Contract rent on a leased office is $30 per sq ft; market rent is $26. The $4 difference is called:
Correct Answer
B) Excess rent, contract over market
Why this is correct: The governing concept is that contract rent is the actual rent specified in the lease, while market rent is the prevailing rent for similar properties. When contract rent exceeds market rent, the difference is termed "excess rent." This excess is a contractual premium that exists only as long as the lease is in effect and the tenant remains solvent, and it is typically valued separately at a higher discount rate due to its higher risk. Why the other choices are wrong: "Deficit rent, borne by the tenant" is incorrect because a deficit would imply rent below market, not above. "Percentage rent from the overage clause" is incorrect because percentage rent refers to additional rent based on sales, not a fixed premium over market. "Effective rent net of concessions" is incorrect because effective rent accounts for concessions like free rent, not simply the difference between contract and market rent. Exam tip: In valuation, excess rent is capitalized separately at a higher rate, reflecting its dependency on the tenant's covenant and lease duration.
Why This Is the Correct Answer
Option B is right because the four-dollar spread of contract over market is excess rent by definition. Identifying it correctly drives the valuation treatment: the appraiser splits the income stream, capitalizes the twenty-six dollars of market rent at the rate the market supports for space of this type, and treats the four dollars of excess separately at a higher rate over the remaining term. The excess also does not survive into the reversion, which is valued at market rent. Naming the term is the first step; the differential treatment follows from it.
Why the Other Options Are Wrong
Option A: Deficit rent, borne by the tenant
Deficit rent describes contract rent below market, which burdens the landlord and advantages the tenant, so it is the wrong direction for these numbers. The option also misplaces who bears it - a deficiency in rent is borne by the landlord who is undercharging, not by the tenant. Both halves of the option are inverted.
Option C: Percentage rent from the overage clause
Percentage rent is additional rent calculated as a share of the tenant's sales above a stated breakpoint, an arrangement common in retail leases and rare in office. It varies with the tenant's business rather than sitting as a fixed differential over market. Nothing in the stem describes a sales-based component.
Option D: Effective rent net of concessions
Effective rent is contract rent adjusted downward for concessions such as free months or tenant improvement allowances, amortized across the lease term. It measures what the landlord actually collects, not how contract rent compares to the market. The stem mentions no concessions, so effective rent would equal contract rent here.
Excess is the overage above market
Line the terms up against market rent. Above market is excess. Below market is deficit. Adjusted for concessions is effective. Based on sales is percentage. Four words, four positions, and only one of them is a simple subtraction from market.
How to use: When a stem gives you two rent figures, subtract and name the difference by its direction. Then check whether the question also wants the valuation treatment, since excess rent and market rent are capitalized at different rates.
Exam Tip
Remember that excess rent evaporates at lease expiration; any option treating it as permanent or capitalizing it into perpetuity at the market rate is wrong.
Common Mistakes to Avoid
- -Confusing excess rent with effective rent
- -Reversing excess and deficit rent
- -Capitalizing excess rent into perpetuity at the market rate
- -Valuing the reversion at contract rather than market rent
Concept Deep Dive
Analysis
This question tests the vocabulary of rent, which the exam rewards because each term has a specific referent. Contract rent is the amount the lease requires, thirty dollars a foot here. Market rent is what the space would command in the open market on comparable terms, twenty-six dollars. Excess rent is the amount by which contract rent exceeds market rent - four dollars - and it exists only because of the contract. Two more terms round out the set. Effective rent is contract rent adjusted for concessions such as free rent or allowances, spread across the term, which measures what the landlord actually realizes. Percentage rent, common in retail, is additional rent computed on the tenant's sales above a breakpoint. Getting the four straight matters because they are treated differently in valuation, and excess rent in particular is customarily capitalized or discounted at a higher rate than the market-rent portion, since it depends on the tenant's credit and disappears at lease expiration.
Background Knowledge
You need the definitions of contract rent, market rent, excess rent, deficit rent, effective rent, percentage rent, and overage rent, and the relationships among them. You should also know how excess rent is treated in valuation - capitalized or discounted separately at a higher rate reflecting the tenant's credit and the remaining term - and that the reversion is valued at market rent because the contract advantage ends with the lease.
Real-World Application
A tenant who signed at the top of the last cycle pays thirty dollars a foot in a market that has settled at twenty-six. With four years remaining, the appraiser values the four-dollar excess over that term at a rate reflecting the tenant's credit, and values the space at twenty-six thereafter.
More Income Approach Questions
In a percentage lease, rent is commonly structured as:
In a DCF, what is the reversion?
Potential gross income differs from effective gross income in that PGI assumes:
The reversion in a discounted cash flow model represents:
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An overall rate extracted from a sale whose NOI excluded reserves, applied to a subject NOI that includes them, will:
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The mortgage constant represents:
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