A site is leased at a ground rent well below current market rent. What must be done before capitalizing the rent to estimate the fee simple value of the site?
Correct Answer
A) Adjust the rent to market levels
If the subject’s ground rent is not at market levels, it must be adjusted to derive a proper estimate of the market value of the fee simple interest in the site.
Why This Is the Correct Answer
Option A is correct because if the subject's ground rent is not at market levels, it must be adjusted to derive a proper estimate of the market value of the fee simple interest in the site. Capitalizing market rent reflects the unencumbered interest.
Why the Other Options Are Wrong
Option B: Capitalize the contract rent unchanged
Option B says to capitalize the contract rent unchanged. A below-market contract rent would value the interest encumbered by the lease, not the fee simple.
Option C: Use the lessee’s building income instead
Option C says to use the lessee's building income instead. Building income includes returns to improvements and is not ground rent, so it would not measure site value.
Option D: Add the tenant’s improvements to the rent
Option D says to add the tenant's improvements to the rent. Tenant improvements are not part of ground rent and adding them would distort the land income being capitalized.
Fix the rent, then capitalize
For fee simple, bring the rent to market first, then divide by the land rate.
How to use: Use this sequence whenever contract ground rent differs from market.
Exam Tip
When a question asks for fee simple value and the rent is off-market, look for the step that adjusts rent to market.
Common Mistakes to Avoid
- -Capitalizing below-market contract rent for fee simple value
- -Using building income as ground rent
- -Adding tenant improvements to ground rent
Concept Deep Dive
Analysis
This question tests the rule for ground rent capitalization when contract rent is below market. Because the fee simple interest assumes no lease encumbrance, the rent must first be adjusted to market levels before capitalizing.
Background Knowledge
Ground rent capitalization values a site by capitalizing its net ground income at a land capitalization rate. For fee simple value, the income must be market rent. A lease at contract rent below or above market affects the leased fee and leasehold interests instead.
Real-World Application
A long-term ground lease pays far below current rents. To estimate fee simple site value for a lender, the appraiser derives market ground rent from recent ground leases and capitalizes that figure rather than the contract rent.
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