Differences Between Property Interests and How They Affect Value
Every parcel of real estate contains different rights associated with it. These rights include the right to sell an interest; the right to lease an interest and occupy the property; the right to mortgage an interest; the right to give an interest away; and the right to do none or all of these things. Together, these interests are known as the “The Bundle of Rights” inherent in the property.
These interests can be identified and defined as follows: Fee Simple Interest A property that has all of these interests held by the owner(s) of the property is said to have a “fee simple interest” in the realty. This is absolute ownership unencumbered by any other interests or estate. The fee simple interest is valued when the definition of “market value” is to be found. Most appraisals value the fee simple interest of a property. It is important to remember that each interest is subject to the governmental powers of taxation, eminent domain, police power and escheat (the right to take property which has no heirs or the owner dies intestate.) When all or part of a property is leased, then another interest must be valued, depending upon if the lease is favorable to the tenant, or to the owner.
Leased Fee Interest When a lease is written for a tenant of a property, the lease may reflect terms and/or fees which are above the typical rental rates being received by other, similar properties in the marketplace at a given time. The leased fee value is compared to the fee simple value of the property to determine if there is additional rent being received which would not typically be obtained by other competing properties. Any additional rent which would be considered in excess over the typical market rent being received at the time, is considered to be an advantage to the owner of the property. The duration and amount of rent during which this excess rent will be received is treated as a declining income stream. This additional income stream must be discounted to a present value and is not a part of the market value of the property. The entire discounted amount over the period it will be received represents the leased fee interest in the property.
Leasehold Interest If the tenant has favorable lease terms which are below market rates, then the tenant is said to have a “leasehold interest” in the property. This favorable condition is compared to the fee simple value of the property. It is valued in a similar manner to the leased fee interest, but with a slight twist. In this instance, the lessee has an in the property during the remaining term of the lease. This is a loss in value to the property owner which needs to be recognized. The property owner’s value is decreased by that amount which is estimated to be in the tenant’s favor. Thus, both the tenant AND the owner have an interest in the value of the property for the remainder of the lease term. If the tenant has sublet his interest to another party (sub-tenant), the sub-tenant may also hold a sub-leasehold interest which must be valued as well.
Undivided partial and minority interests A property can be held by multiple owners, each having a different percentage of ownership. When all owners have equal, undivided partial interests, with none having complete control of the property, each owner’s share can be sold, but at a price which is less than his/her proportional part of the total property’s value. This lower price reflects its lack of marketability of the share in the open market. In order to sell an undivided partial interest, the share being sold is discounted to a value the market would be willing to pay for it.
Because the underlying property will most likely not be sold in total, the lack of marketability of this share is the discount required by the open market. The discounted value of the share is determined by comparing it to other partial interests which have sold through a secondary market. This market specializes in purchasing and re-selling shares of undivided partial interests from similar partnerships. This secondary market provides the analyst a good source of information to compare to the type of property from which the share is being sold. This secondary market is regulated by the Security Exchange Commission (SEC).