An enforceable below-market lease expires in five years, with no renewal rights; supported market rent is higher. How should that expected transition affect today's leased-fee model?
Correct Answer
A) Include the anticipated transition to market terms and its costs in the forecast/reversion.
An anticipated expiry and market-rent reversion should already affect current leased-fee value. Expiration alone does not require an unanticipated instantaneous value jump. Under the stated ability to relet at higher rent, model the transition and associated vacancy, costs and market risk.
Why This Is the Correct Answer
Option A is correct because the anticipated transition to market terms, along with its downtime, leasing costs and market risk, already affects current leased-fee value and belongs in the forecast or reversion. Value reflects expected future benefits, so a known expiration is included now rather than waiting for it to happen.
Why the Other Options Are Wrong
Option B: Assume the leased-fee value becomes zero at lease expiry.
Option B is wrong because leased-fee value does not become zero at lease expiry. When the lease ends, the lessor regains the right to relet at market rent, so the property keeps substantial value.
Option C: Ignore the transition until the expiration date.
Option C is wrong because ignoring the transition until the expiration date leaves an expected future change out of today's value. An anticipated expiry and reletting at market rent should already be reflected in the current forecast.
Option D: Assume a sudden value jump at expiry that the current forecast does not anticipate.
Option D is wrong because assuming a sudden value jump at expiry that the current forecast does not anticipate conflicts with modeling expected events. When the transition is anticipated, its effect is already built into current value, so expiration alone does not require an unanticipated instantaneous jump.
Expected Is Already Priced
If the market can see the lease ending, today's value already counts the move to market rent and its costs.
How to use: Use this idea when a question asks how a known future lease change affects current value.
Exam Tip
Choose the answer that models anticipated changes in the forecast now, including transition costs, rather than one that waits for the event.
Common Mistakes to Avoid
- -Ignoring a known lease expiration until it occurs
- -Assuming leased-fee value disappears at lease expiry
- -Leaving out downtime and leasing costs in the transition to market rent
Concept Deep Dive
Analysis
This question tests how an anticipated lease expiration enters a current leased-fee valuation. Because the market already expects the below-market lease to end in five years and the property to relet at higher market rent, that transition is part of today's forecast. The model should show contract rent until expiry, then the move to market terms with its vacancy, costs and risk.
Background Knowledge
Value is the present worth of anticipated future benefits, so expected events such as lease expirations affect value today. In a leased-fee DCF, the forecast typically shows contract rent through expiration and market rent afterward, with allowances for vacancy, leasing costs and risk. A below-market lease reduces leased-fee value only for the remaining term.
Real-World Application
An appraiser values a warehouse leased well below market with five years left and no renewal option. The DCF shows the low contract rent through year five, then a downtime period, tenant improvements and leasing commissions, and finally market rent, with the reversion reflecting the re-leased property.
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