Mass Appraisal of Leasehold Interest in Exempt Real Property Kirk F. Boone, PPS North Carolina Advanced Personal Property Seminar September 13, 2010

What we’ll cover regarding the mass appraisal of LIERP What is it? Why does it matter? Can it be done? If so how?

What is Leasehold Interest? Careful –not to be confused with Leasehold Improvement. Leasehold improvements. Items associated with a lessee (the tenant), that have been affixed to the real property owned by a lessor.

What is Leasehold Interest? The three most common forms of ownership interest in real property are: 1) Fee Simple 2) Leased Fee 3) Leasehold

Explicitly assumed, the most complete bundle of rights available Unencumbered by any other interest. Perpetuity Fee Simple Interest

Leased Fee Interest The Fee Simple interest, but encumbered by a lease. (Rights of use and occupancy conveyed to lessee) If lease rates are market rates, Lease Fee Value and Fee Simple Value are equal. If lease rates exceed market rates? If market rates exceed lease rates?

Leasehold Interest The interest held by a tenant If lease rates = market rates, leasehold has no value. If lease rates < market rates, leasehold interest has value. Value is dependent on the specific terms of the lease. Fee Simple = Leased Fee + Leasehold

Market rent(2k) = Contract rent(2k)+Leasehold Fee Simple(FS) = Leased Fee(LF)+Leasehold(0) Market Rent(2k)=Contract rent(1k)+Leasehold(1k) Fee Simple $2,000 Leased Fee $1,000 Leasehold $1,000

Leasehold Interest Example #1 Subject property is leased for $10,000/ mo. All comparable properties lease for $30k/ mo. Other terms of lease of the subject property are common, same as comparables. Does Leasehold Interest have value?

Leasehold Interest Example #2 Subject property is leased for $1/ yr. All comparable properties lease for $20k/ mo. Other terms of lease of subject property are common, same as comparables/ Does Leasehold Interest have value? How is it measured?

Leasehold Interest Example #3 Subject property is airport garage, leased for $1/ yr. 3 yr renewable lease. 20 yr history. All comparable properties lease for $2,000/ mo. Terms of subject lease require lessee to perform all maintenance, resurface and mark the tarmac every 4 years, supply gasoline and maintenance for aircraft owned by landlord. Does Leasehold Interest have value? How is it measured?

Leasehold Interest Appraisal You must examine the terms of the lease to determine if leasehold interest has value. All leases are not the same. The value is for a benefit – a cash savings. The benefit is intangible property.

Leasehold Interest Why does it matter? If the real property being leased is exempt real property – the intangible property is taxable! NCGS (31) In North Carolina, Leasehold interest in exempt real property is taxable as intangible personal property! NCGS (8)

Appraising Leasehold Interest, can it be done? Yes! Here’s the formula.

Appraising Leasehold Interest, can it be done? How to appraise the benefit of a cash flow? Present value of future cash flows? How about direct capitalization method? How about discounted cash flow analysis?

Direct Capitalization NOI $20,000/mo benefit for 8 years using a10% cap rate? V=I/R NOI $240,000 /yr divided by 10% ? $2.4 million value? $240,000 x 8 years = $1,920,000 Wrong.

Discounted Cash Flow Analysis Why is discount rate lower than capitalization rate? Monthly benefit is $20,000 Term is 8 years Present value of an annuity due, discounted at 6% is….. $1,538,356 Calculator, excel, websites

Mass appraisal challenges You cannot look at only the lease amounts, but also the terms of subject and comps. What net benefit are you appraising and can it be translated to a cash flow? Even if rent is zero cash, the terms and conditions may negate any benefit. Did the city/county gratuitously lease the space without realizing property tax liability? Determining discount rate and length of lease.

Steps to overcome challenges Review exempt real property parcels Determine which ones are leased Require and review copies of the lease Start with the clear ones (Example 2 vs. 3) Discuss with assessor the result. Determine uniform standards for rate and length.

Discount Rate Average of 10 year Treasury yields is about 4.5%. Let’s say 5% Add for risk. Building could burn, landlord could not allow renewal. Be very reasonable. (6 to 7%) Consider how risk relates to monthly benefit/rent payment or lack thereof. If the TP argues the rate is too high…. If TP says you should add more for risk…..

Length of lease Is a 3-year renewable lease really a 3 year lease? Many short renewable leases are in reality, renewed many times. Long leases have much risk in later years, with less present value for later years. Suggest using 8 years, reviewing every January. Why?

Keep in mind three principles NCGS – It is taxable NCGS and – Uniform appraisal and assessment Don’t sweat the petty things and don’t pet the sweaty things.

In Conclusion What is it? – A taxable intangible benefit Why does it matter? – You’re required to assess and appraise it Can it be done? – Yes, but it’s different. If so how? – Discounted Cash Flow, Present Value of an annuity due.  Equitably  Uniformly

Contact Information Kirk F. Boone, PPS North Carolina Sales and Marketing Tax Management Associates, Inc. (TMA) 2225 Coronation Blvd. Charlotte, NC (mobile)