Fee Simple Estate – How Many Sticks in the Bundle?
Paul Hornsby & Company
dh BUSINESS ADVISORS
8303 North Mopac
Suite A-150
Austin, TX 78759
Phone: (512) 477-6311
Fax: (512) 477-1793
phornsby@paulhornsbyandco.com August 28, 2008
Today’s Discussion
Overview
Definitions
Legal Basis
Literature Support
Fee Simple Construct
Valuation Theory Alternatives
Supportable Application Methods and Techniques
Adjustments to Leased Fee Sales
Income Approach
Closing Thoughts
Paul Hornsby & Company
dh BUSINESS ADVISORS 8.28.08
Fee Simple Estate Definitions
Dictionary of Real Estate Appraisal (4th Edition)
§ Absolute ownership unencumbered by any other
interest or estate, subject only to limitations imposed
by the governmental powers of taxation, eminent
domain, police power, and escheat.
Black’s Law Dictionary (8th Edition)
§ An interest in land… being the broadest property
interest allowed by law…
Paul Hornsby & Company
dh BUSINESS ADVISORS 8.28.08
Legal Basis
Texas Property Tax Code
“The market value of property shall be determined by the
application of generally accepted appraised methods and
techniques.” (p. 189)
Relevant Cases
“The value of the entire fee necessarily contains the lesser value
of the leasehold that it includes. A leasehold derives from and is
part of the fee estate, so the lessor is responsible for taxes on
the full value of its property”. (Dallas Central Appraisal District v.
Jagee Corp., 812 S.W.2d.49).”
“It has long been the law that the lessor… is responsible for
taxes on the full value of his property.” (Cherokee Water Co. v.
Gregg County Appraisal District, 801 S.W.2d 872 (Tex. 1990)).
Paul Hornsby & Company
dh BUSINESS ADVISORS 8.28.08
Literature Support
Unit Rule/Undivided Fee Rule:
“…the property should be appraised as a whole, embracing the
rights, estates, and interests of all who may claim, and as if in
one ownership.” (Real Estate Valuation in Litigation, 2nd ed.)
“Under this rule, a property encumbered by a lease is valued in
the same way as a property not so encumbered. In other words,
the property is appraised as if its fee simple title were held by
one individual or entity.”
Paul Hornsby & Company 8.28.08
dh BUSINESS ADVISORS
Fee Simple Estate Construction
Value
Leasehold
Leased Fee
Time
Paul Hornsby & Company
dh BUSINESS ADVISORS 8.28.08
Valuation Theory Alternatives
Value at current occupancy and market rent
Most generally accepted
Value at zero occupancy
Pure, theoretical unencumbered estate
Despite recent Canadian decision; presents Daubert risk
2008 Toronto Ontario ARB Interim Decision
BCE Place Limited et al vs. Municipal Property Assessment
Corp. & City of Toronto
ARB ruled proper context was exclusion of encumbrances,
including leases
ARB held leases were personal property
ARB held tenant improvements had no value in exchange
ARB held cap rate is linked to legal interest to be valued
Final Decision yet to be rendered
Paul Hornsby & Company
dh BUSINESS ADVISORS 8.28.08
Supportable Application Methods
The Appraisal of Real Estate, 13th Ed.
Cost Approach indicates fee simple value
Sales Comparison Approach may require
adjustments to leased fee sales
Income Approach inputs include actual occupancy
and market rent; capitalization rate may differ from
leased fee rate
Paul Hornsby & Company
dh BUSINESS ADVISORS 8.28.08
Adjustments to Leased Fee Sales
Examples:
Property rights conveyed, recognizing positive or
negative leasehold
Occupancy variance vis-à-vis subject
Contract vs. market rent
Atypical finish-out
Non-market expenses
Credit worthiness of tenant; which can affect rent and
cap rate
Paul Hornsby & Company
dh BUSINESS ADVISORS 8.28.08
Income Approach Application
Inputs:
Market rent and expenses
Deductions for non-stabilized occupancy (tenant
finish, leasing commissions, unrealized income)
Possible capitalization rate differential
Market surveys (Korpacz, etc.) are typically fee
simple/expected rates.
Leased fee rates from sales can be adjusted by expected
income growth differential in sale property and subject.
Paul Hornsby & Company
dh BUSINESS ADVISORS 8.28.08
Income Approach Example
Assumptions:
•9% IRR (Discount Rate) applicable to both leased fee sale and
subject
•IRR-OAR=annual income growth rate
Leased Fee Sale Fee Simple Subject
IRR (Discount Rate) 9% 9%
Expected Growth Rate 3% 2%
Cap Rate (OAR) 6% ?
In this example the applicable fee simple capitalization rate is 7%, or
1% above the leased fee rate. If expected growth rates are equal, no
adjustment to capitalization rate would be required.
Paul Hornsby & Company
dh BUSINESS ADVISORS 8.28.08
Closing Thoughts
The Fee Simple Estate always includes both the leased
fee and leasehold interests.
The supportable application of the Income Approach
uses market rent and actual occupancy. Cap rates and
other inputs may be different than in leased fee sales.
Adjustments may need to be made to leased fee sales in
Sales Comparison approach.
Paul Hornsby & Company
dh BUSINESS ADVISORS 8.28.08
Paul Hornsby & Company
dh BUSINESS ADVISORS
8303 North Mopac
Suite A-150
Austin, TX 78759
Phone: (512) 477-6311
Fax: (512) 477-1793
phornsby@paulhornsbyandco.com