3 valuation of lease interests

8/10/2019 3 Valuation of Lease Interests

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Comprehensive Real Estate Appraisal Seminar and Training (CREASAT) RTPunzalan, CPV

VALUATION

OFLEASE INTERESTS


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LEASE INTERESTS

Lease interests are a form of real property arising from the con tractual re lat ions hip ( the term s o fwh ich are co nveyed b y a lease) between

a l essor, one wh o own s the p rop erty leased to another,

and

a lessee, or tenant , one who typically receives a n o n - permanent r igh t to u se the leased property in re turn forrental paym ents or other valuable economic consideration.


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Lease.

A con t rac t a r rangement in w hich r igh t s o f use andposs ess ion a re conveyed from a propertys title owner(called the landlord, or lessor) in return for a promise by

another (called a tenant, or lessee) to pay rents asprescribed by the lease.

A lease is an agreement whereby the lessor (owner ofproperty) allows the lessee use of the proper ty inexchang e for lease paym ents .

In practice the rights and the duties of the parties can becomplex, and are dependent on the specified terms of theircontract.

LEASE INTERESTS

DEFINITION OF TERMS


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Lease.

Classification of Leases

Operating Lease Operating leases give the lessee the use of

proper ty wi thou t own ersh ip .

Financing Lease More popularly known locally as lease-to-own Financing leases t r ans fe r ownersh ip f rom lessor to

lessee.

LEASE INTERESTS

DEFINITION OF TERMS


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Leased Fee or Lessors Interest ,

Represents the ow nership in teres t of a less or owningreal estate that is subject to lease to others

In operat ing leases , the value of the Leased Fee orLessors Int erest is the value of th e rem aining renta lpaym ents and the value of the proper ty a t the end ofthe lease per iod, the revers ion value of the p roper ty

In f inancial leases , the value of the Leased Fee orLessors Interest is the value of the remaining leasepayments

LEASE INTERESTS

DEFINITION OF TERMS


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Leasehold o r Lessees Int erest , or Leasehold Esta te .

The ow nership in teres t o f the lessee or tenant that iscreated by the terms of a lease

The lease interest is subject to the terms of a specific leasearrangement, expires within a specified time, and m ay becapable of su bdiv is ion, or subleas ing to other par t ies

In op erat ing lease , the value of the Lessees Interes t isestimated as the value o f rental g ain/(los s) , i f any, andthe value of th e leasehold im pro vement /s , i f any

In f inanc ial lease , the value of the Lessees Int erest isestimated as market value of the proper ty less theremaining lease paym ents .

LEASE INTERESTS

DEFINITION OF TERMS


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Rent Types

Market Rent. The estimated amount for which a property, or space within a

property, should lease on the date of valuation betw een awil l ing lesso r and a wi l l ing lessee on app ropr ia te leaseterms in an arms -length t ransact ion, af ter p roperm arket ing wh erein the par t ies had each actedknow ledgeably, p rudent ly, and wi thout com puls ion

Contract Rent , or Pass in g Rent .

The rent sp eci f ied b y a g iven lease arrangement ; althougha given contract rent may equate to the Market Rent, inpractice they may differ substantially, particularly for olderleases with fixed rental terms.

LEASE INTERESTS

DEFINITION OF TERMS


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Turno ver Rent or Part icipation Rent. Any form of lease rental arrangement in which the l e ssor

receives a form of renta l that i s based on the earning sof th e less ee. Percentage rent is an example of a

turnover rent.

LEASE INTERESTS

DEFINITION OF TERMS


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Posi t ive L easehold Interes t A positive leasehold is created wh en the market rent i s

greater than th e con tract rent .

Negative Leaseho ld Interest Negative leasehold interest is created wh en the contract

rent i s h ig her than the cu rrent market rent .

Even if the leasehold interest is positive, there may be novalue because the leasehold interest is not transferable to athird party. The lease agreement may prevent a transfer.

If the con tract rent and the m arket rent are equal , theLeasehold o r Lessees Int erest is zero , assuming there isno leasehold improvements.

LEASE INTERESTS

DEFINITION OF TERMS


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The valuation of a lease interest is anchored on theeconomic princ iple of ant ic ipat ion . Value is cr eated bythe future benef its (inco m e s t ream) of ow nership(wh ole o r p art ial).

The inco m e capi tal iza t ion approach is based on thesame principle. The approach perc eives value as c reatedby the exp ecta tion o f fu ture benef i ts (inco m e s t reams) .

Inc om e capital izat ion employs processes that considerthe present value of ant ic ip ated futu re inco m ebenefi ts .

VALUATION OF LEASE INTERESTS

METHOD OF VALUATION


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The approach cons iders inc om e and expense da ta relating to the property being valued and estimates valuethrough a capi ta lizat ion proc ess .

Capital izat ion relates income (usually a net income figure)and a defined value type by converting an income amountinto a value estimate.

This p rocess m ay cons ider d i rec t relat ionsh ips(kno wn as capi ta l iza t ion ra tes) , y ie ld or d isc ou nt ra tes

(ref lec t ing m easures o f re turn on investm ent), or b oth .

Bas ic Form ula: Value = Inc om e / Rate


METHOD OF VALUATION


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One of the accepted methodologies within the incomecapitalization approach to valuation is the Discounted CashFlow (DCF) analysis.

Discou nted Cash Flow (DCF) analys is is a financialmodeling technique based on explicit assumptions regardingthe prosp ec t ive incom e and expenses o f a p roper ty o rbus iness .

Such assumptions pertain to the quantity, quality, variability,

timing, and duration ofin f lows and ou t f lows

that arediscou nted to p resen t v a lue .


METHOD OF VALUATION


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Income Approach Discounted Cash Flow

I 1

I 2

I 3

I 4 I 5

Reversion Value(end of period)

PV1

PV2

PV3

PV4

PV5

RV

pwf x I 1

pwf x I 2

pwf x I 3

pwf x I 4

pwf x I5

pwf x RV

1 2 3 4 50+

+

+

+

+

=

MV

6



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EXAMPLE:

Mr. Lessor owns a property consisting of a parcel of land leased to Mr. Lessee atan annual lease of P100,000. The lease which is about to commence is for 5 years.The lease is payable at the end of each year. Based on market data, thecapitalization rate for similar properties is 8% per year. The market value of theproperty at the end of the lease is estimated at P1,500,000. Determine the LessorsInterest.

Given Data:Rental Rate is P100,000 per yearLease Period is 5 yearsCapitalization Rate is 8% per yearValue of Property at the end of Lease is P1,500,000


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I 1

I 2

I 3

I 4 I 5

P1,500,000 x NPV factor

1 2 3 4 50

P100,000 x NPV factor





CASH FLOW DIAGRAM:

LESSORS INTEREST = NET PRESENT VALUE (NPV) OF RENTALS +REVERSION VALUE OF PROPERTY


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A. NET PRESENT VALUE OF RENTAL

YEAR RENTAL NPV FACTOR NPV

1 100,000 0.9259 92,590

2 100,000 0.8573 85,730

3 100,000 0.7938 79,380

4 100,000 0.7350 73,5005 100,000 0.6806 68,060

399,260

B. REVERSION VALUE

YEAR MV END OF LEASE

5 1,500,000 0.6806 1,020,900LESSOR'S INTEREST 1,420,160

COMPUTATION:


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EXAMPLE:

Corp. A owns an industrial land and leases it to Corp. B. The lease is for 10 years andcommenced in 2008. Corp. B built a warehouse on the land and as stipulated on thelease agreement, the warehouse will be turned over to Corp. A upon the expiration of thelease. The starting rental rate is P80,000 per year and is subject to an increase ofP5,000 per year henceforth. Based on market data the capitalization rate of similarproperties is 6% per annum. The value of the land and the building are estimated atP2,000,000 and P1,500,000, respectively, at the end of the lease. The rentals arepayable at the start of every year. Determine the Lessors Interest.

Given Data:Date of Appraisal is 2010Lessor is Corp. ALease Period is 10 yearsRemaining Lease Period is 8 yearsRental Rate is P80,000 per annum subject to increase payable at the start of the yearCapitzalization Rate is 6% per annumValue of Land at the end of the Lease is P2,000,000Value of the Building at the end of the Lease is P1,500,000


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LESSORS INTEREST = NET PRESENT VALUE (NPV) OF RENTALS + REVERSION VALUE OF THELAND VALUE + REVERSION OF BUILDING VALUE

COMPUTATION:

A. Net Present Value of Remaining Lease

Year Year per Lease

Agrmt.Rental per Annum

NPV Factor at 6% perannum

NPV

2008 1 80,000 paid -

2009 2 85,000 paid -

2010 3 90,000 paid -

2011 4 95,000 0.9434 89,623

2012 5 100,000 0.8900 89,000

2013 6 105,000 0.8396 88,158

2014 7 110,000 0.7921 87,131

2015 8 115,000 0.7373 84,790

2016 9 120,000 0.7050 84,600

2017 10 125,000 0.6651 83,138

Subtotal 606,439

B. Reversion of Land Value

2,000,000 0.6651 1,330,200

C. Reversion of Building Value

1,500,000 0.6651 997,650

Lessor's Interest 2,934,289


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EXAMPLE:

Corp. C leases an office condominium unit in Makati. The lease is for 8 years and willcommence on January, 2011. Monthly rental is P20,000 payable on the first day of everymonth. Based on market data, the prevailing rental rate for condominium units isP25,000, and the capitalization rate is 6% per annum. The unit is fully-furnishedcomplete with telephone lines and air- conditioning system. Determine the LesseesInterest.

Given Data:Lease Period is 8 yearsContract Rate is P20,000 per monthMarket Rent is P25,000 per monthRental Gain is P5,000 per month or P60,000 per yearCapitalization Rate is 6% per year


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COMPUTATION:LESSEES INTEREST = NET PRESENT VALUE (NPV) OF RENTAL GAIN

Lessee's Interest = Present Net Value of Rental Gain

Year perLease

Agrmt.

Rental Gain per Annum

NPV Factor at 6%per annum NPV

1 60,000 0.9434 56,604

2 60,000 0.8900 53,400

3 60,000 0.8396 50,376

4 60,000 0.7921 47,526

5 60,000 0.7473 44,838

6 60,000 0.7050 42,300

7 60,000 0.6651 39,906

8 60,000 0.6274 37,644

Lessee's Interest = 372,594


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EXAMPLE:

Corp. D is leasing a parcel of land in an industrial subdivision is Laguna for 20 years.The lease started in 2005. The rental rate is P1,000,000 per year. Corp. D constructedbuildings of the land but the buildings will be turned over to the land owner uponexpiration of the lease contract. As of the data of appraisal, 2010, the value of thebuildings is estimated at P8,500,000, the prevailing capitalization rate is 6%, theprevailing rental rate for similar land is P1,200,000, and the remaining life of the buildingsis 35 years. Determine the Lesees Interest.

Given Data: Appraisal date is 2010Lease Period is 20 yearsRemaining Life of Lease Contract is 15 yearsContract Life Ratio is 15 years / 20 years or 75%Capitalization Rate is 6%Contract Rent is P1,000,000 per yearMarket Rent is P1,200,000 per yearRental Gain is P200,000 per yearValue of Buildings is P8,500,000


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COMPUTATION:LESSEES INTEREST = NET PRESENT VALUE (NPV) OF RENTAL GAIN + LEASEHOLD VALUE OFIMPROVEMENTS (BUILDINGS)

A. Present Worth of Rental Gain

Rental Gain per Annum

NPV Factor at 6%per annum* NPV

200,000 9.7122 1,942,440

* NPV factor for annuity

B. Leasehold Value in Improvements

Value of Buildings Contract LifeFactor

8,500,000 0.75 6,375,000

Lessee's Interest = 8,317,440

3 valuation of lease interests

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