Leased Fee vs. Fee Simple
PART 1
LEASED FEE – THE SALE
DEMAND GENERATOR
THE DEVELOPER
THE SITE – 7.0 ACRES
 Land Costs
 $4,300,000
 Per Bldg. Area
 $71.66/SF
The - Improvements
 Net Rentable Area
 40,000 SF Anchor
 20,000 SF In-Line
60,000 SF Total
 Bldg. Costs
 $12,000,000
 Per Bldg. Area
 $200/SF
Total Development Costs
 $16,300,000
 $272 per square foot
Rent Roll
LEASE TERMS
 Triple Net – Pro Rata Share
Real Estate Tax Clause
The Investment Sale
 Developer engages a national brokerage firm
 Marketed at a list amount of $21,200,000
 Exposed to the investment market for 90 days
 Eight offers considered Top Four offers from:
 10 31 Tax Exchange Buyer - $20,500,000
 Institutional Investor - $20,400,000
 Public REIT - $20,200,000
 Private REIT - $20,000,000
The Lucky Winner – 1031 Exchange
 Sale Amount
 $20,500,000
 NOI = $1,295,940
 Cap Rate = 6.32%
The True Winner
 Sale Amount
 $20,500,000
 Total Costs
 $16,300,000
 Total Profit
 $4,200,000
 Implied Profit
 25.7 %
 2 Year Process
PERMANENT DEBT FINANCING
 The Sponsor
 Mortgage Brokers
Sponsor & Mortgage Brokers
 The sponsor also known as the owner, wants to free up as
much of the capital possible that was used to buy the
shopping center. The sponsor engages a middle-man or
mortgage broker to represent the sponsors interests. The
mortgage broker represents the interests of the sponsor
and at the same time holds the relationship with the
lenders, financial institutions and life companies.
 A mortgage broker may charge the sponsor one mortgage
point upfront for origination, meaning they’ll be paid one
percent of the loan amount for getting the sponsor the
loan, while also tacking on loan processing fees.
THE LENDERS
LOAN TERMS – CONDUIT LENDING
 COMMERCIAL MORTGAGE BACKED SECURITY (CMBS)
 NON-RECOURSE
 30 YEAR AMORTIZATION
 INTEREST ONLY YEARS 1 THROUGH 4
 INTEREST RATE 4.5%
 10 YEAR LOAN TERM
 LOAN TO VALUE (LTV) AT 75%
 LOAN AMOUNT - $15,375,000
 SPONSOR EQUITY CONTRIBUTION - $5,125,000
 ANNUAL DEBT SERVICE PAYMENT - $933,314
 DEBT COVERAGE RATIO - 1.38 (NOI/Debt Payment)
 INTEREST ONLY PAYMENT YEAR 1 - $690,750
 YEAR 1 – CASH ON CASH = 13.5%
UNDERWRITING REQUIREMENTS
 “Mark to Market” – CMBS lenders are required to “mark to
market” any contract rents that are above the appraiser’s
opinion of market rent. This can dramatically impact the
loan proceeds and terms for the borrower.
 Market Rent - The most probable rent that a property
should bring in a competitive and open market reflecting
all conditions and restrictions of the lease agreement,
including permitted uses, use restrictions, expense
obligations, term, concessions, renewal and purchase
options, and tenant improvements (TIs).
THE APPRAISAL
 Loan terms agreed upon
 Lender orders appraisal
 Appraiser typically has two to three weeks to perform
the valuation.
 Appraiser relies heavily on Income Approach
methodology.
 Appraiser concludes that the contract rents within the
subject development are market supported having
compared the subject’s rents with other first
generation contract rents in the market, also known
as build to suit contract rents.
CONTRACT RENT VS. MARKET RENT
ATTAINED RENT LEVELS
Contract Rent
Area
Equiv.
Tenant Name
( SF )
Rent/SF
> 40,000 SF
Grocery Store
> 3,000 SF
Pet Store
Restaurant
< 3,000 SF
Nail Salon
Beauty Massage
Asian Restaurant
Hair Salon
Beauty Salon
Soup & Salads
GRAND-TOTALS
MARKET RENT
Market Rent
Rent/SF
COMPARISON
Comparison
Contract Rent
Versus Market Rent
40,000
40,000
$19.25
$19.25
$20.00
$20.00
3.75% below market
3.75% below market
4,600
4,300
8,900
$21.52
$27.35
$24.34
$25.00
$25.00
$25.00
13.91% below market
9.40% above market
2.65% below market
1,900
2,100
1,900
1,300
1,600
2,300
11,100
$30.82
$24.79
$29.37
$25.85
$26.25
$29.25
$27.86
$28.00
$28.00
$28.00
$28.00
$28.00
$28.00
$28.00
10.08%
11.47%
4.89%
7.69%
6.25%
4.48%
0.48%
60,000
$21.60
$22.22
above market
below market
above market
below market
below market
above market
below market
2.80% below market
THE APPRAISAL - CONCLUSION
 Appraiser analyzes the terms of the initial sale from
developer to 1031 buyer and concludes the implied
going in cap rate of 6.32% is market supported. This
opinion is based on analyzing sale comparables (cap
rate extraction), broker interviews and institutional
investment surveys.
 Since the appraisal report concludes contract rents are
at “market levels” and the cap rate for these type of
investments is bracketed between 6.0 and 6.5 percent,
the lender and sponsor proceed with the closing of the
loan.
ALL’S WELL THAT ENDS WELL
PART 2
FEE SIMPLE – THE TAX APPEAL
EXTRA EXTRA - READ ALL ABOUT IT
 SHOPPING CENTER SELLS FOR $20,500,000
THE TAX MAN COMETH
 SCHOOL BOARD
We’ve Got a
Live One !
 SCHOOL BOARD ATTORNEY
$20.5
What?
TALE OF TWO CITIES
 A recent arms-length sale of a property will typically invoke a
reassessment of value to the sale amount. This holds especially true if
the reassessment results in an increase in value, generating more tax
dollars for the local schools, municipality and county.
RE Taxes Pre-Sale
$3.00/SF
$180,000/yr
RE Taxes Post-Sale
$10.00/SF
$600,000/yr
333% Increase
THE TENANT RESPONSE
ACTION DEMANDED
We were told
$3.00/SF not
$10/SF
How can we
resolve this
problem?
I collect rent
checks……this
is not my
problem
ACTION TAKEN
Tenant Response
 Ownership is far less likely to file a tax complaint when the
tax expense is the tenant’s responsibility.
 Anchor tenant lease contracts (National Chain Tenancy) will
often allow the tenant the right to contest the real estate tax
assessment on behalf of the ownership entity. Smaller
storeroom tenancy lease contracts will not typically include
this provision.
 Tenant, through legal representation, engages an appraiser to
estimate the market value of the property.
THE APPEAL PROCESS
 While tax law may be different state to state, reassessment based on a
recent sale of a property is common practice in many states.
 Relative to properties such as this case study, we find it common for the
Respondent (tenant or owner) to engage an appraiser in defense of a
significant increase in real estate taxes even at the lowest level of the
appeal process.
 At the lower level of the appeal process the Petitioner (local school
board) will almost exclusively rely on the most recent sale as the best
evidence of market value. If appealed to a higher level an appraiser is
likely to be engaged as a means to defend the reassessment value.
THE ROAD TO THE APPEAL PROCESS
 It is likely the sale of the subject will not result in a
amenable resolution between the Respondent and
Petitioner at a low level of the appeal process.
 Even if the Respondent provides an appraisal as
evidence of value, most lower level hearing decisions
have been reluctant to ignore the most recent sale
premise.
 The appraisal process moves forward and both parties
engage an appraiser to estimate the FEE SIMPLE
market value of the subject.
LEASED FEE - FEE SIMPLE
 WORLD’S COLLIDE - Appraising the fee simple interest of
what is typically a leased fee interest property type is often
complicated by decisions handed down from hearing
examiners at higher levels of the appeal process.
 WORLD’S COLLIDE - The acceptance of leased fee practice
within a fee simple valuation has become beneficial to the
tax authority yet burdensome to the tenant/owner and an
appraiser that full understands fee simple valuation.
 WORLDS COLLIDE - Unfortunately the appraisal practice
techniques of licensed appraisers can often be at odds.
Both sides of the appeal believe the other is agenda driven.
THE ISSUES AT HAND
 Leased fee valuation rests heavily on tenancy credit
strength, lease term longevity, capitalization of
contract rents that may be above or below market.
 In a fee simple appraisal a tenant’s CREDIT
STRENGTH is not suppose to be on trial; however, it is
often the core economic component driving value
leased fee ownership interest.
 In a fee simple appraisal MARKET RENT is to be
applied to the tenancy storerooms and the appraiser
should adhere the Appraisal of Real Estate definition
of MARKET RENT.
THE ISSUES AT HAND
 CONTRARY to fee simple valuation practice,
the
decisions handed down by hearing examiners relative
to leased fee infusion into fee simple valuation has
caused for additional adverse decisions relative to
market rent application in fee simple appraisal
practice.
 FIRST GENERATION and/or BUILD TO SUIT rent
contracts are now being construed as evidence of
MARKET RENT even though these types of rents do
not adhere to the definition of MARKET RENT.
TYPES OF RENT
 Rent, relative to the subject’s use type, requires a basic
understanding and recognition that the term “rent”
can often take on several different interpretations,
especially in the tax appeal process. Within the
commercial real estate industry, rent is often identified
as being one of the following:
 Build-to-Suit Rent – First Generation
 Market Rent – First & Second Generation
 Sale-Leaseback Rent
BUILD TO SUIT RENT
 In a build-to-suit contract lease arrangement, the rent paid is
specifically tied to the tenant’s development specifications both in
location, site and vertical improvements. These specifications result in
a contract rent born out of the developer’s land cost basis, all soft/hard
costs of construction, and developer profit. The sum of these basic
components results in a build-to-suit contract rent; however, it does
not necessarily conform to the definition of market rent.
 Build to suit rent is not exclusively tied to single-tenant properties. The
subject, as a multi-tenant shopping center, involved build to suit
contractual terms for the anchor and while the in-line space was
developed as generic white box or shell space, the inclusion of tenant
allowances paid by the developer to the tenants to complete build-out
also can be considered build to suit or in some instances modified
build to suit (white box or shell delivery with no allowances).
MARKET RENT
 The most probable rent that a property should
bring in a COMPETITIVE and OPEN MARKET
reflecting all conditions and restrictions of the
lease agreement, including permitted uses, use
restrictions,
expense
obligations,
term,
concessions, renewal and purchase options, and
tenant improvements (TIs).
 The words competitive and open market are
integral to the selection of rent comparables in fee
simple valuation.
MARKET RENT
 In the appraisal process, collection of rent comparables requires
equivalency adjustment analysis.
Many contract rent
comparables involve tenant specific allowances relative to their
use type or there may be up front rent concessions with stepped
up rent increases at the back-end of a lease term. Allowances and
concessions can significantly cause for a contract rent to be above
other market participant expectations for like kind space.
 It has been our experience that most market participants
interpret market rent as being the probable rent a storeroom
could achieve in a competitive environment assuming competent
marketing and adequate exposure time to the open market.
MARKET RENT
 Relative to newly developed, first generation shopping
center and/or freestanding retail development, it has
also been our experience that some market
participants believe market rent should closely
mirror the contract rents already being paid by the inplace tenancy.
MARKET RENT
 It has become common practice within the appeal
process to identify rent comparables as being first
generation (typically build to suit) or second
generation (initial tenant vacates and the space is
subsequently re-leased to another use).
 With consideration for the definition of Market Rent,
most second generation rent comparables are the best
evidence of market rent, recognizing the storeroom or
freestanding building was exposed to a competitive
and open market prior to being re-leased.
TAX APPEAL SELECTION OF RENTS
Rent = $15.00/SF Net
Second Gen Tenant
$30/SF allowance
Respondent’s Appraiser
Rent = $20.00/SF Net
First Gen Tenant
Build To Suit
Petitioner’s Appraiser
TAX APPEAL SELECTION OF RENTS
Rent = $25.00/SF Net
Second Gen Tenant
$20/SF allowance
Respondent’s Appraiser
Rent = $30.00/SF Net
First Gen Tenant
White Box + $15/SF in TI
Petitioner’s Appraiser
MARKET RENT CONCLUSIONS
$1,073,000 - Annual Rent
Respondent’s Appraiser
$1,333,300 - Annual Rent
Petitioner’s Appraiser
CAP RATE SUPPORT
Q3 2015 Average Cap Rate = 6.81%
CAP RATE & VALUE CONCLUSION
$1,073,300 - NOI
7.0% - Cap Rate
$15,350,000 - Value
Respondent’s Appraiser
$1,333,300 – NOI
6.5% - Cap Rate
$20,500,000 – Value
Petitioner’s Appraiser
WORLDS COLLIDE