Possessory interest cases have tax stipulations and liabilities that apply to businesses that lease government land for private use. For example business that operated in a city-owned airport is considered possessory interest property, and the valuation process is normally unique and complex.
Possessory interest valuation uses the three conventional approaches to value – sales comparison, income and cost. However, the use of any of these three approaches must consider the fact that the property will revert back to the public owner at some point. This “reversion” value must be removed so that the taxable value reflects only the lessee’s portion of interest.
The most common type of possessory interest is the lease of land and/or improvements from a public owner. Typically, the public owner charges a rent to the lessee on a dollar per square foot basis, or it may require the payment of a percentage of the lessee’s revenue or income.
For valuation of these types of possessory interests, the use of the direct income approach is appropriate and requires a discounting of the economic rent through the full term of the lease contract (net present value), less the expenses paid by the public owner. By calculating the net present value of this income stream to the public owner, only the lessee’s portion of value or interest is considered. Therefore, it is unnecessary to remove a reversionary value for the lessor’s portion of interest.
Example / Pertinent Data:
» Five year lease for thousand square foot office
» Rent at $3 per square foot per month
» Lessee pays all expenses, net lease
» Use 10% discount rate for income stream, based on recent market data
» Use 3% expense deduction to income for lessor’s administrative expense
|x 60||(Five years, 60 months)|
|-$5,400||(Lessor admin. expense, 3%)|
|x .607789||(Net present value factor, 5 years, 10% discount rate, monthly payment)|
|$ 106,120||Indicated value of possessory interest|
Possessory interest properties can be very complex and have many other issues. We highly recommend you calling us to discuss your specific situation.