The subject is valued at market rent. A comparable leased to a tenant at $3,000 per year below market rent for five more years sold for $410,000. Using an 8% market discount rate (5-year annuity factor 3.9927), what lump-sum adjustment reflects the rent loss, and in which direction?
Correct Answer
B) +$11,978, since the lease lowered the price
The below-market lease reduced the comparable’s price. Discounting the $3,000 annual shortfall over five years at 8% gives $3,000 × 3.9927 = $11,978, which is added to the comparable to reflect market (unencumbered) rent.
Why This Is the Correct Answer
Option B is correct because the present value of the $3,000 annual shortfall over five years at 8% is $3,000 x 3.9927 = $11,978. The below-market lease made the comparable inferior to a subject valued at market rent, so $11,978 is added to the comparable.
Why the Other Options Are Wrong
Option A: −$11,978, since the lease lowered the price
Option A, -$11,978, has the right present value but the wrong direction. Since the lease lowered the comparable's price, the adjustment must be added, not subtracted.
Option C: +$15,000, the undiscounted five-year rent loss
Option C, +$15,000, is the undiscounted total of $3,000 x 5 years. A lump-sum adjustment should reflect the present value of the shortfall, $3,000 x 3.9927 = $11,978.
Option D: +$3,000, one year of the rent difference
Option D, +$3,000, counts only one year of the rent difference. The shortfall continues for five years, and its present value is $3,000 x 3.9927 = $11,978.
Discount the gap, add it back
Find the present value of the rent gap over the lease term, then add it back to the comparable that suffered the below-market lease.
How to use: Use this for any leased-fee comparable with below-market rent.
Exam Tip
Multiply the annual difference by the annuity factor given in the stem, then confirm direction by asking whether the lease hurt or helped the comparable's price.
Common Mistakes to Avoid
- -Using the undiscounted total of the rent shortfall
- -Subtracting the adjustment when the lease lowered the price
- -Counting only one year of the rent difference
Concept Deep Dive
Analysis
This question tests a lump-sum adjustment for a below-market lease on a comparable. The rent shortfall over the remaining lease term is discounted to present value, and because the lease lowered the comparable's price, the adjustment is added.
Background Knowledge
When a comparable is encumbered by a lease at below-market rent, its price reflects the reduced income. A lump-sum adjustment is estimated by discounting the difference between contract and market rent at a market-derived rate over the remaining term, which converts the comparable to the subject's market-rent basis.
Real-World Application
Appraising a rented single-family house at market rent, an appraiser finds a comparable house whose long-time tenant pays below market for five more years. The appraiser discounts the rent shortfall at a market rate and adds that amount to the comparable.
More Sales Comparison Questions
Supported adjustments are: non-market financing $10,000, GLA $36/sf, garage $3,500 per car, pool/spa $12,500. A comparable identical to the 2,800 sf subject sold for $267,000 with non-market financing. What is its adjusted price?
Using GLA $36/sf and non-market financing $10,000: a 3,100 sf comparable sold for $277,000 with non-market financing; the subject has 2,800 sf. Bath count differences are not adjusted. What is the adjusted price?
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