A property is leased at $22 per square foot when market rent is $28. The difference creates:
Correct Answer
D) A leasehold advantage to the tenant, reducing the leased fee value
Why this is correct: The governing concept is that a lease with a contract rent below market rent creates a leasehold estate, which is an advantage for the tenant. This advantage is a separate, valuable interest that reduces the value of the owner's leased fee estate. The original explanation correctly states the $6 per foot bargain leaves the owner's interest. Applying this, the leased fee value is lower than the fee simple value because a buyer would pay less for the property subject to this below-market lease. Why the other choices are wrong: 'A required rent increase at the next anniversary date' is wrong because lease terms are fixed by contract; rent does not automatically increase to market rate. 'An immediate increase in the property's leased fee value' is wrong because a below-market lease decreases, not increases, the leased fee value. 'No effect, since only market rent matters for valuation' is wrong because the actual contract rent, not just market rent, determines the cash flow to the leased fee owner, directly impacting value. Exam tip: Remember: Below-market lease = leasehold advantage (tenant benefit) = leased fee value penalty.
Why This Is the Correct Answer
Option D is correct because contract rent below market creates a bargain for the tenant, which is a positive leasehold, and the mirror image of that bargain is a reduced leased fee. The owner is contractually locked into collecting less than the space commands, and the reduction persists for the remaining lease term. Quantifying it means discounting the $6 per square foot annual shortfall over the remaining term at an appropriate rate and subtracting it from the fee simple indication. The reversion at lease end still returns the property to market rent, which is why the discount is term-limited rather than permanent.
Why the Other Options Are Wrong
Option A: A required rent increase at the next anniversary date
Rent changes only when the lease document provides for them, through escalation clauses, indexed increases, or scheduled steps. Nothing in law raises contract rent to market at an anniversary date, and a lease that lacked such a clause would keep the below-market rent for its full term. That fixity is precisely why the shortfall reduces the owner's interest.
Option B: An immediate increase in the property's leased fee value
This inverts the effect. Below-market rent means the owner collects less than the space would command, so the leased fee is worth less, not more; it is above-market contract rent that lifts leased fee value above fee simple. Selecting this option means reading the bargain as running to the landlord when it runs to the tenant.
Option C: No effect, since only market rent matters for valuation
Market rent alone determines fee simple value, but a leased fee assignment values the actual contractual cash flows the buyer will inherit. Ignoring contract rent would produce a value no informed purchaser would pay, since the purchaser cannot collect market rent until the lease expires. The property rights appraised are part of the assignment definition and drive which rent applies.
The bargain belongs to somebody
Compare contract rent to market rent and ask who got the better deal. Tenant pays less than market, so the tenant holds the bargain and the landlord's leased fee shrinks. Tenant pays more than market, and the bargain flips to the landlord.
How to use: Write the two rents side by side, circle the smaller contract rent, and let the arrow point to the tenant. Then confirm the answer choice moves leased fee value in the opposite direction.
Exam Tip
Check which property rights the question asks you to value. A stem that says leased fee is telling you contract rent controls, not market rent.
Common Mistakes to Avoid
- -Valuing a leased fee at market rent and ignoring the contract
- -Reversing which party benefits from below-market rent
- -Discounting the rent shortfall in perpetuity instead of over the remaining term
- -Failing to state the property rights appraised when a lease is in place
Concept Deep Dive
Analysis
This tests how a lease splits the fee simple estate into two interests and how below-market contract rent shifts value between them. When a property is leased, the owner holds the leased fee, which is the right to receive contract rent plus the reversion at lease end, and the tenant holds the leasehold, which is the right to occupy at the agreed rent. Fee simple value assumes market rent; leased fee value depends on the rent actually contracted. With contract rent at $22 and market rent at $28, the tenant occupies for $6 per square foot less than the space is worth, so the tenant enjoys a positive leasehold advantage and the owner receives an income stream worth less than market. A buyer takes the property subject to that lease and pays accordingly, so the leased fee value falls below the fee simple value by roughly the present value of the $6 shortfall over the remaining term.
Background Knowledge
You need the vocabulary of divided interests: fee simple, leased fee, leasehold, contract rent, market rent, and reversion. You also need to know that a positive leasehold arises when contract rent is below market, that the leased fee and leasehold together sum to something close to the fee simple value, and that the property rights appraised must be stated in the assignment.
Real-World Application
You appraise a retail building whose anchor signed a long lease years ago at $22 when comparable space now leases at $28. You value the fee simple from market rent, then discount the annual shortfall over the seven remaining years and report a leased fee value below it, disclosing the property rights appraised in the report.
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