A tenant pays $18 per square foot under a lease signed years ago; similar space now commands $24. The $18 figure is the:
Correct Answer
A) Contract rent, and the leased fee reflects being bound to it
Why this is correct: 'Contract rent' is the actual rent specified in the lease. The 'leased fee' estate is the landlord's interest, which is burdened by this below-market contract rent during the lease term. Why the other choices are wrong: 'The market rent, since a real tenant is actually paying it' confuses contract rent with market rent; market rent is current market rate. 'The effective rent after netting out landlord concessions' refers to net effective rent considering concessions, not the contract rate. 'The excess rent generated by the location's foot traffic' is not a standard term; excess rent would be above market. Exam tip: Contract rent = lease rate; Market rent = current rate. A below-market contract rent creates a leasehold value for the tenant.
Why This Is the Correct Answer
Option A is correct because $18 is the amount specified in the lease, which is the definition of contract rent, and it correctly identifies the consequence for the ownership interest. The leased fee is burdened by the obligation to accept below-market rent for the balance of the term, so it is worth less than a comparable unencumbered fee. That reduction equals the present value of the $6 per square foot annual shortfall over the remaining years. At expiration the space reverts to market rent, which is why the discount is limited to the remaining term rather than permanent.
Why the Other Options Are Wrong
Option B: The market rent, since a real tenant is actually paying it
That a real tenant pays the amount makes it contract rent, not market rent; market rent is what the space would fetch today from a new tenant on typical terms, which the stem gives as $24. Contract rents drift from market constantly as leases age, which is the entire premise of the question. If actual payment defined market rent, every lease would be at market by definition and the comparison would be meaningless.
Option C: The effective rent after netting out landlord concessions
Effective rent is face rent adjusted for concessions such as free rent periods, tenant improvement allowances, or moving allowances, spread over the lease term. Nothing in the stem mentions concessions, so there is no basis for calling $18 an effective figure. Effective rent is a refinement applied to whichever contract rent exists, not a synonym for it.
Option D: The excess rent generated by the location's foot traffic
Excess rent is contract rent above market rent, which is the opposite of this fact pattern where contract sits $6 below market. Excess rent belongs to the landlord as an advantage and is typically capitalized at a higher rate because it depends on the tenant's continued creditworthiness. The reference to foot traffic also confuses percentage rent with the excess rent concept.
Contract is written, market is current
Contract rent is what the paper says; market rent is what the street says. Compare them and the difference tells you which party holds the bargain and which estate shrinks.
How to use: When a stem gives two rent figures, label the one tied to a signed lease as contract and the one described as current or comparable as market. Then check the direction before choosing.
Exam Tip
Below market means excess rent is off the table, since excess rent runs the other way. Confirm the direction before reaching for that term.
Common Mistakes to Avoid
- -Treating actual paid rent as market rent
- -Confusing excess rent with a below-market contract rent
- -Ignoring concessions when comparing face rents across leases
- -Valuing the leased fee at market rent when a below-market lease is in place
Concept Deep Dive
Analysis
This tests rent vocabulary, which the income approach depends on because each term names a different number for the same space. Contract rent is the amount the lease actually requires the tenant to pay, fixed by the document regardless of what the market has done since signing. Market rent is what the space would command today if offered to a new tenant on typical terms, here $24. When contract rent sits below market, the tenant holds a positive leasehold and the landlord's leased fee is worth less than the unencumbered fee, because a buyer inherits the obligation to accept $18 until the lease runs out. The gap is quantified by discounting the annual shortfall over the remaining term. Two related terms complete the family: effective rent adjusts face rent for concessions such as free months or tenant improvement allowances, and excess rent is the amount by which contract rent exceeds market rent, the reverse of this situation.
Background Knowledge
You need the rent vocabulary set: contract rent, market rent, effective rent, excess rent, and percentage or overage rent, and the ability to tell them apart from the facts given. You also need to know how a below-market lease creates a positive leasehold and reduces the leased fee, and that the property rights appraised determine which rent drives the analysis.
Real-World Application
Appraising an office building for a purchaser, you abstract each lease and find one tenant at $18 in a $24 market with six years remaining. You value the fee simple from market rent, then deduct the discounted shortfall to reach the leased fee, and you state the property rights appraised so the lender understands what was valued.
More Income Approach Questions
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