasehold interest. If the resulting value is negative, the leasehold interest holds no value.
Use the Income Approach to Value the Leasehold Interest
Calculate the present value of the beneficial lease terms over the life of the lease. Multiply the annual savings generated by the relatively lower rent expense by the appropriate present value factor. You can estimate annual savings generated by the leasehold interest by subtracting actual rental fees from fair market rental fees. Use the weighted average cost of capital, also referred to as the discount rate, to calculate the present value factor. Apply the present value factor to the cost savings each year and then take the sum of savings generated in all years. Calculate the present value factor using this formula: 1 / (1 + r)^n, where “r” equals the discount rate and “n” equals the time period.