February 21, 2019 – Every once in awhile the same question arises from several people in different parts of the country. I wonder if people attended the same seminar and were told the same (erroneous) information. Or just plain coincidence.
The topic du jour is bank/credit union clients asking appraisers to ignore existing subject leases and appraise Fee Simple Estate only. There are two main scenarios to deal with – one where such a request is not acceptable and one where it is.
Scenario #1 – The subject has one or more arm’s-length leases in place that are not all month-to-month or say expire within a month. I just use one month as technically the appraisal will be done by then and the tenants could be removed in that time period (assuming such is legal). In this case, Market Value ‘As Is’ MUST be of the Leased Fee Interest. The subject must be appraised as it legally and physically stands today. If the bank/credit union would also like to know the Fee Simple Estate value, then this can be provided IN ADDITION TO Market Value ‘As Is’ of the Leased Fee Interest. I would call this additional value Hypothetical Value of Fee Simple Estate. A Hypothetical Condition is needed as this value assumes the existing leases are not in place. Now, if the subject is leased to a single tenant and that tenant is purchasing the property…we go to…
Scenario #2 – The subject is leased to a single tenant who is purchasing the property. Obviously, when the purchase occurs the lease goes away. Or at least for us appraisers, it is ignored because now it is no longer arm’s-length. The bank/credit union’s request for Fee Simple Estate only is now acceptable. With a bit of a twist though….Market Value ‘As Is’ would still be of Leased Fee Interest. However, this value is not needed. Why? Because the loan is not being made until the property is purchased. Therefore, the appraiser provides a Prospective Value as of say a month or two in the future (whenever a closing is projected to occur). An Extraordinary Assumption is needed to say that we assume the purchase will occur and the lease will be extinguished in the stated timeframe. What about the requisite Market Value ‘As Is’ that FIRREA requires? Well, on the day the property is purchased and the loan is closed, the appraiser’s Prospective Value is now Market Value ‘As Is.’ And now FIRREA is satisfied and all is good in Appraisal Land:)
((As an aside, Scenario #2 is useful when a zoning change is in process. Until it occurs, Market Value ‘As Is’ must consider the subject as currently zoned. I encourage banks not to make the loan until the zoning change occurs. This way an appraiser can provide a Prospective Value ‘Upon Zoning Change’ with a future date and not have to deal with Market Value ‘As Is.’ But, if the loan is being made today, then two difference scenarios must be valued. Once again, the value difference might not be that much.))
There are likely some other less common scenarios that arise. But, the above two seem to take care of the vast majority of transactions.
I will quickly mention one scenario that provides an example of why Market Value and Market Value ‘As Is’ are not always the same.
The subject is leased to a single tenant with say 3 or 6 months left on the lease. The owner or a buyer is going to occupy the property once the lease expires and the tenant has moved out.
In non-bank/cu appraisals, Market Value could likely just ignore the existing lease. We could argue that market participants don’t care about the next 3-6 months of the tenant being in place. They know they will occupy the property very soon. This is ok for Market Value.
However, for a bank appraisal under FIRREA, this is not acceptable. The lease is in place and Market Value ‘As Is’ is of Leased Fee Interest and the lease must be part of the value. Obviously, if the rental rate happens to be at market, then there is no difference in value between the Leased Fee Interest today and the hypothetical Fee Simple Estate today. If contract rent is above or below market, then there is a difference in these two values. Admittedly, it is likely to be a small amount. But, it MUST be included in the Market Value ‘As Is’ conclusion. In this case, Market Value and Market Value ‘As Is’ differ. And this is one of several examples where USPAP and FIRREA differ.
As with FF&E, please do not pull the ol’ ‘this is absorbed in rounding and thus is not added or deducted’ routine. Make the addition or deduction to get to Market Value ‘As Is’ and move on.
Please contact me if you have any questions. Any other scenarios worth me addressing. et al. Thanks for taking the time to read my blog:)