An institution is financing a building leased long term to a highly rated tenant at contract rent below market rent, and the leased fee interest is being appraised. Under the Interagency Appraisal and Evaluation Guidelines, which market value should be used?
Correct Answer
D) The leased fee value, which is below the fee simple value
The Interagency Guidelines state that when the leased fee interest is appraised and contract rent is below market rent on a long-term lease to a highly rated tenant, the leased fee value is less than the unencumbered fee simple value, and the leased fee value should be used. A strong tenant does not erase the below-market rent, and the leased fee would exceed the fee simple only if rent were above market.
Why This Is the Correct Answer
Option D is correct because the Interagency Guidelines state that with a long-term below-market lease to a highly rated tenant, the leased fee value is less than the unencumbered fee simple value, and the leased fee value should be used. That value reflects the rent the lender's collateral can actually produce during the lease.
Why the Other Options Are Wrong
Option A: The fee simple value, which assumes the space is leased at market rent
Option A uses the fee simple value, which assumes market rent. The landlord is locked into below-market rent for a long term, so a fee simple value would overstate the collateral being financed.
Option B: The fee simple value, because the tenant's strong credit offsets the lease
Option B argues the tenant's strong credit offsets the lease. Good credit makes the below-market rent more reliable, but it does not raise the rent to market, so the leased fee remains below the fee simple value.
Option C: The leased fee value, which is above the fee simple value
Option C picks the leased fee value but says it is above the fee simple value. The leased fee exceeds fee simple only when contract rent is above market; here rent is below market, so the leased fee is lower.
Lend on what's leased
When a long lease is below market, the lender's collateral is the leased fee, and it is worth less than fee simple.
How to use: Use this when a lending question pairs a long-term below-market lease with a choice of property interest.
Exam Tip
Tenant quality and rent level are separate questions; a strong tenant does not turn below-market rent into market rent.
Common Mistakes to Avoid
- -Lending on the fee simple value when a long below-market lease encumbers the property
- -Assuming strong tenant credit cancels out below-market rent
Concept Deep Dive
Analysis
This question tests which property interest a lender should rely on when a long lease locks in below-market rent. The landlord cannot collect market rent until the lease ends, so the leased fee is worth less than the unencumbered fee simple. The guidelines direct the institution to use that lower leased fee value.
Background Knowledge
The interest appraised must be clearly identified when leases do not reflect current market terms. A leased fee interest is the landlord's ownership encumbered by leases, while fee simple is unencumbered ownership. Below-market leases reduce the leased fee value relative to fee simple for as long as they run.
Real-World Application
A bank finances a store leased for many years to a national retailer at rent well under today's market. The appraiser values the leased fee interest, which falls below the fee simple value, and the bank sizes the loan on that figure.
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