In a discounted cash flow analysis for a ground lease with 40 years remaining, the appraiser projects level annual ground rent of $120,000 and estimates a reversion (fee simple value at lease expiration) of $3,000,000. The appraiser selects a 5.0% yield rate for the leasehold interest. Which statement accurately describes how the reversion is treated in this analysis?
Correct Answer
B) The reversion is discounted at 5.0% over 40 years and added to the present value of the rent annuity.
In a leasehold DCF, the reversion (i.e., the value of the fee simple interest reverting to the lessor at lease expiration) is a lump-sum benefit accruing at the end of the lease term and must be discounted to present value using the same yield rate applied to the lease payments — here, 5.0% over 40 years. The total leasehold value equals the present value of the annuity of ground rent plus the present value of the reversion. USPAP Standards Rule 1-10 and The Appraisal of Real Estate (12th ed.), Ch. 17, confirm that all future benefits attributable to the interest being appraised must be included and discounted at the appropriate yield rate. Option B correctly applies this principle; options A, C, and D violate fundamental DCF logic or USPAP requirements.
Why This Is the Correct Answer
In a leasehold DCF, the reversion (i.e., the value of the fee simple interest reverting to the lessor at lease expiration) is a lump-sum benefit accruing at the end of the lease term and must be discounted to present value using the same yield rate applied to the lease payments — here, 5.0% over 40 years. The total leasehold value equals the present value of the annuity of ground rent plus the present value of the reversion. USPAP Standards Rule 1-10 and The Appraisal of Real Estate (12th ed.), Ch. 17, confirm that all future benefits attributable to the interest being appraised must be included and discounted at the appropriate yield rate. Option B correctly applies this principle; options A, C, and D violate fundamental DCF logic or USPAP requirements.
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Previous Question
An appraiser is developing a discounted cash flow (DCF) model for a newly constructed office building with a 7-year holding period. The property is expected to generate net operating income (NOI) of $250,000 in Year 1, increasing at 3% annually thereafter. The reversion value at the end of Year 7 is estimated at $4,200,000 using a terminal capitalization rate of 6.5%. The investor’s required yield (discount rate) is 7.2%. Which component of the DCF model must be discounted using the 7.2% rate?
Next Question
Market vacancy for the area is 7%, but the subject has run 2% for a decade under long-term leases expiring in eight years. The vacancy allowance should reflect: