An office building's fee simple market value is $2,000,000. It is leased to a reliable tenant whose contract rent exceeds market rent by $30,000 per year for the remaining 6 years; the present value of that excess rent at a market discount rate is $150,000. What is the market value of the leased fee interest?
Correct Answer
D) $2,150,000
When contract rent is above market rent, the leased fee interest is worth more than the fee simple interest, and the leasehold interest has a negative value. The difference is the present value of the excess rent over the remaining term, so the leased fee value is $2,000,000 + $150,000 = $2,150,000. Deducting the $150,000 treats the lease as below market, $2,000,000 ignores the lease, and $2,030,000 adds only one year's excess rent instead of its present value over the term.
Why This Is the Correct Answer
Option D is correct because contract rent above market rent makes the leased fee interest worth more than the fee simple interest. The landlord gains the present value of the excess rent over the remaining term, so $2,000,000 + $150,000 = $2,150,000.
Why the Other Options Are Wrong
Option A: $1,850,000
Option A, $1,850,000, subtracts the $150,000 ($2,000,000 - $150,000). A deduction applies when contract rent is below market; here the tenant pays above market, so the leased fee is worth more, $2,150,000.
Option B: $2,000,000
Option B, $2,000,000, is the fee simple value and ignores the lease. The leased fee interest carries the above-market lease, which adds $150,000 of present value to reach $2,150,000.
Option C: $2,030,000
Option C, $2,030,000, adds only one year of excess rent ($2,000,000 + $30,000). The benefit runs for the remaining 6 years, and its present value of $150,000 is the correct increment, giving $2,150,000.
Above-market rent lifts landlord
If the tenant overpays, the landlord's leased fee rises above fee simple and the tenant's leasehold turns negative. If the tenant underpays, it is the reverse.
How to use: Use this to set the direction before computing any leased fee or leasehold value.
Exam Tip
Decide the direction from contract rent versus market rent first, then use the present value over the remaining term, not one year's rent difference.
Common Mistakes to Avoid
- -Deducting the lease effect when contract rent is above market
- -Using one year's rent difference instead of its present value over the remaining term
- -Reporting the fee simple value when the leased fee is the interest appraised
Concept Deep Dive
Analysis
This question takes two judgments: the direction of the lease's effect and the right measure of its size. Above-market contract rent makes the landlord's leased fee worth more than the unencumbered fee simple. The size of the difference depends on the rent gap and the remaining term, which the stem gives as a present value of $150,000.
Background Knowledge
A lease splits the fee simple bundle into the leased fee interest held by the landlord and the leasehold interest held by the tenant. When contract rent differs from market rent, the two interests diverge from the fee simple value. The size of the divergence depends on the rent difference and the length of the remaining lease term.
Real-World Application
A lender finances an office building leased years ago at rents now above market. The appraiser values the leased fee interest, adding the present value of the excess rent over the remaining term, and notes the risk that the premium ends when the lease expires.
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