A ground lease was signed twenty years ago at rent well below today's market. What follows for the leased fee value?
Correct Answer
C) It falls below the unencumbered value of the land
Why this is correct: The leased fee estate is the landlord's interest, receiving the contract rent. If contract rent is below current market rent, the leased fee's value (present value of that below-market income stream) is less than the fee simple value (unencumbered land value). The tenant's leasehold estate holds the positive value of the rent savings. Why the other choices are wrong: "It exceeds the unencumbered value of the land" would occur if contract rent were above market. "It equals the unencumbered value of the land" would occur only if contract rent equals market rent. "It cannot be estimated until the lease expires" is false; it can be valued based on the existing lease terms. Exam tip: Below-market lease = leased fee value < fee simple value. The difference is leasehold value.
Why This Is the Correct Answer
The leased fee is the right to below-market contract rent plus the reversion, so its value falls below the unencumbered land value by the amount transferred to the leasehold.
Why the Other Options Are Wrong
Option A: It exceeds the unencumbered value of the land
Value would exceed the unencumbered figure only where contract rent is above market, which is the reverse of this case.
Option B: It equals the unencumbered value of the land
The two are equal only where contract rent equals market rent, so no advantage passes to either party.
Option D: It cannot be estimated until the lease expires
The leased fee is routinely valued during a lease term by discounting the contract rent and the reversion. Waiting for expiry is unnecessary.
Below Market Costs the Landlord
Below Market Costs the Landlord. What the owner gives up, the tenant holds.
How to use: Check the two interests sum to roughly the unencumbered value. That reconciliation catches directional errors.
Exam Tip
Remaining term drives the magnitude. The same rent shortfall matters far more with fifty years to run than with two.
Common Mistakes to Avoid
- -Reversing the direction of the effect
- -Ignoring the remaining term
- -Omitting the reversion from the leased fee analysis
Concept Deep Dive
Analysis
The leased fee is what the landowner owns: the right to receive the contract rent for the lease's remaining term plus the reversion of the property at its end. When contract rent sits well below market — as a twenty-year-old ground lease commonly does — the income stream the owner actually receives is worth less than the stream the land could command, so the leased fee value falls below the unencumbered land value. The shortfall is the value of the leasehold, which the tenant holds: the tenant occupies land worth more than they pay for. The two interests together sum to something close to the unencumbered value, which is a useful check. Two factors govern the size of the gap: how far below market the contract rent sits, and how long the lease has to run. A large discount with fifty years remaining is a substantial transfer of value; the same discount with two years remaining is nearly immaterial, since the reversion arrives soon.
Background Knowledge
The leased fee comprises the right to contract rent for the remaining term plus the reversion. Below-market contract rent reduces leased fee value relative to the unencumbered value, with the difference accruing to the leasehold.
Real-World Application
An appraiser values a leased fee by discounting twenty years of below-market ground rent plus the reversion, arriving well below the unencumbered land value.
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