Of Co-ops and Condos and Leasehold Estates

Fee simple ownership of property rights is usually thought of in terms of owning some land and any improvements on it. For most single-family homeowners, this is still the predominant way of looking at real estate. The bundle of property rights may be reduced by such things as deed restrictions, and impacted by the presence of mandatory Home Ownership Association fees ( a characteristic of the Planned Unit Development, or PUD ), but for the most part, ownership of the land is a paramount consideration.

There are three other major ways to own real estate ( at least in NE Ohio ) which impact the valuation process. One of them involves owning the home, and renting the land -- the leasehold estate. Another, the co-op, involves buying shares in the property as a whole and renting the home on a perpetual basis. The third, the condominium, involves ownership of the home space, with ownership of an undivided interest in the common areas, and payment of rent ( an HOA fee ) to manage the commons. It should be noted that with both co-op and condominium ownership, the ownership of the building is not part of the homeowner's real estate, even when the condominium is a free-standing unit! ( Those who doubt that should carefully check their HOA papers to see what kind of modifications they might be permitted to make to the exterior. I would be surprised if any private modifications were permitted at all. )

Homeownership on Leased Land

Aside from mobile home parks, there are a few developments in the Akron area which feature homes built on leased land. One of them, just to the south, in Stark County, is the Willowdale Country Club. If you search the Stark County Auditor's records for a street address in that subdivision, you will find a parcel number and tax card which shows a building assessment, but no lot dimensions or land assessment. Purchase of a home in Willowdale involves signing a purchase agreement for the house (with the current owner) and a lease assignment. The Auditor shows a single parcel number for the land in Willowdale, 16-28425, having roughly 217 acres of house lots, reserve land, lake, and swamp. Each house has its own parcel number as well. Each homeowner pays a pro-rated share of the Country Club's real estate tax, and an HOA fee to cover maintenance of the common areas, including the streets, lake, and recreation areas (which are private).

Since the homeowner does not own the land, how is the market value of the home determined?

The appraiser needs some additional information to work with. He needs to know the terms of the ground lease : how much does the homeowner pay per month for the rent of the land, and what is the length of the lease? He also needs to know if there are any resale restrictions on the home tied to the lease. Some leased land has conditions on who qualifies as a potential lessee (based on income, usually). He should also investigate what happens to ownership of the improvements if the lease expires without being renewed. In most cases, the improvements revert to the lessor, so if a long-term lease is in place, it is important to know how many years are left on the lease and whether it can be renegotiated before it expires.

It is obvious that the best comparable sales will come from the same community. Those sales may not have the same lease terms, though.

The ground lease is a separate interest in the real estate, and the lessor holding the lease has a leased fee interest in the property. That leased fee interest has a value, and it will need to be determined. If several comparable homes are available with similar features and identical leases, the job is easy. That rarely happens. In fact, a search of Willowdale in the CRIS MLS for the past two years only shows about a dozen sales, and not many of the houses are really all that similar. As a result, the prices paid are quite varied.

When someone rents something today, they are anticipating a return on their investment in the future. The money has a time value. This is best described as a capitalization rate; in other words, what rate of interest must I charge to recover the cost of my asset and make a profit comparable to that available in another investment with similar risk? Capitalization rates can be extracted from the market by comparing the prices of homes on leased land to the prices of homes that are owned in fee simple. The annual ground rent, divided by the difference in prices, is the capitalization (cap) rate. That is a process that requires a good bit of data, and is a specialized area.

A simpler and generally acceptable way of determining the value of the leased fee interest is to divide the annual rent by a cap rate for an investment with similar risk characteristics. For land, an acceptable alternate investment might be a 30 year Treasury Bond. At the close of the market today, the rate for a 30-year Treasury was just under 4.9%.

OK, let us assume we are appraising a home on leased land. We have no good comparables for our subject within our leased-land subdivision, so we choose other similar homes with similar sized sites and view considerations, and develop a fee simple indicated sales price for the subject of, say $140,000. Now we have to make an assumption. Let us assume the rent on our subject's land is $50/month, or $600/year. The value of the leased fee estate, using today's cap rate for the 30-year Treasury, would be $600 / .049 = $12,244.90, which we round to $12,200. Then, the leasehold value for the subject can be derived by subtracting the leased fee value from the fee simple value; $140,000 - $12,200 = $127,800.

Quite frankly, the run-of-the-mill licensed appraiser has never done this type of exercise. If he is appraising a home on leased land for an equity line refinance, and appraises it in fee simple instead of leasehold, he will overvalue it every time. This can lead to problems if the homeowner finds himself in a situation where he has borrowed more than the leasehold value of his home.