Valuation of Lessors Interest
Lessor is the owner of an asset that is leased under an agreement to a lessee
A lessor can be either an individual or a legal entity
Lessor retains ownership of the property while generating a return on his invested capital
Some lessors can also grant a “rent-to-own” least whereby some or all of the payments made by lessee will eventually be converted from lease payments to a down payment on the eventual purchase of lease item
points to be considered for lessors rights
1) total lease period and unexpired period of lease
2) whether lease is renewable for further term or on maturity of lease period the property will revert back to lessor?
3) what is the covenant concerning status of building erected on plot
At the time of maturity of lease period, the building on plot will have to be demolished or retained or handed over to lessor?
4) what lease rent is payable by the lessee for use of land and whether there is a provision for periodical increase in lease rent?
5) in case of lease renewal, what will be the lease rent for the second period of lease? Same or based on prevalent market rent on maturity date?
6) if on the maturity building vests to lessor, will it be free of cost or depreciated cost of building?
7) what amount is payable to lessor (unearned increase premium) in case of transfer/assignment of the property during lease period?
unearned premium calculation
Divide the premium by the total number of periods in the term
Unearned Premium
It is the premium corresponding to the time period remaining on an insurance policy
These are proportionate to the unexpired portion of the insurance and appear as a liability on the insurers balance sheet since they would be paid back upon cancellation of the policy
Lease types
1) Building lease (open land leased for development)
2) Occupational lease (land with building is leased)
3) Sub lease
4) Lease for life (lease cotrminous with life of lessee)
Value of Lessors interest
1) capitalized value of ground rent income receivable for unexpired lease period
2) present value of right of reversion of the property (land or land with building) at the expiry of lease period
calculations of fair and reasonable lease rent for lessor
Data
1) plot area 1200 sqm
2) least period 99 years
3) freehold plot rate Rs 5000/sqm
4) premium expected Rs 2000/sqm
5) renewable after 99 years at mutually agreed revised rent
Solution
1) premium amount Rs 2400000.00
2) balance investment amount Rs 3600000.00
*lessor is eligible to charge lease rent on the balance investment at the yield rate prevalent in the locality*
3) Yield rate 8%
4) fair and reasonable lease rent
Rs 288000.00/year or
Rs 24000.00/month
renewal clause lease agreement
1) lessor is not free to lease property to third party but is bound to renew lease with the sitting lessee only if lessee is ready and willing to pay reasonable rent
2) there are no competing tenants in the market
3) land offered for lease renewal is encumbered with the structure erected by lessee
4) land value to lessor on renewal date is less. It’s present worth is only deferred value of land and not full value as if freehold.
5) lower yield rate than market yield rate has to be considered because of closed market and bounded duty of lessor for renewal
Data
1) plot area 8750 sqm
2) lease date 1972
3) lease period 40 years
4) lease rent for first lease period Rs 30000/year
5) lease renewal 30 and 29 years
6) on maturity of lease period of 99 years, property vest to lessor free of cost
solution
1) after end of 40 years
ie in year 2012
Prevalent land rate Rs 15000/sqm
2) land value is year 2012
Rs 131250000.00
3) lessor is bound for two more renewal
4) hence total value of land in year 2012 has to be differed for 59 years at 6%
5) present worth of land (deferred value of land in 2012)
= Rs 131250000 X. 0321
= Rs 42,13,125.00/year
6) revised lease rent for second period of 30 years at 6% of value
= Rs 4216125 X 0.06
= Rs 2,52,787.00/year
7) allowing 25% rebate for renewal compulsion
Revised lease rent in year 2012
= 0.75 X Rs 252787
= Rs 1,89,590.00/year
Say Rs 1,90,00.00/year
Data
1)plot area 2000 sqm
2) built-up area 1200 sqm
3) lease year 1975
4) lease period 40 years
5) prevalent land rate in year 2012 is Rs 8000/sqm
6) replacement cost for year 2012 is Rs 9500/sqm
7) no renewal clause
8) maturity of lease period property vest to lessor free of cost
solution for lessors interest
1) value of lease rent income for 3 years or derived by capitalising income at 7%
2) capitalized rental value
= Rs 40000 X 2.684
= Rs 104960.00
3) value of land for year 2012
= Rs 16000000.00
4) value of building
1200 Sam X Rs 9500/sqm
= Rs 11400000.00
5) depreciation for 37 years assuming 10% salvage value
= Rs 114000000 X 0.9 X (37/60)
= Rs 6327000.00
6) net value of building
Rs 5073000.00
7) Total value of property
Rs 21073000.00
8) Differing value at 7% for 3 years period
Recessionary value of property
= Rs 21073000 X 0.8163
= Rs 17201890
9) total value of lessors interest
Rs 17306850.00
Valuation of Lessee’s Interest
A lessee is a person who rents an asset for use from a lessor that is leased under an agreement
A lessee can be either an individual or a legal entity
In the case of capital leases, the lessee is also the debtor to the lessor
When real estate is leased, the lessee is called a tenant
Lessee’s Covenant
1) Payment of building tax
2) building insurance
3) repairs and unkeep of property
4) timely payment of lease rent
points to be considered for lessee’s interest
1) Capitalised value of net rental income receivable from the building, for unexpired period of lease
As lessee would lose the building on maturity, provision for recoupment of capital invested in building should also be made by selecting duel rate table
2) if the plot is not fully developed but is underutilized, in such cases, the lessee would also hold interest equivalent to the present worth of unutilized fsi land
Data
1) land 1800 sqm
2) year 1976
3) full premium Rs400/sqm
4) lease period 95 years renewable for further 95 years
5) lease rent Rs 1/year
6) lessee construct building 950 Sqm in 1976
7) lessee shall pay 10% of unearned increase in land value to lessor
8) replacement cost at year 2015 is Rs 15000/sqm
9) land value for year 2015 is Rs 5000/sqm
solution
lessors interest in land value would be restricted to claim of 10% unearned increase in land value
Unearned increase
= 1800 X (5000-400)
= Rs 82,80,000.00
Value of lessors right at 10% = Rs 8,28,000.00
value of lessee’s interest
Total value of land on year 2015
= 1800X5000
= Rs 90,00,000.00
Valuation of lessee’s interest = Rs 81,72,000.00
Lessee also holds interest in building valur
Replacement cost for year 2015
950 Sqm X Rs 15000/sqm
= Rs 1,42,50,000.00
Depreciation for 39 years
With 10% salvage value
= 0.9 X 1,42,50,000 X (39/60)
= Rs 83,36,250.00
Depreciated value of building in 2015
= Rs 59,13,750.00
Value of Lessee’s interest = Rs 1,40,85,750.00
Data
1) land area 1500 sqm
2) lease on year 1970
3) lease period 70 years
4) lease rent Rs 4000/year
5) sublease rent Rs 50000/year
6) after maturity building will vest to lessor free of cost
7).rent control act applicable to tenant
solution
Lessee has Right to receive house rent for 25 years only, as lessee would lose rental income after maturity
R = 8%
r = 4%
n = 25
S = r / {(1+r)n – 1} = 0.024
YP = 1 / (R + S) = 9.614
Value of lessee’s interest
= 50000 X 9.614
= Rs 4,80,700.00
Data
1) lease year 1985
2) lease period 35 years
3) lease rent Rs 40000/year
4) net income 2015 is
Rs 350000/year
solution
Value of lessee’s interest to run cinema and earn income for 5 years more
As this income would cease after 5 years
R = 12%
r = 4%
n = 5
S = r / {(1+r)n – 1} = 3.27
Value of lessee’s interest
= 350000X3.27
= Rs 11,44,500.00
Lease types
1) Building lease (open land leased for development)
2) Occupational lease (land with building is leased)
3) Sub lease
4) Lease for life (lease cotrminous with life of lessee)
Compiled by
Avinash kulkarni
Chartered Engineer, Govt Approved Valuer
