A 50-unit apartment complex is subject to a 99-year ground lease with annual land rent fixed at $75,000, payable in perpetuity. The improvements were constructed by the leaseholder and will revert to the landowner at lease expiration. The appraiser is developing a market value opinion of the leasehold interest. Which statement BEST describes the appropriate income approach treatment?
Correct Answer
C) Calculate the present value of the NOI attributable to the improvements over the remaining lease term, less the present value of the fixed ground rent payments over the same term.
For a leasehold interest with a finite term (even if long), the income approach requires discounting the net income attributable to the leasehold (i.e., NOI less ground rent) over the lease term, plus any reversionary value — but here, improvements revert, so no reversion value accrues to the leaseholder. USPAP Standards Rule 1-2 and the Appraisal of Real Estate (12th ed.) state that leasehold value is the present value of the benefit of paying below-market (or fixed) rent — here, the benefit is the spread between market land rent and the fixed $75,000, but more directly, it’s the NOI from operations minus the contractual ground rent, discounted over the lease term. Option C correctly specifies this finite-term DCF treatment. Option A incorrectly treats ground rent as a deduction from a fee-simple NOI; Option B is vague and avoids the required term-limited analysis; Option D violates USPAP by ignoring the legal restraint on ownership duration.
Why This Is the Correct Answer
For a leasehold interest with a finite term (even if long), the income approach requires discounting the net income attributable to the leasehold (i.e., NOI less ground rent) over the lease term, plus any reversionary value — but here, improvements revert, so no reversion value accrues to the leaseholder. USPAP Standards Rule 1-2 and the Appraisal of Real Estate (12th ed.) state that leasehold value is the present value of the benefit of paying below-market (or fixed) rent — here, the benefit is the spread between market land rent and the fixed $75,000, but more directly, it’s the NOI from operations minus the contractual ground rent, discounted over the lease term. Option C correctly specifies this finite-term DCF treatment. Option A incorrectly treats ground rent as a deduction from a fee-simple NOI; Option B is vague and avoids the required term-limited analysis; Option D violates USPAP by ignoring the legal restraint on ownership duration.
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