Three's Company in Commercial Appraisals
Fee Simple, Leased Fee and Leasehold Interest
A professor, an accountant and an appraiser walk into a conference room. The lawyer is on the phone. This isn’t the start to a joke, but rather, the group of professionals we often find ourselves collaborating with, especially on complex appraisals. A recent example involved a medical group that became the causality of their “run fast” approach to success. While too cumbersome to serve as a good case study, decision makers must understand differences between fee simple and leased fee positions before retaining our services. As is always the case, appraisal pre-planning includes appraisal-interest vetting to make sure the correct legal interest is valued.
What is a fee simple appraisal?
Fee simple appraisals apply when there is absolute ownership of a property except for limitations imposed by governmental powers, i.e., taxation, eminent domain, police power, and escheat. The classical example is the bundle of rights/bundle of sticks associated with the real estate. This concept originated from English Common Law, with consideration of the following rights:
- The right to sell an interest
- The right to lease an interest
- The right to occupy the property
- The right to mortgage an interest
- The right to give an interest away
With a fee simple estate, the owner has not given away or shared any of the aforementioned rights. Fee simple positions are typically appraised when a property is owner-occupied.
which leads us to leased fee appraisals
A leased fee appraisal is needed when we are called upon to value property leased to third party/non-related lessors and lessees. For most income-producing real estate assets, a leased fee appraisal captures a) the present value of the fee rights to receive the rent plus b) the right to reoccupy the subject property when the lease expires.
These type of nuances are frequently a topic of discussion to be addressed before our services commence. As was the case with our professor, accountant, lawyer, and medical group example, real estate appraisers should make sure those using our services are adequately advised to assure the interest appraised is germane to the problem that has prompted the need for the appraisal. In this case study, a teaching hospital had grown over the years, with some real estate owner-occupied while some locations were operating out of leased properties.
which leads us to leasehold improvements
Although the medical group was renting some of its locations, substantial sums were sometimes spent in tenant upgrades/improvements including trade fixtures (leasehold improvements). Put differently, the question of “who owns what” should be determined before a valuation commences. For example, in a groundlease the underlying site is owned by the groundlessor; however, the structures and improvements on the parcel may be owned by the groundlesee. In this engagement, we were asked to estimate separate values for the underlying site and the leasehold improvements. This can be a daunting task because the sum of the parts may not yield the same result as an appraisal of all the components assumed as a single economic unit. While our client’s medical practice was growing rapidly, the value of leasehold improvements they paid for had not been recorded on their books. Thus, a note of caution for business owners who are growth focused – It is more difficult/ time-consuming and expensive to recreate financial data from past activity rather than taking appropriate steps for recording such costs/value enhancements at the time such improvements are completed.
If you find yourself in a room with a professor, an accountant, a lawyer or a variation thereof and the topic involves valuation, you probably should have an appraiser by your side as well. Give the team at Argianas & Associates a call at (630) 390-0113 or complete this form. To receive more real estate appraisal resources or to receive our original thought pieces, be sure to join our mailing list to receive our e-newsletter.