"Is excess rent intangible?".
In "Is Excess Rent Intangible?" (Spring 2016), by Stephen D. Roach, MAI, SRA, AI-GRS, the main issue addressed is whether the present value of excess rent is intangible. After concluding that the present value of excess rent is intangible, Mr. Roach also concludes that the identification of the present value of excess rent as an intangible asset is not optional for professional appraisers. Further, he implies that in many market value assignments, the value contribution of this intangible component of value may have to be quantified. While I agree that the present value of excess rent is intangible, because it is a real property intangible, there is no requirement for its separate allocation in most market value appraisals.
Value is defined by The Dictionary of Real Estate Appraisal as "the monetary relationship between properties and those who buy, sell, or use those properties. Value expresses an economic concept. As such, it is never a fact but always an opinion of the worth of a property at a given time in accordance with the specific definition of value. In appraisal practice, value must always be qualified-for example, market value, liquidation value, or investment value. (SVP)" (1) Based on this definition, the present value of anything is intangible because it is a theoretical concept of worth. Hence, the present value of excess rent is intangible. However, just because it is intangible, must it be allocated separately in an appraisal? The article implies that in a market value appraisal, it must. This is based on an assertion that fee simple estate and real estate are synonymous and consequently any rent above market is produced by something other than the physical property.
A review of the definitions of the terms demonstrates that they are not synonymous. Fee simple estate is defined in The Dictionary of Real Estate Appraisal as "absolute ownership unencumbered by any other interest or estate, subject only to the limitations imposed by the governmental powers of taxation, eminent domain, police power, and escheat." (2) Fee simple estate addresses real estate ownership and, as such, is a concept--thus, it is intangible. On the other hand, real estate is defined as "(1) an identified parcel or tract of land, including improvements, if any. (USPAR 2016-2017 ed.) (2) land and all things that are a natural part of the land (e.g., trees, minerals) and things that have been attached to the land (e.g., buildings and the site improvements) and all permanent building attachments (e.g., mechanical and electrical plant providing services to a building) that are both below and above ground (IVS)." (3) Therefore, physical real estate is tangible. It is soil, trees, bricks, etc. Because market value of real estate is determined by intangible rights and the market's desire for those rights, tangible real estate, void of rights, has no market value. (4) Clearly, fee simple estate (intangible) and real estate (tangible) are different.
The article states that a lease is distinct from the bundle of rights. I disagree. When the intangible rights of use and occupancy are temporarily given to another via lease, the compensation for borrowing those rights is contract rent (all contract rent whether above, below, or at market rent). Clearly a lease is directly related to real property, as one stick in the bundle of rights is the right of use and occupancy.
It is correct that a lease never increases the market value of real property rights to the fee simple estate and that any potential value increment in excess of a fee simple estate is attributable to the particular lease contract. (5) However, one must remember that a fee simple estate is an intangible, unencumbered ownership interest in real estate, not the physical real estate itself. Nothing in the definition of fee simple estate suggests that a fee simple estate is equivalent to the physical real estate being leased at market rent, as Mr. Roach implies. The assertions that "the fee simple interest (the real estate) can obtain market rent but no more" (p. 121) and that "anything above the market-rent level must be produced by something other than the physical property itself' (pp. 121-122) are not supported by the definitions. Physical real estate does not "obtain" market rent. Contract rent (regardless of its relationship to market rent) is simply compensation for the borrowing of intangible rights to real estate. As such, all contract rent, whether it is at, above, or below market, impacts the market value of a property's leased fee interest and is inherently tied to the real property. It is also noted that while real estate market value is affected by intangible property rights, it is also affected by other intangibles (e.g., zoning, easements, etc.), yet there is no suggestion that any of these other real property-related intangibles should be allocated separately.
The article implies that the Uniform Standards of Professional Appraisal Practice (USPAP) requires an allocation of the present value of excess rent in market value appraisals. I disagree. It is a stretch to suggest that USPAP's definition of intangible property (intangible assets) means "leases" when it says "contracts." USPAP is largely a real estate-oriented document. The concepts of contracts and leases are treated as different terms in the document. It is noted that USPAP's definition of intangible property does not mention rent or excess rent. If in fact "contracts" did mean leases, it would mean all leases, not just leases at above-market rent. Also, USPAP Standards Rule l-2(e)(iv) lists leases and contracts separately as items appraisers must identify as characteristics of the property that are relevant to the type and definition of value and intended use of the appraisal. This reference also appears in USPAP FAQ 193, which was discussed in the article without recognition that leases and contracts are listed separately. While FAQ 193 suggests that intangibles exist in the example provided, the conclusion does in fact resolve the issue; it states, "the subject of this appraisal is real property, not intangibles, specifically the leased fee estate." This clarifies that in the example the assignment is to provide a value opinion of the property owner's leased fee interest, i.e., the value of the owner's interest in the physical real estate, whereby the rights of use and occupancy have been temporarily lent to a tenant in exchange for rent. Any buyer of this leased fee interest would price the real estate subject to that lease, and such price would reflect the contract rent's relationship to market rent and any inherent risk associated with that relationship. The article challenges USPAP's response to FAQ 193, paraphrasing that Standards Rules l-2(e) and 1 -4(d) require the appraiser to identify whether "any intangible items" are included in the appraisal and to analyze the effect on value of the terms and conditions of the lease. This paraphrasing misses a key element of Standards Rule l-2(e) (iii), which states that "an appraiser must identify the characteristics of the property that are relevant to the type and definition of value and intended use of the appraisal, including: ... (iii) any personal property, trade fixtures, or intangible items that are not real property (emphasis added), but are included in the appraisal." It does not say "any intangible items," but specifically addresses intangibles that are not real property. USPAP's inclusion of the words "real property" point out that intangibles may or may not be real property items.
The article points to the Interagency Appraisal and Evaluation Guidelines to support its premise; however, the guidelines do not specifically address excess rent. Like USPAP, the guidelines suggest that when appraising the market value of a property subject to a lease, the market value should be of the leased fee interest.
As to the ad valorem tax cases cited in the article, it is important to understand the jurisdictional requirements regarding the property rights to be appraised. Many states require assessments to be based on fee simple valuations. The question in many of these cases is not whether excess rent (or any rent for that matter) is intangible, but rather what property rights are applicable based on the state statute. If the rights are the leased fee, the properties should be valued based on the contract rent. If the rights are the fee simple, then the properties should be valued as unencumbered. A court's determination, in a fee simple state, that excess rent should be excluded does not lend any support to the excess rent premise because in a fee simple valuation all contract rent should be excluded as the property should be valued as unencumbered.
While appraisers are required to analyze the effect on value of above-market leases, there is no requirement to separately allocate the present value of excess rent in a market value appraisal of a leased fee interest. In a proper market value appraisal of a leased fee interest, the appraiser compares contract rent to market rent and analyzes risk associated with the rent relationship. In a proper market value appraisal of a fee simple estate in a property leased above market (such as in some ad valorem cases), excess rent is never addressed because the property must be appraised as unencumbered.
So yes, the present value of excess rent is intangible, but it is associated with real property. It is acknowledged that there may be assignments where clients request appraisers to provide opinions of the present value of excess rent. However, because excess rent is a real property intangible, separately allocating the present value of excess rent is typically not necessary when providing market value opinions of fee simple estates or leased fee interests.
Gary E. Heiland II, MAI, AI-GRS
I thank Gary Heiland for his interest in the subject and his detailed reading of my article. I respectfully disagree with Mr. Heiland's comments in a number of areas. First, I have seen no text, treatise, or accepted publication supporting the concept of a "real property intangible." In accepted professional literature in the appraisal, accounting, and legal professions there are three general asset classes: tangible property, intangible property, and financial assets. Tangible property is further divided into tangible real property and tangible personal property. Intangible property is defined as "an identifiable nonmonetary asset without physical substance." (See The Dictionary of Real Estate Appraisal, sixth edition; also the International Accounting Standards referenced in my article). The fact a lease is connected to or associated with a property does not make the excess rent generated by that lease real property (defined as an interest in real estate). Second, the article does not state or imply, and I do not believe, that a fee simple estate is equivalent to the physical real estate being leased at market rent. In fact, Leslie Sellers and I did a presentation on this very issue at the 2016 Appraisal Institute Annual Conference; quoting from one of my slides used in the presentation, '"As if leased at market rent' is NOT a proxy for fee simple." Finally, while I agree that in a given situation it may not be necessary to separately allocate the present value of excess rent when appraising a leased fee interest (there can be no excess rent in a fee simple estate), I believe that it is always necessary to identify the existence of this non-realty asset when communicating the results of the assignment.
Stephen D. Roach, MAI, SRA, AI-GRS
San Diego, California
(1.) Appraisal Institute, The Dictionary of Real Estate Appraisal, 6th ed. (Chicago: Appraisal Institute, 2015).
(4.) See Appraisal Institute, The Appraisal of Real Estate, 14th ed. (Chicago: Appraisal Institute, 2013), 4.
(5.) Ibid., 441.