An enforceable long lease fixes below-market rent with no reset or termination rights during the term. Why can it reduce the lessor’s rent-benefit component, other factors equal?
Correct Answer
D) It limits receipts to contract rent until the specified reset opportunity.
Under the stated enforceable below-market lease without resetting rights, the lessor cannot collect market rent during the remaining term. Model that expected shortfall and supported reversion. A strong tenant’s credit may reduce collection risk but does not itself erase the contractual rent difference.
Why This Is the Correct Answer
Option D is correct because the lessor's receipts are limited to the below-market contract rent until the lease's next opportunity to reset rent, which here comes only at the end of the term. The shortfall between market and contract rent over the remaining term reduces the lessor's rent benefit, and it can be measured by discounting that difference to present value.
Why the Other Options Are Wrong
Option A: It requires a higher vacancy allowance for the remaining lease term.
Option A says the lease requires a higher vacancy allowance. A below-market lease with an enforceable tenant does not by itself raise vacancy; the reduction comes from the lower contract rent, not from more vacancy.
Option B: It means the lease includes below-market renewal options as well.
Option B claims the lease also includes below-market renewal options. Nothing in a fixed below-market rent implies renewal options exist; those would have to be stated in the lease.
Option C: It obliges the lessor to provide additional building services.
Option C says the lease obliges the lessor to provide additional building services. A below-market rent term does not create extra service obligations; the issue is the reduced rent the lessor can collect.
Locked rent, locked shortfall
If the lease locks rent below market, the landlord's loss is locked in until the lease lets rent reset.
How to use: Use this to remember that the leased-fee value reflects contract rent for the remaining term.
Exam Tip
For leased-fee questions, focus on what the lease actually lets the landlord collect and when. Tenant credit affects collection risk but does not erase a contractual rent gap.
Common Mistakes to Avoid
- -Valuing a leased property at market rent despite an enforceable below-market lease
- -Assuming a creditworthy tenant offsets a below-market rent
- -Confusing a rent shortfall with a vacancy allowance
Concept Deep Dive
Analysis
This question tests how contract rent affects the leased-fee interest. When an enforceable lease fixes rent below market with no way to reset or terminate it during the term, the lessor can only collect the contract rent until the lease ends, so the rent stream is smaller than a market-rent stream.
Background Knowledge
Contract rent is the actual rent specified in a lease, while market rent is what the property could command on the open market. An adjustment for a below-market lease can be estimated by discounting the difference between market and contract rent over the remaining lease term.
Real-World Application
An appraiser values a building leased to a strong tenant at rent well below market for eight more years with no escalation or reset. She discounts the annual rent shortfall over the remaining term and recognizes market rent only after the lease expires.
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Previous Question
The subject property is a 10,000-sf office building leased on a gross basis, with the landlord paying all operating expenses of $97,000 a year. Similar buildings nearby rent for $24 per square foot annually, with tenants directly paying $2 per square foot of costs that the subject's landlord pays. Stabilized vacancy and credit loss is 5% of PGI, and the market overall rate is 7.5%. What is the indicated value, to the nearest dollar?
Next Question
A lease provides annual potential base rent of $60,000. The tenant also pays $20,000 of expenses directly to third-party suppliers; the landlord neither receives nor pays these amounts. Combined vacancy and collection loss is 5% of base rent only. What is the landlord's EGI?