An appraiser is valuing a retail plaza subject to a 20-year triple net lease with 12 years remaining. The contract rent is $24 per square foot annually, while current market rent for comparable space is $18 per square foot. The leased fee interest is being appraised for estate tax purposes. Which statement is correct regarding the income approach?
Correct Answer
C) The appraiser must capitalize contract rent for the remaining lease term and then apply a reversion to market rent at lease expiration, as the leased fee interest includes both the leased period and the reversionary interest.
Under USPAP Advisory Opinion 21 (AO-21), the leased fee interest represents the owner’s rights during the lease term plus the reversionary interest at lease expiration. For market value of the leased fee, the income approach must model the contract rent for the lease term *and* a reversion to market rent (or market value) at lease end — reflecting both the leased income stream and the future value of the reversion. Option A is incorrect because capitalizing only contract rent ignores the reversion; Option B misstates USPAP — market value of the *leased fee* is not based solely on market rent, but on the actual lease plus reversion; Option D confuses market value with fee simple unencumbered — estate tax valuation still requires appraisal of the interest held (here, leased fee), not a hypothetical unencumbered interest. See USPAP Standards Rule 1-2(c) and AO-21.
Why This Is the Correct Answer
Under USPAP Advisory Opinion 21 (AO-21), the leased fee interest represents the owner’s rights during the lease term plus the reversionary interest at lease expiration. For market value of the leased fee, the income approach must model the contract rent for the lease term *and* a reversion to market rent (or market value) at lease end — reflecting both the leased income stream and the future value of the reversion. Option A is incorrect because capitalizing only contract rent ignores the reversion; Option B misstates USPAP — market value of the *leased fee* is not based solely on market rent, but on the actual lease plus reversion; Option D confuses market value with fee simple unencumbered — estate tax valuation still requires appraisal of the interest held (here, leased fee), not a hypothetical unencumbered interest. See USPAP Standards Rule 1-2(c) and AO-21.
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