Question
How is above market rent handled in a real property appraisal?
USPAP is vague on the topic but the Interagency Guidelines are more specific.
USPAP FAQ 193 (2016-2017) specifically addresses above market rent. It simply states that the appraiser must analyze the effect on value, if any, of the terms and conditions of the lease.
USPAP FAQ 217 (2016-2017) indicates that if the client asks for the fee simple interest, a lease can be ignored.
Interagency Guidelines (2010)
“Non-market Lease Terms: For properties subject to leases with terms that do not reflect current market conditions, the appraisal must clearly state the ownership interest being appraised and provide a discussion of the leases that are in place. If the leased fee interest is being appraised and contract rent is less than market rent on one or more long term lease(s) to a highly rated tenant, the market value of the leased fee interest would be less than the market value of the unencumbered fee simple interest in the property.50 In these situations, the market value of the leased fee interest should be used.”
Answer
Ultimately, I think the answer to this reverts back to the definition of market value. If a typical buyer’s perception of the market value for a property is influenced by the terms of the lease, the appraisal should reflect that perception.
Market participants should be able to help you answer these questions that will drive your scope of work:
If the remaining term is 20+ years and the tenant is a credit tenant would a typical buyer capitalize the above market rent into perpetuity? What about 10+ years? Or 3 years with renewal options?
If it is a short remaining term, credit tenant and no renewal options do you discount the above market rent for the remaining term? Or do a DCF? Or reflect the risk in the cap rate selection?
Insert a non-credit tenant into the above questions. Does that change the answer? What if that tenant made a significant tenant finish out investment at the start of the lease?