commercial leases - out of line


The following leases are generally, poor evidence of market rent unless adjusted to meet the requirements of the willing lessor willing lessee theory. For example a "rack rent lease" is a lease with a rent well above the market rent because either/or the term is very short, the use is illegal, there is temporary short term scarcity or the "lease" is really a licence.

What in first instance appears to be a lease, may in fact be a franchise arrangement, licence or it may include a goodwill component. All these factors, will cause the lease to be an out of line land it cannot be used as evidence of market rental value without adjustment.

Some lessees will pay more than market rent for the goodwill of a business or the right to name the building. The valuer should be careful when analyzing the rent being paid by franchise managers or a business where personal goodwill is a large component of value. The rent being paid may be for items other than real estate such as goodwill or plant and equipment. The "lessee" may in fact, be a "quasi" manager for the company. For example, chain restaurants, chain fast food outlets and service stations.

The market rent of an investment property is the rent payable under a lease where the lessee makes a normal or typical contribution to the outgoings (recoverables). Where the lessee is required to pay more or less than the normal amount, the valuer when analyzing such leases, will have to raise or lower the base rent by an amount equivalent to the excess.

EXAMPLE

It is normal for a tenant in a shopping centre to pay the pro rata (based on area occupied) of ALL the outgoings of the centre. If the analyzed rental agreement requires the tenant to pay none or only some of those outgoings then the base rent will have to be reduced by the amount of the outgoings not paid.

The rent being analyzed may be less than market rent because the lessee is making some unusual payment. For example, a premium, fines, or key money. In such as case the base rent will have to be adjusted to an equivalent periodic market rent using compound formulae. The method is covered later.

Some shop and particularly, supermarket rents are "tied" to the gross turnover of the business. This can result in a "non market" rent but may also include a goodwill component which should not be used in the valuation of real estate.

The analyzed rent may be an old lease agreement for example, the last years rent of a lease negotiated 4 years ago. Such rents will be less than the market rent in an expanding economy. If the rent being paid in an investment property is less than market rent and particularly if the landlord is tied to the low rent for a long period, the present value of that rental stream is found by capitalizing at a lower capitalization rate than that applicable for a market rent. This is because the low income stream is safer than a market rental stream. The lessee will always pay the rent rather than lose his/her profit rent.


See management - leases


See quality of tenants



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