A commercial office building is leased to a single tenant under a 20-year absolute net lease with rent escalating annually at 2.5% compounded. The tenant has invested $1.8 million in tenant improvements that will have no residual value at lease expiration. The appraiser is asked to value the leasehold interest. Which factor is MOST directly relevant to determining whether that interest has positive value?
Correct Answer
B) Whether the contract rent is less than or greater than current market rent for comparable space.
A leasehold interest has value to the tenant when contract rent is below market rent (a favorable lease), and negative value (a liability) when contract rent exceeds market rent (an unfavorable lease) — per USPAP Advisory Opinion 22 and the Appraisal of Real Estate (12th ed.), Chapter 29. Tenant improvements with no residual value are sunk costs and do not confer value to the leasehold unless they support occupancy under a below-market rent. Options A, C, and D relate to credit risk, physical life, and leased fee valuation — all irrelevant to the *existence* of leasehold value, which hinges solely on the rent differential. Thus, B is correct and most directly determinative.
Why This Is the Correct Answer
A leasehold interest has value to the tenant when contract rent is below market rent (a favorable lease), and negative value (a liability) when contract rent exceeds market rent (an unfavorable lease) — per USPAP Advisory Opinion 22 and the Appraisal of Real Estate (12th ed.), Chapter 29. Tenant improvements with no residual value are sunk costs and do not confer value to the leasehold unless they support occupancy under a below-market rent. Options A, C, and D relate to credit risk, physical life, and leased fee valuation — all irrelevant to the *existence* of leasehold value, which hinges solely on the rent differential. Thus, B is correct and most directly determinative.
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An appraiser is developing a band of investment rates for a mixed-use property in a transitioning neighborhood. She selects four reliable sources: (1) local commercial mortgage lenders’ current stated loan rates on stabilized properties; (2) recent equity investor return expectations cited in a CBRE market report; (3) historical IRRs from NCREIF Property Index for similar assets; and (4) the 10-year U.S. Treasury yield. Which of these four sources is LEAST appropriate for inclusion in the band of investment analysis?