An appraiser is developing a stabilized rental income model to value the fee simple interest in a leased property. Contract rent is $1,100 and market rent is $1,275. Which rent is the appropriate base for the model?
Correct Answer
D) The $1,275 market rent, with lease effects addressed separately when relevant.
The fee simple stabilized model uses market rent, while existing lease effects must be addressed when the appraised interest is leased fee. Market value does not universally mean ignoring enforceable contracts. Align the rights and cash-flow model before drawing a conclusion.
Why This Is the Correct Answer
Option D is correct because the fee simple model uses market rent, $1,275, and the fee simple interest is estimated without regard to actual lease arrangements. Lease effects are then addressed separately when a leased-fee interest is being appraised.
Why the Other Options Are Wrong
Option A: The $1,100 contract rent, because the existing lease controls the model.
Option A, the $1,100 contract rent because the existing lease controls the model, fits a leased-fee analysis, not the fee simple model. The fee-simple model uses market rent, with lease effects handled separately.
Option B: The lower of the two rents, as a conservative base for the model.
Option B, the lower of the two rents as a conservative base, picks a rent for its size rather than for the property rights being appraised. Conservatism is not a basis for choosing rent; the fee-simple model calls for market rent of $1,275.
Option C: An automatic average of contract and market rent.
Option C, an automatic average of contract and market rent, has no support in the model. Averaging blends two different rights bases and does not reflect either the fee simple or the leased fee interest.
Fee simple, market rent
Fee simple ignores the existing lease and uses market rent; leased fee follows the lease and uses contract rent.
How to use: Use this pairing to choose the rent base once you know which interest is being appraised.
Exam Tip
Identify the property rights appraised before choosing a rent; the correct rent follows from the interest, not from which number is higher or lower.
Common Mistakes to Avoid
- -Using contract rent for a fee-simple valuation
- -Choosing the lower rent to be conservative
- -Averaging contract and market rent
Concept Deep Dive
Analysis
This question tests matching the rent used to the property rights being appraised. A fee-simple stabilized model uses market rent because the unencumbered fee simple interest is valued without regard to actual leases. Existing lease effects are analyzed separately when the leased-fee interest is relevant.
Background Knowledge
Fee simple is ownership unencumbered by leases, so its income is based on market rent. Leased fee is the landlord's interest subject to existing leases, so contract rent and lease terms matter. The appraiser identifies the interest appraised first and then selects the rent and cash-flow model that fit it.
Real-World Application
A lender asks for the fee simple market value of a rented house where the tenant pays $1,100 under an old lease but market rent is $1,275. The appraiser uses $1,275 in the fee-simple income analysis and notes the below-market lease separately.
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An appraiser estimates potential gross income for a lawful four-unit building at full occupancy and current market rents. One rentable unit is occupied rent-free by the owner. How is that unit included in PGI?