A medical office building is leased to a physician group under a 12-year lease with rent set at $24.00/sf/year, escalating 3% annually. Market rent for similar space is currently $26.50/sf/year and is projected to grow at 2.75% annually. The appraiser calculates the present value of the rent differential (market minus contract) over the lease term at a 7.5% discount rate and arrives at $1,024,000. What does this figure represent?
Correct Answer
B) The value of the leasehold interest.
The present value of the rent differential (market rent minus contract rent) over the lease term equals the value of the leasehold interest — i.e., the value to the tenant of occupying under below-market terms. This is a core principle of leasehold valuation in the Income Approach (Appraisal of Real Estate, 12th ed., Ch. 29; USPAP AO-22). Here, contract rent < market rent, so the leasehold has positive value — precisely the $1,024,000 computed. Option A is incorrect: leased fee value includes the contract rent stream *plus* the reversion. Option C is unrelated — functional obsolescence arises from design deficiencies, not rent differentials. Option D is incorrect because fee simple includes full market rent rights, not just the leasehold benefit.
Why This Is the Correct Answer
The present value of the rent differential (market rent minus contract rent) over the lease term equals the value of the leasehold interest — i.e., the value to the tenant of occupying under below-market terms. This is a core principle of leasehold valuation in the Income Approach (Appraisal of Real Estate, 12th ed., Ch. 29; USPAP AO-22). Here, contract rent < market rent, so the leasehold has positive value — precisely the $1,024,000 computed. Option A is incorrect: leased fee value includes the contract rent stream *plus* the reversion. Option C is unrelated — functional obsolescence arises from design deficiencies, not rent differentials. Option D is incorrect because fee simple includes full market rent rights, not just the leasehold benefit.
More income-approach Questions
In a percentage lease, rent is commonly structured as:
Escalation clauses and expense stops in a lease matter to the income analysis because they:
In a DCF, what is the reversion?
Potential gross income differs from effective gross income in that PGI assumes:
The reversion in a discounted cash flow model represents:
Two identical buildings differ only in risk: one has a single tenant on a short lease, the other five tenants on staggered terms. How do their cap rates compare?
Contract rent on a leased office is $30 per sq ft; market rent is $26. The $4 difference is called:
Building A (new, credit tenant, 20-year lease) and Building B (older, month-to-month tenants) sell the same week. Their cap rates should differ how?
An appraiser is analyzing a 15-unit apartment building. Market research indicates a 6% vacancy rate is typical for similar properties, but this property's historical vacancy has averaged 4%. The subject has experienced a 1% collection loss (uncollectible rents) over the past two years. When estimating effective gross income for the subject, what vacancy and collection loss percentage should the appraiser apply?
An overall rate extracted from a sale whose NOI excluded reserves, applied to a subject NOI that includes them, will:
People Also Study
Valuation Principles & Procedures
25% of exam
Property Description & Analysis
20% of exam
Market Analysis & Highest/Best Use
15% of exam
Appraisal Math & Statistics
15% of exam
USPAP (Ethics & Standards)
15% of exam