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valuation of a leasehold property

 
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amibrahim



Joined: 03 Sep 2008
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PostPosted: Fri Sep 12, 2008 9:55 am    Post subject: valuation of a leasehold property Reply with quote

   

Valuation of Leasehold Property
 
1.00 Section 105 in the Transfer of Property Act, 1882

S. 105. Lease is defined. - A lease of immoveable property is a transfer of a right to enjoy such property, made for a certain time, express or implied, or in perpetuity, in consideration of a price paid or promised, or of money, a share of crops, service or any other thing of value, to be rendered periodically or on specified occasions to the transferor by the transferee, who accepts the transfer on such terms. 

Lessor, lessee, premium and rent defined.- The transferor is called the lessor, the transferee is called the lessee, the price is called the premium, and the money, share, service or other thing to be so rendered is called the rent. (S. 105). 

 

 When the lease period is 99 years, it is called long lease and when it is 999 years or more it is called lease in perpetuity. Under Rule 3 of the Wealth-tax Act 1957 lease period of 50 years or more has a Multiplier of 10.00 and lease period > 15 to 49 years has a multiplier of 8.00, whereas freehold property has 12.5 in calculation of capitalized value of NMR (Net Maintainable Rent) of an immovable property.Cambridge Dictionary meaning of freehold is the legal right to own and use a building or piece of land for an unlimited time.

Lease Type: a) Ground Lease is usually a long term lease of land with the lessee permitted to improve or build on the land and to enjoy those benefits for the term of the lease and b) Turnover Lease or Percentage Lease.  

(1)For the valuation of leasehold interests of the Lessor and the Lessee in respect of a property subject to a lease the following facts will have to be carefully ascertained:
 
  1. Nature of property
  2. Fair rent which the property may be estimated to yield on the date of valuation
  3. Leasehold rent and the un-expired period of the lease
  4. Special terms and conditions if any in the deed of lease affecting the interest of the lessor and lessee (1)
 The value of lessee’s interest depends upon the profit rents, the period of lease and restrictive covenants mentioned in the lease
 
The annual Net Income from the leased property in the hands of lessee: (Total Income – Annual Rent – Annual Sinking Fund Deposit, if structure by him)
 
Lessor interest can be valued on the basis of rent receivable plus reversionary value of becoming full owner after the expiry of the lease period.
 
2.0 In case of on acquisition of a leasehold property by Government under the Land Acquisition Act 1894, after the market value is determined as per S 23 (1&2) & 24, the question of apportionment of the total compensation money payable between the lessor and lessee will arise for which the following court rulings will throw some light for valuation professionals:
 
(1)In Surendra Nath v Peary Charan, 42 C. W. N 1191, “ It seems to be only common sense that as between lessor and lessee, the acquisition should be not place either party in a better or worse position than he was before the acquisition. The acquisition transforms the property into a certain sum of money, but the rights of parties relatively to this sum ought to be the same as they were with reference to the property.
   
Where a property is subject to a lease, theoretically speaking the total compensation for the property should be the sum total of the compensation payable in respect of the interests of the lessor and the lessee. If the total compensation is not however arrived by separately calculating the interests of the lessor and lessee, it seems to us that the amount should be divided between them to such proportions as would represent the value their respective interests”.
 
2.1 The Hon’ble Court in another Ruling, “While the lessor’s interest may not be capable of valuation with a fair degree of certainty, the calculation of the lessor’s interest is a much more uncertain process, the lessee’s interest should be valued by calculating the present value of what he would have received during the unexpired portion of the lease, if the land had not been acquired and this with Solatium Amount (S.A) should be awarded to him and the balance of compensation money should be awarded to the lessor.
 
2.2 While the lessor’s interest is capable of valuation with a fair degree of certainity but not so the lessee’s interest, the lessor’s interest should be valued by calculating the present value of what he would have received during the unexpired portion of the lease and adding to it the present value of the reversion that would have fallen in on the expiry of the lease, if the land had not been acquired and that this total sum (With S. A) Should be awarded to the lessor and the balance of the compensation money should be awarded to the lessee.
 
2.3 The third principle was that the lessee’s interest and the lessor’s interest should be valued separately and the compensation money should be apportioned between the lessor and the lessee in the same proposition as the value of the lessor’s interest, thus calculated, bears to the lessee’s interest as calculated.” (Sitanath Pal & Ors v K. C. Basu. A. O. D No.80 of 1948 (1).
 
2.4 It is not necessary that the total value of the lessor’s and lessee’s interests shall be equal to the market value of the property. It may be less or more than the market value of the property. However in the cases of acquisition, it has been held by the Hon’ble courts that in such cases firstly the value of the property would be determined and then the respective interest of lessor and lessee shall be estimated and the proceeds of the acquisition should be divided between the lessor and the lessee in the proportion as would represent the value of their respective interest. (Source: Valuation of Immovable Property by G. C. Gupta, published by Bharat Law House, 1983, PP 53)
 
3.0 A current scenario of leasehold interests in the metropolitan city is valued as under:
 

A promoter has leased 5.9 acres of land on annual lease rent of Rs 85,00,000/annum (for a period of 33 years and the lessor will have reversion thereafter) to develop two residential towers; the promoter will build, finance, manage and expected to transfer the property after the expiry of the 33 years lease. Market value of land can be assessed @ Rs 14,00,00,000 per acre in the locality.

 

Valuation of a leasehold Twin Residential Towers

Online valuation table can be referred in ^  http://www.lawyersclubindia.com/forum/Valuation-tables-85186.asp#.UfBup9Iwfuo

Market value of land Say (By comparable sales method)

Rs 82,60,00,000

Investment in construction (Deferred suitably for the period of construction) complete

Rs 96,25,00,000

The built-up area of Tower "A” 2,50,000 sq. ft

 

The built-up area of Tower “B” 3,00,000 sq. ft

 

Expected Gross Annual Rent from Tower “A”: Rs 6,00,00,000

(2,50,000 * 0.80 * Rs. 25 * 12)

 

Expected Gross Annual Rent from Tower “B”: Rs 7,20,00,000

(3,00,000 * 0.80 * Rs. 25 * 12)

 

Total Gross Annual Rental Income (GARI) from

Tower “A” + “B”: Rs 13,20,00,000

 

Full Market Value of the Property @ 5% interest in perpetuity (GARI*20):

Rs. 264,00,00,000

Lessee’s total net Income: (Gross Annual Income - Annual Lease Rent - Annual Sinking Fund Deposit 3%)

(13,20,00,000 - 85,00,000 - 1,73,25,000) = 10,61,75,000

 

Lessee’s Present value @ 6% and 3% interest per annum for a period of 33 years; YP: 12.795 (USPWF from Dual Rate Table) Say (“P”): 10,61,75,000 x 12.795

Rs. 135,85,09,125

Lessor’s Interest @ 6% in the Income: This can be calculated by two methods: 1)Multiply the years purchase in perpetuity by the present value of Re 1/= receivable at the time when the income will commence; (16.67 x 0.146 = 2.43) or 2)Subtract the Years purchase for the period before the income commences from the years purchase in perpetuity (16.67 – 14.23 = 2.44)

 

In the above manner lessor’s interest in the present value of reversion to a annual net income of Twin Tower is assessed : 13,20,00,000; Less outgoings @ 32.5% which is:  Rs. 8,91,00,000  x 2.44: Rs. 21,74,04,000    (Say “AA”)** (Say “AA”)  ** Edited on December 26, 2018

 

Reversionary value of land deferred for 33 years (Table: SPPWF: 0.146) Rs 12,05,96,000 (Say “BB”)

 

Reversionary value of depreciated structure: (SPPWF: 0.079 from Table) [1 – 33/60] = 0.45;  0.45*0.90*0.146*96,25,00,000 =  Rs. 5,69,12,625 (Say “CC”)

 

Present value of lease income: (Rs. 85,00,000*14.23: Rs. 12,09,55,000 (say “DD”)

 

Total of Lessor’s (AA+BB+CC+DD) Rs. (Say “Q”)

Rs. 51,58,67,625

Lessor’s Interest (Q)

Lessee’s Interest (P)

P+Q

Full Market Value

Rs 51,58,67,625/-

Rs. 135,85,09,125/-

Rs 187,43,76,750/=

264,00,00,000/=

Assessed Value (Lessor + Lessee)

Full Market Value of the Development (Rental)

Rs.187  Crore

Rs 264 Crore

(Note: The figures given are only to illustrate the answers and are not to be taken as representing each and every case). 

  (1) Parks on Valuations, Fourth Edition, Calcutta Eastern Law House 1977

A year’s purchase of 20 / 5% can be allowed for freehold property, which is about 250 basis points below benchmark gilt yield and 100 basis points above post office and RBI saving rates (June 2013). Our traditional philosophy is reversing. The lessor’s interest in perpetuity can be valued with a Year’s purchase of 16.67 /. Security percent of 6.

** For income-tax valuation of lessor’s interest ceiling is 16.67 / 6% in perpetuity and for unexpired period of lease, the formula for Year’s purchase is:

               K - I/ (I + i)n/ (i) ; As per formula the lessor year's  purchase would be 14.23 / 7.03 for Income-tax valuation. 

According to the formula : where i represents the percentage of return expressed as a fraction and n represents the unexpired portion of lease and ’ k’ is factor: 16.67 ((Source: Instruction : No. 1312 [F. No. 309/3/73-ED], dated 29-2-1980 [Source : 8th Report (1980-81) of the Public Accounts Committee, pp. 49-54])).As amended upto June 2013**

 

 



Last edited by amibrahim on Wed Dec 26, 2018 8:07 am; edited 17 times in total
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amibrahim



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PostPosted: Wed Sep 16, 2009 2:13 pm    Post subject: A 20 Year cash-flow Reply with quote

 

Please find attached a 20 Year graphical Cash-flow statement (Lessee's Interest).

 

A. M. Ibrahim




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amibrahim



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PostPosted: Fri Apr 26, 2013 10:56 am    Post subject: Different Types of Rent Reply with quote

 Different Type of Rent: 

Ground Rent: Money paid by the owner of a building or apartment to the person who owns the land on which it has been built. Ground rent may be made secure by a clause requiring the lessee to erect structures at his own expense, which is more secure than unsecured ground rent.

 Head Rent: The rent reserved under the first document by the lessee to the lessor in the original document is known as head rent. If lessee is allowed to sub lease, the rights and lease period cannot exceed the first lease document. 

Improved Rent: The rent in the second lease document which is generally higher than the head rent or rent fixed under the terms of first lease is termed as Improved Rent. 

Profit Rent: The difference between the head rent and improved rent is termed as Profit Rent. 

Rack Rent: Full rental capacity of a property unhindered by any legal restrictions. It is also maximum rent a property is likely to fetch. Cambridge Dictionary meaning is a rent that is agreed between the owner of a property and the person renting it, rather than being fixed or controlled by law. In the United States of America, an unfairly high level of rent. 

Nominal or Acknowledgement Rent: It is a token rent, say Rupee 1 sometimes mentioned in the lease document in order to establish the relation between lessor and lessee as absence of rental clause would debar the lessor from exercising his title to the property. 

Fair Rent & Standard Rent: Fair Rent is rent receivable as per prevailing rent Laws and Standard Rent is rent fixed as per prevalent Rent Control Act. 

Pugree or Selami: Source: http://www.unesco.org/most/p2basu.htm:  In housing transactions, it means the sum of money deposited with the property owner by the tenant to gain right of occupation, to be returned to the latter at the time of vacating the premise. 

In large cities like Mumbai, the sum equals the market value of the property which is never returned to the tenant. The latter receives pugree from the next tenant for vacating the premise, giving him the occupancy right. It is a practice in most of the large cities in the country to take a certain amount as advance when renting out a house/flat, the amount varying with the demand and supply situation. The modality of the payment, however, varies across cities/regions. In the city of Mumbai, the amount, known as pugree, is generally as big as the value of the house and is not refundable. Payment of pugree makes the tenant a virtual owner of the premise which he can rent out by receiving a pugree. In Delhi, however, the amount is a few months’ rent and is adjusted against the monthly rentals, damages to property or refunded at the end of the tenancy. It is called "deposit" or "advance". In Calcutta, such payments are often described as selami. Similarly, one word may have different connotations in different places or contexts, bustee, for example, would imply any habitation in Hindi speaking areas, while in Bengal it refers to a slum. In the Hindi speaking areas a slum will be called a gandi basti or a dirty locality. (Source: http://www.unesco.org/most/p2basu.htm). 

Example: A shop in Kadayanallur of Tirunelveli District, Tamil Nadu is let out for 15 years on a monthly rent of Rs. 2,000. The tenant pays to the landlord a sum of Rupee 1, 50,000 as Advance. Determine the amount of rent represented by the Advance (Pugree or Selami). Prevalent rate of interest is 10%. 

Present Value of Rupee 1 per annum for 15 years @10% interest

(From the Table):  7.606 

Or Rupee 7.606 paid initially is equivalent payment Rupee 1 per annum for a period of 15 years. 

Hence Rupee 1, 50,000 paid initially is equivalent to: Rupee 150000/7.606: Rupee 19,721 / Annum or Rupee 1,643 / month. 

Virtual Rent: The rent payable by the lessee plus the rent equivalent to cost of improvement to be carried out by him is Virtual Rent.

 Example: A lessee agrees to pay annual rent of Rupee 9,600 for a vacant site leased out to him for a period of 15 years. In addition, the lessee agrees to spend a sum of Rupee 3,000 for site improvement .Prevailing rate of interest is 10%. Determine the virtual Rent. 

Annual lease rent: Rupee: 9,600 Say “L”

Present Value of Rupee 1 per annum for 15 years @10% interest

(From the Table):  7.606.

Or Rupee 7.606 paid initially is equivalent payment Rupee 1 per annum for a period of 15 years.

Hence Rupee 3,000 = an annual rent of Rs. 3,000 / 7.606 = 394 Say “M”

Virtual Rent: .L+M: 9,600 + 394 = 9,994 per annum.

Market Rent Vs Contract Rent

Market Rent

Contract Rent or Passive Rent

If a property is let out in an open market between a willing landlord and a willing tenant under normal condition what it would fetch that has to be construed as market rent.

The rent specified by a lease agreement, which may be equal or less than market rent.

 

Over Rented situation (Negative Market Value) will arise when contract rent exceeds market rent in a falling rental market. Lease interest is more difficult to dispose of other than thru payment of a “reverse premium”. Such rental, if considered, it is advised to capitalize at a higher discount rate.

In a rising market, the contract rent may become “reversionary” (A financial benefit over the remaining term of the lease) and the lease interest may attract a positive market.

 

A M IBRAHIM



Last edited by amibrahim on Wed May 08, 2013 4:56 pm; edited 2 times in total
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amibrahim



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PostPosted: Sat May 04, 2013 9:18 am    Post subject: Indian Accounting Standards 17-Treatment of Leases Reply with quote

 LEASES: Relationship to Indian Accounting Standards (Ind AS. 17). 

The following terms are used in this Standard with the meanings specified: 

A lease is an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time. 

The inception of the lease is the earlier of the date of the lease agreement and the date of commitment by the parties to the principal provisions of the lease. As at this date: (a) A lease is classified as either an operating or a finance lease; and

(b) In the case of a finance lease, the amounts to be recognized at the commencement of the lease term are determined.

Guaranteed residual value is:

(a) for a lessee, that part of the residual value that is guaranteed by the lessee or by a party related to the lessee (the amount of the guarantee being the maximum amount that could, in any event, become payable); and 

(b) For a lessor, that part of the residual value that is guaranteed by the lessee or by a third party unrelated to the lessor that is financially capable of discharging the obligations under the guarantee. 

Unguaranteed residual value is that portion of the residual value of the leased asset, the realization of which by the lessor is not assured or is guaranteed solely by a party related to the lessor. Initial direct costs are incremental costs that are directly attributable to negotiating and arranging a lease, except for such costs incurred by manufacturer or dealer lessors. 

Gross investment in the lease is the aggregate of: 

(a) The minimum lease payments receivable by the lessor under a finance lease, and

(b) Any unguaranteed residual value accruing to the lessor. 

Net investment in the lease is the gross investment in the lease discounted at the interest rate implicit in the lease. 

Unearned finance income is the difference between: (a) The gross investment in the lease, and (b) The net investment in the lease. 

The interest rate implicit in the lease is the discount rate that, at the inception of the lease, causes the aggregate present value of (a) the minimum lease payments and (b) the unguaranteed residual value to be equal to the sum of (i) the fair value of the leased asset and (ii) any initial direct costs of the lessor. 

The lessee’s incremental borrowing rate of interest is the rate of interest the lessee would have to pay on a similar lease or, if that is not determinable, the rate that, at the inception of the lease, the lessee would incur to borrow over amount but is based on the future amount of a factor that changes other than with the passage of time (eg. percentage of future sales, amount of future use, future price indices, future market rates of interest). 

A non-cancellable lease is a lease that is cancellable only: 

(a)  Upon the occurrence of some remote contingency; (b) With the permission of the lessor; (c) If the lessee enters into a new lease for the same or an equivalent asset with the same lessor; or (d) Upon payment by the lessee of such an additional amount that, at inception of the lease, continuation of the lease is reasonably certain. 

A Contingent rent is that portion of the lease payments that is not fixed in amount but is based on the future amount of a factor that changes other than with the passage of time (eg percentage of future sales, amount of future use, future price indices, and future market rates of interest). 

Method of reporting in the Financial Statements: 

Finance Lease:A lease that transfers substantially all the risks and rewards incidental to an ownership of an asset to the lessee. Title may or may not eventually be transferred”. 

Initially, lessors shall recognize assets held under a finance lease in their balance sheets and present them as a receivable at an amount equal to the net investment in the lease. Subsequent measurement: The recognition of finance income shall be based on a pattern reflecting a constant periodic rate of return on the lessor’s net investment in the finance lease. 

At the commencement of the lease term, lessees shall recognize finance leases as assets and liabilities in their balance sheets at amounts equal to the fair value of the leased property or, if lower, the present value of the minimum lease payments, each determined at the inception of the lease. The discount rate to be used in calculating the present value of the minimum lease payments is the interest rate implicit in the lease, if this is practicable to determine; if not, the lessee’s incremental borrowing rate shall be used. Any initial direct costs of the lessee are added to the amount recognized as an asset. Subsequent Measurement: Minimum lease payments shall be apportioned between the finance charge and the reduction of the outstanding liability. The finance charge shall be allocated to each period during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability. Contingent rents shall be charged as expenses in the periods in which they are incurred. A finance lease gives rise to depreciation expense for depreciable assets as well as finance expense for each accounting period. The depreciation policy for depreciable leased assets shall be consistent with that for depreciable assets that are owned, and the depreciation recognized shall be calculated in accordance with Ind AS 16 Property, Plant and Equipment and Ind AS 38 Intangible Assets. If there is no reasonable certainty that the lessee will obtain ownership by the end of the lease term, the asset shall be fully depreciated over the shorter of the lease term and its useful life. 

Operating Lease: “A lease where the lessor retains substantially all the risks of ownership of the leasehold property”. 

Lessors shall present assets subject to operating leases in their balance sheet according to the nature of the asset. Lease income from operating leases shall be recognized in income on a straight-line basis over the lease term, unless another systematic basis is more representative of the time pattern in which use benefit derived from the leased asset is diminished. Initial direct costs incurred by lessors in negotiating and arranging an operating lease shall be added to the carrying amount of the leased asset and recognized as an expense over the lease term on the same basis as the lease income. The depreciation policy for depreciable leased assets shall be consistent with the lessor’s normal depreciation policy for similar assets, and depreciation shall be calculated in accordance with Ind AS 16 and Ind AS 38. 

From the lessee’s view, lease payments under an operating lease shall be recognized as an expense on a straight-line basis over the lease term unless another systematic basis is more representative of the time pattern of the user’s benefit.

A M IBRAHIM

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tdsb



Joined: 19 Dec 2009
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PostPosted: Sat May 04, 2013 9:47 am    Post subject: Reply with quote

Dear  Mr. A. M. Ibrahim,

I appreciate and thank you very much  for your goodwill gesture in sharing your knowledge and knowhow resources for the benefit of all valuer friends!

Regards,

T D Suresh Babu

 

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suchdevs



Joined: 30 Aug 2008
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PostPosted: Sat May 04, 2013 2:34 pm    Post subject: Reply with quote

Mr Ibrahim as been regularly posting valuable information based on deep study and research, which should become a ready reference for all members... my heartiest appreciation...

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ersenthilraj



Joined: 30 Aug 2008
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PostPosted: Mon May 06, 2013 4:33 pm    Post subject: Reply with quote

Dear Sir,

Thank you for your useful information,

Er S Senthil Raj

Cuddalore

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vijaykumarpatil



Joined: 13 Apr 2009
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PostPosted: Tue May 14, 2013 10:10 am    Post subject: Re: Different Types of Rent Reply with quote

R/Sir,
A M IBRAHIM

Thank you very much for valuable information given to all of the valuers fraternity

Thanks & keep going

Er. Vijaykumar B. Patil

Sangli. Maharashtra

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amibrahim



Joined: 03 Sep 2008
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PostPosted: Tue Dec 25, 2018 1:05 pm    Post subject: Premium - Virtual Rent Reply with quote

Valuation of Leasehold Properties: Refer A. M. Ibrahim Valuation Table:

^  http://www.lawyersclubindia.com/forum/Valuation-tables-85186.asp#.UfBup9Iwfuo

 

Author: A. M. Ibrahim

 

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djagan1949



Joined: 07 Jan 2009
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PostPosted: Wed Dec 26, 2018 10:10 am    Post subject: Premium - Virtual Rent Reply with quote

 

Amibrahim Sir,

I am really amazed to realize the in depth knowledge you possess in these kind of intricate subjects. Hats off to you for wiilingly sharing with us and help us to learn. No doubt you are a precious Jewel in our feternity that can never be stolen by any one other than God Himself.

Warm regards

Vr. D. Jagannathan

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