The elements under this standard are:

The most common use of compound formulae is for the valuation of investment properties subject to a lease. If the lessee is not paying market rent then the sale price needs adjustment to bring it to an unencumbered in possession value, a datum value that can be used for comparison and analysis purposes. That is, it is assumed for comparison purposes that the analyzed sale is a property with vacant possession and unencumbered with any interest. This is known as the unencumbered fee simple in possession.

To adjust a sale to this common datum the valuer needs to determine the lessee's and lessor's interest. The valuer is also called upon to determine these interests when determining market value of a property subject to a lease. That is, the encumbered fee simple.


If the lessee is paying LESS than the market rental value of the property, he/she is enjoying a profit rental. The profit rental is the difference between the market rent and the rent being paid by the lessee under the lease agreement. For example:

MARKET RENT: $100 000 pa
LESS LEASE RENT $ (50 000) pa

PROFIT RENT: $ 50 000 pa

The difference is called a profit rental because the lessee enjoys the difference as a profit. For example, he/she is able to sublet (if allowed to under the lease agreement) the premises for $100 000pa and thus enjoy a profit of $50 000pa. If the lessee cannot sublet he/she still enjoys $50 000pa profit as opportunity cost. That is, the lessee enjoys the benefit of a $100 000pa premises for only $50 000pa.


The lessee's interest (LEEI) in an investment property is the present value of the profit rental. Therefore, there is no lessee's interest if there is no profit rental. The lessee's interest as used in this context is an economic interest as the lessee paying market rent still has a legal interest in the property while the lease is current.

Where the tenant is paying market rent, it has been held that the only claim for compensation is for disturbance - Keogh v Housing Commission [1969] VR 809.


The remainder of the lease for the tenancy above is 10 years.

Using 12%pa what is the lessee’s interest?

The value of the lessee's interest is found using the PVPMT formula:

PVPMT = (1 PV)/(i/100) = (1  0.3220)/0.12 = 5.650

LEEI = PR * PV.PMT= 50 000 * 5.650= 282 500
Lessee's interest say $283 000


The lessor's interest (LORI) in an investment property is the unencumbered market value (that is, the value assuming that the property is vacant) less the lessee's interest (LEEI). The market rental for the above property is $100 000 pa and a capitalization rate of 12% pa has been analyzed from sales of comparable properties. Therefore, the unencumbered value is:

100 000 * 100/12 = $833 333

Because the subject property is occupied by the lessee under an old lease, the owner is receiving a rent less than market rent. The lessor's interest (LORI) is:



LORI = lessor's interest
UMV = unencumbered market value
LEEI = lessee's interest

LORI = 833 333   282 500 = $550 833
Lessor’s interest say $551 000

Therefore, the market value (that is, encumbered fee simple) is $551 000.

This is equal to the amount that the property will sell for on the open market. All sales of tenanted properties are lessor’s interests and should be analysed as above.


It is common practice to assume that the lessor's or lessee's interest can be calculated by subtracting the other party's interest from the unencumbered value. However, in practice it is found that the sum of the two parts exceeds the unencumbered value. Why is this?

For this reason the courts have held that the assessment of compensation of lessee’s and lessor’s interest must be assessed on an individual basis and not by subtracting one determination from the unencumbered fee simple to find the other value.

The reason appears to be that there is a legal "subdivision" of the property into the two interests which required time, expense and effort. Therefore, an existing and proved tenancy is worth more than the sum of the value of an expected tenancy and the expected lessor's interest. The analogy can be made between the value of in globo land not subdivided and the value of otherwise comparable land subdivided into two allotments.


From the above formula, the unencumbered market value (UMV) is found as follows:

UMV = LORI + LEEI= 550 833 + 282 500 = $833 333

As a general rule (subject to the synergy argument above), the unencumbered value of a tenanted investment property is the sum of the lessee's and lessor's interests.

The adjusted sale price of $833 333 can now be used for comparison purposes with another comparable investment property to determine it's unencumbered market value.


It can be seen that the lessor's or owner's interest in a leased property consists of 2 parts:

The unencumbered value due at the end of the lease term is known as the reversionary interest because the vacant property reverts to the owner at the end of the lease term. This is shown on a time line as follows:


Lease period Reversionary period
YEARS   ----------------------------------------------------------  >


The reversionary value can also be used as an alternative method for determining the lessor's, owners, or encumbered market value of the property:


Determine the value of the lease to the lessor (owner). This is the present value of the net rental income during the lease term:

50 000 * 5.6502 (PVPMT) = $282 511


Determine the value of reversion. This is the present value of the expected unencumbered value in 10 years:

833 333 * 0.322 (PV) = $268 333


Determine the lessor's interest (LORI):

LORI = value of lease + reversionary value
282511 + 258333 = $550 844
say $551000

See shortfall method