An enforceable transferable lease has five years of below-market rent and no offsetting differences. What measures its rent-benefit component?
Correct Answer
D) Present value of the expected net rent savings during that term.
For the stipulated lease terms without offsetting disadvantages, the below-market rent-benefit component is the present value of expected net rent savings over the remaining term. Total leasehold value can also depend on transferability, improvements, options and other obligations; the rent difference alone is not always the whole interest.
Why This Is the Correct Answer
Option D is correct because the rent-benefit component equals the present value of expected net rent savings during the five-year term. The size of leasehold value depends on the difference between contract and market rent and on the length of the remaining term. With no offsetting differences, discounting those savings measures the benefit.
Why the Other Options Are Wrong
Option A: The refundable security deposit alone.
Option A uses the refundable security deposit alone. A deposit is returnable security for the landlord and does not measure the value of paying below-market rent over five years.
Option B: The fee-simple value of all comparable space.
Option B uses the fee-simple value of all comparable space. Fee-simple value measures unencumbered ownership, not the narrower benefit a tenant gains from below-market rent.
Option C: The original improvement allowance, apart from remaining benefits.
Option C uses the original improvement allowance apart from remaining benefits. A past allowance is a historical cost and does not capture the remaining rent savings over the term.
Savings times time, discounted
A below-market lease is worth the rent the tenant saves each year, for the years left, brought back to today.
How to use: Use this when valuing the benefit of a favorable lease.
Exam Tip
Look for an answer that combines the rent difference, the remaining term and discounting to present value.
Common Mistakes to Avoid
- -Using a security deposit as a measure of lease value
- -Ignoring the time value of future rent savings
- -Confusing fee-simple value with leasehold value
Concept Deep Dive
Analysis
This question tests how to measure the value of a below-market lease's rent benefit. The benefit is the stream of rent savings over the remaining term, and its value is the present value of those savings. Other items like deposits or allowances do not measure this rent advantage.
Background Knowledge
When contract rent is below market, the tenant's leasehold may have positive value because the tenant pays less than market for the remaining term. That value is generally measured by discounting the rent difference over the remaining lease term, considering other lease terms as well.
Real-World Application
A tenant has five years left on a transferable lease of a house at well below market rent. An appraiser valuing the leasehold discounts the annual rent savings over the five years to estimate the benefit.
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