A tenant holds an enforceable renewal option at projected below-market rent and market evidence supports likely exercise. How can it affect leased-fee value?
Correct Answer
D) It can extend the period of below-market landlord receipts.
An enforceable favorable renewal option can extend below-market receipts to the lessor if exercise is reasonably expected. Analyze term, rent, tenant incentives and constraints rather than treating exercise as certain. The lessor cannot assume a unilateral reset contrary to the option.
Why This Is the Correct Answer
Option D is correct because an enforceable renewal option at below-market rent, likely to be exercised, can extend the period during which the landlord receives less than market rent. That lowers the leased fee value relative to an interest at market rent. The appraiser should weigh the option's term, rent and the tenant's incentives rather than treating exercise as certain.
Why the Other Options Are Wrong
Option A: It favors the landlord under any set of option terms.
Option A says the option favors the landlord under any set of terms. A below-market renewal option favors the tenant, and its effect depends on the actual terms and market rent.
Option B: It has no valuation relevance until actually exercised.
Option B says the option has no valuation relevance until actually exercised. When exercise is reasonably expected, buyers consider the option's effect on future income, so it can affect value before exercise.
Option C: The landlord can freely ignore the option and reset rent.
Option C says the landlord can freely ignore the option and reset rent. An enforceable option binds the landlord, who cannot unilaterally reset rent contrary to its terms.
Tenant's option, tenant's advantage
A below-market renewal option benefits the tenant and can prolong below-market receipts to the landlord.
How to use: Use this when deciding how lease options affect leased fee versus leasehold value.
Exam Tip
Consider who holds the option and whether the rent is above or below market to decide which interest it favors.
Common Mistakes to Avoid
- -Ignoring renewal options until exercised
- -Assuming the landlord can reset rent despite an enforceable option
- -Treating option exercise as certain without analysis
Concept Deep Dive
Analysis
This question tests how a tenant's below-market renewal option affects the leased fee interest. If the option is enforceable and exercise is reasonably expected, the landlord may receive below-market rent for longer. The appraiser analyzes the option terms and the likelihood of exercise rather than ignoring the option.
Background Knowledge
The leased fee interest is the landlord's interest subject to existing leases, including renewal options. When contract rent is below market, the difference between market and contract rent over the relevant term affects value. A favorable tenant renewal option can lengthen that term.
Real-World Application
An appraiser values a building leased to a retailer with an option to renew for five years at a fixed rent below current market rent. Since the tenant is likely to renew, she projects below-market income through the option period when valuing the leased fee.
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Next Question
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