An appraiser is analyzing a triple net (NNN) lease where the tenant is obligated to pay all property taxes, insurance, and maintenance — but the lease agreement explicitly excludes roof replacement from the tenant’s responsibilities, assigning that cost to the landlord. During the assignment, the appraiser learns the roof has 3 years of remaining economic life and will cost $420,000 to replace. How should this obligation affect the valuation of the leased fee interest?
Correct Answer
B) It should reduce the leased fee value by the present value of $420,000 discounted over 3 years at the appropriate yield rate.
Under USPAP Standards Rule 1-2 and the Income Approach, a landlord’s future capital obligations that are not borne by the tenant represent a diminution in the value of the leased fee interest. The present value of the expected roof replacement cost — a material, non-recurring capital outlay — must be deducted from the value indicated by capitalizing the contract rent stream. This is consistent with the ‘cost-to-cure’ concept in lease analysis and is required to reflect the net benefit to the fee owner. Option A is incorrect: capital expenditures affecting the asset’s longevity *are* relevant to value in long-term leases. Option C mischaracterizes the issue — the rent is not defective; the obligation is an unaccounted liability. Option D confuses control with economic burden.
Why This Is the Correct Answer
Under USPAP Standards Rule 1-2 and the Income Approach, a landlord’s future capital obligations that are not borne by the tenant represent a diminution in the value of the leased fee interest. The present value of the expected roof replacement cost — a material, non-recurring capital outlay — must be deducted from the value indicated by capitalizing the contract rent stream. This is consistent with the ‘cost-to-cure’ concept in lease analysis and is required to reflect the net benefit to the fee owner. Option A is incorrect: capital expenditures affecting the asset’s longevity *are* relevant to value in long-term leases. Option C mischaracterizes the issue — the rent is not defective; the obligation is an unaccounted liability. Option D confuses control with economic burden.
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Previous Question
An investor is evaluating a 12-year leasehold interest in a retail property. The lease provides fixed annual rent of $95,000, with no renewal option. At lease expiration, the tenant surrenders possession and the landlord receives no reversionary value. The investor’s required yield is 7.5%. What is the present value of this leasehold interest?
Next Question
An appraiser develops two DCF models for the same industrial warehouse: Model A uses a 6.0% yield rate and a 5.5% terminal cap rate; Model B uses a 7.2% yield rate and a 6.8% terminal cap rate. All other assumptions (NOI projections, holding period, reversion timing) are identical. Assuming both models are properly constructed, what is the most likely effect on the indicated value?