13.4 Fee Simple, Leased Fee, Leasehold and Income Reconciliation
Key Takeaways
- Fee simple income capitalization typically uses market rent and market expenses; leased fee uses contract rent (and terms) for leased space; leasehold value arises when contract rent is below market rent.
- When contract rent ≠ market rent, leased fee and leasehold values generally sum (conceptually) toward fee simple value of the property as a whole, subject to risk, enforceability, and term—exam teaching often uses neat additive examples.
- Direct capitalization and yield capitalization can both value fee simple, leased fee, and leasehold interests (ECO VI.g and VI.h); the income premise and cash flow rights must match the estate appraised.
- Reconciliation to the indicated value by the income approach (ECO VI.i) weighs quality of income data, rate/multiplier support, and consistency—not automatic averaging of every intermediate calculation.
- Never apply a fee-simple market Ro to below-market contract NOI without adjusting the rate or method; risk and duration of the lease advantage/disadvantage change the appropriate conversion.
Rights First, Then the Math
Chapters 12–13.3 built income, rates, and DCF tools. ECO still requires you to aim those tools at the correct bundle of rights:
| ECO reference | Task |
|---|---|
| VI.g | Indicate value through direct capitalization — fee simple, leased fee, leasehold |
| VI.h | Indicate value through yield capitalization — fee simple, leased fee, leasehold |
| VI.i | Reconciliation to indicated value by the income approach |
If the assignment is leased fee and you capitalize market rent as if vacant and free of the lease, you answered a different question than the client asked—even if IRV arithmetic is perfect.
Three Interests — Income Premises
| Interest | Who holds it | Typical income for valuation |
|---|---|---|
| Fee simple | Full ownership (as unencumbered by atypical leases for market value analysis) | Market rent, market vacancy, market expenses |
| Leased fee | Landlord’s interest subject to existing lease(s) | Contract rent (and reimbursements) per leases; vacant space at market; expenses per lease structure |
| Leasehold | Tenant’s interest under the lease | Advantage of occupancy: roughly market rent − contract rent (when contract < market), for the remaining term, risk-adjusted |
Above-market contract rent tends to increase leased fee value (landlord benefit) and can create a negative leasehold / liability concept for the tenant (or simply no positive leasehold). Below-market contract rent tends to decrease leased fee relative to fee simple and create positive leasehold value for the tenant.
Conceptual Identity (Teaching Form)
Fee simple value ≈ Leased fee value + Leasehold value
(when the only difference is the lease’s rent relative to market and both sides are valued consistently)
Markets, default risk, and non-rent lease clauses can break neat addition—but exam problems often illustrate the split cleanly.
Direct Capitalization by Interest
Fee Simple — Direct Cap
- Reconstruct market PGI → EGI → NOI
- Apply market Ro extracted from fee-simple / market-income sales
- V_fee ≈ NOI_market ÷ Ro
Example: Market NOI $200,000; Ro 8% → $2,500,000 fee simple indication.
Leased Fee — Direct Cap
- Build income on contract rents for leased SF (plus market on vacant)
- Expenses consistent with lease (gross vs net)
- Capitalize leased fee NOI at a rate reflecting lease quality, term, and credit (may differ from pure market Ro)
Example (simplified level perpetual teaching model):
Contract NOI $160,000; appropriate leased-fee Ro 7.5% (strong tenant, long term) →
V_LF = $160,000 ÷ 0.075 ≈ $2,133,333
If fee simple was $2,500,000 on market NOI $200,000 at 8%, the $400,000 annual income gap ($200k − $160k) is the lease disadvantage to the landlord—value gap depends on rates and duration, not only one-year ΔNOI ÷ Ro.
Leasehold — Direct Cap / Income Capitalization
Annual leasehold income advantage (basic):
Market rent − Contract rent (for the leased premises), sometimes after tenant expense differences.
If that advantage is treated like an annuity:
V_leasehold ≈ Annual advantage ÷ R_leasehold
(or × years factors / PV annuity if term-limited—closer to yield thinking)
Example: Market rent $100,000/year; contract rent $70,000/year; advantage $30,000/year.
If a 10% leasehold cap/discount-style rate is appropriate for this risk and assumed duration structure in a simplified level model:
V_LH = $30,000 ÷ 0.10 = $300,000 (only valid under the stem’s rate/duration assumptions).
Check vs fee simple / leased fee:
If V_fee = $2,500,000 and V_LF = $2,200,000, implied leasehold ≈ $300,000—matches the illustration.
Worked Split — Same Building, Three Answers
Property market NOI if rented at market: $120,000
Fee simple Ro: 8% → V_fee = $1,500,000
Existing lease: contract NOI to landlord $90,000 for a long remaining term (simplified as level)
Leased fee Ro: 7.5% (credit tenant) → V_LF = $90,000 ÷ 0.075 = $1,200,000
Leasehold advantage: $120,000 − $90,000 = $30,000
Leasehold rate: 10% → V_LH = $300,000
Sum: $1,200,000 + $300,000 = $1,500,000 = fee simple ✓
Exam trap: Capitalizing the $30,000 advantage at the same 8% property Ro forever without thinking about lease expiration—when the lease ends, leasehold goes to zero and landlord returns to market. Term matters. Direct cap of leasehold is a blunt instrument; yield/DCF over remaining term is often more faithful.
Yield Capitalization by Interest
Fee Simple DCF
Forecast market rents, market vacancy, market expenses → NOI path → terminal resale on market basis → discount at YO.
Leased Fee DCF
- Years with lease in place: contract cash flows
- At rollover: move to market rent (and renewal probability if given)
- Reversion reflects sale of leased fee (buyer takes remaining leases)
- Discount at yield reflecting tenant credit + residual market risk
Leasehold DCF
- Each year: PV of market − contract (and other tenant benefits/costs)
- No building “reversion” to tenant unless sublease/sale of leasehold estate is modeled
- Ends at lease expiration (unless renewal options valued)
Mini Yield Illustration — Below-Market Lease, 3 Years Left
Market rent $50,000/year; contract $40,000/year; advantage $10,000/year for 3 years only, then zero. Discount leasehold benefits at 12%.
PV = 10,000/1.12 + 10,000/1.12^2 + 10,000/1.12^3
= 8,929 + 7,972 + 7,118
= $24,019
Compare wrong “perpetual” direct cap: $10,000 ÷ 0.12 = $83,333—vastly overstates a 3-year advantage. This is why yield methods dominate term-limited leasehold problems.
Contract ≠ Market — Decision Table
| Situation | Fee simple indication uses | Leased fee uses | Leasehold? |
|---|---|---|---|
| Contract = market | Market income | ≈ same as fee simple | ≈ $0 |
| Contract < market | Market income | Lower contract income | Positive (tenant) |
| Contract > market | Market income | Higher contract income | Negative / none for tenant benefit |
| Short remaining term | Market | Near market soon (DCF) | Small PV of brief advantage |
| Long AAA tenant below market | Market | Contract; rate may be lower | Large PV if transferable |
Reconciliation to Indicated Value by the Income Approach (VI.i)
Reconciliation (within the income approach) means reviewing the quantity, quality, and reliability of the income indications you developed and concluding a single income-approach value indication (or a supported range that you reconcile to a point if required).
This is not yet final reconciliation among sales comparison, cost, and income (Chapter 14 / ECO VII). Here you only tidy the income family of indications.
What You Might Reconcile Among
| Indication | Source |
|---|---|
| GRM value | Multiplier path |
| GIM value | Gross income path |
| Direct cap on NOI | Ro path |
| Band-of-investment Ro vs extracted Ro values | Rate sensitivity |
| DCF value | Yield path |
| Leased fee vs fee simple (if both developed) | Rights clarity—usually one rights assignment |
Usually one rights definition governs the assignment. You do not average fee simple and leased fee to “split the difference” when the appraisal is only leased fee.
Reconciliation Criteria
| Factor | Higher weight when… |
|---|---|
| Data quality | Comps’ NOI verified; leases reviewed; expenses market-tested |
| Method match to market | Buyers actually use Ro or GRM for this property type |
| Stability | Direct cap on stabilized properties with good Ro sales |
| Complexity | DCF when irregular leases/lease-up dominate |
| Consistency | Income level matches rate/multiplier definition |
| Sensitivity | Small rate changes do not explode value without support |
Poor reconciliation: “Average of $1.8M GRM, $2.1M cap, and $2.4M DCF = $2.1M” with no discussion.
Better: “Primary weight on direct cap at 7.75% from three verified sales ($2.08M); GIM supports within 3%; DCF at 9.5% YO with 5-year hold indicates $2.05M; conclude $2,075,000 income approach indication.”
Worked Reconciliation Sketch
Assignment: fee simple market value, stabilized multifamily.
| Method | Indication | Comment |
|---|---|---|
| Extracted Ro 7.5% on NOI $300,000 | $4,000,000 | Best comps, similar vintage |
| Ro 7.75% (slightly inferior subject) | $3,870,968 | Qualitative adjustment |
| GIM 9.0 on EGI $480,000 | $4,320,000 | Expenses on subject slightly high; GIM may overstate |
| DCF 5-year, YO 9%, RT 7.75% | $3,950,000 | Supports mid range |
Reconciled income indication: $3,950,000 — weight direct cap (adjusted) and DCF; down-weight GIM due to expense-ratio mismatch.
Putting the Whole Income Approach Together
Rights & rent premise (market vs contract)
→ PGI → EGI → NOI (Chapter 12)
→ Direct cap (Ro / GRM / GIM) and/or Yield cap (DCF)
→ Rates from extraction / band of investment
→ Interest-specific application (FS / LF / LH)
→ Reconcile income indications → Income approach value indication
→ (Later) Reconcile with Sales Comparison & Cost → Final value
Common Exam Traps — Interests & Income Reconciliation
- Fee simple assignment but capitalizing contract rent without adjustment
- Leased fee assignment but forcing market rent only
- Adding leased fee + leasehold incorrectly when both already include overlapping claims
- Using perpetual leasehold cap when two years remain
- Averaging fee simple and leased fee indications for a single-rights assignment
- Reconciling by blind mean of every worksheet line
- Applying residential GRM comps to a multi-tenant office leased fee problem
- Ignoring tenant credit when contract rent is above market (default risk)
Formula & Logic Card
- Fee simple: market NOI ÷ market Ro (or market DCF)
- Leased fee: contract-based income ÷ appropriate Ro (or leased-fee DCF)
- Leasehold ≈ PV of (market − contract) over remaining term
- Teaching check: V_fee ≈ V_LF + V_LH
- Reconcile by reliability and market relevance—not pure arithmetic average
- Term + risk decide whether direct cap of a lease advantage is acceptable
Chapter 13 Synthesis
| Section | ECO focus | Skill |
|---|---|---|
| 13.1 | VI.d | IRV, Ro, GRM, GIM, when to use which |
| 13.2 | VI.e | Extract Ro; band of investment (RM, RE, M) |
| 13.3 | VI.f | Yield rates, property models, DCF + reversion |
| 13.4 | VI.g–i | FS / LF / LH by direct & yield; reconcile income approach |
Income Approach remains a major CG block (~19%) and still appears on CR/LR. Clean NOI, defensible rates, correct rights, and thoughtful reconciliation are the difference between a right-looking number and a defendable appraisal conclusion—and between a missed item and a scored one on the National Exam.
Pocket card
V = I / R Ro = NOI / Price Ro = M·RM + E·RE
GRM = Price / Rent (match monthly!)
DCF = Σ PV(CF) + PV(reversion)
FS = market · LF = contract · LH = market − contract (PV over term)
Reconcile income tools by data quality → one income indication
A property would produce $150,000 NOI at market rents. Under the existing long-term lease, NOI to the landlord is $120,000. Fee simple value at an 8% overall rate is $1,875,000. If leased fee value is estimated at $1,500,000 by capitalizing contract NOI, what is the indicated leasehold value under the simple additive teaching model?
An appraiser develops three fee simple income indications for the same stabilized property: GRM $2,050,000; direct capitalization $1,980,000; and DCF $1,995,000. The GRM comps have dissimilar utility expense structures, while cap-rate sales are strong and DCF inputs are market-supported. Which reconciliation best follows ECO income-approach reconciliation principles?