An appraiser is valuing a retail strip center subject to multiple leases with varying terms. One tenant occupies 40% of the leasable area under a 10-year lease at $22.50/sf/year, while market rent for comparable space is $28.00/sf/year. The lease includes a fixed 3% annual rent escalation and no renewal options. To estimate the leased fee value using the income approach, the appraiser must first determine the present value of:

Correct Answer

C) The difference between contract rent and market rent over the lease term, discounted at an appropriate rate, plus the present value of market rent for the reversion.

Under USPAP Standards Rule 1-2 and the Income Approach guidance in the Appraisal of Real Estate (12th ed.), the leased fee value equals the present value of the contract rent for the lease term plus the present value of market rent for the reversionary interest (i.e., post-lease term). Because contract rent ($22.50) is below market ($28.00), the leased fee is worth less than the fee simple — the shortfall (the 'rental adjustment') must be quantified and discounted. Option C correctly identifies both components: (1) the present value of the below-market contract rent stream, and (2) the present value of market rent for the reversion. Option A ignores the reversion; Option B conflates leased fee with fee simple; Option D omits discounting and misapplies reversion treatment.