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Appraisal clients often ask the question about the difference between Leased Fee and Fee Simple interests. Not only should they be differentiated, but these two terms are ones that your regulator cares about.

What does leased fee mean?

Put simply, a leased fee interest is a landlord’s right of use of property and the right to lease to others. For example, let’s say your client owns an office building and is the landlord to several office tenants under standard office leases. The tenants occupy the building and the landlord, in general, does not. It might be common in real estate circles to say that your borrower owns the “fee” and that the handful of tenants that occupy the building own a “leasehold” interest. This is just another way to say that they rent space.

What does fee simple mean?

The fee simple interest, on the other hand, is the unencumbered ownership right in real estate. Fee simple is also the most common. The fee simple interest is the most complete form of ownership in that the buyer owns the title for the property. The owner can occupy the property, divide it if zoning allows, add on to a building, paint it, tear it down, etc. All of this is, of course, subject to ordinances or permits that may be applicable. In the example above, the landlord owns the fee simple interest.

When can the two terms get muddled?

The terms can become muddled when you order an appraisal. When you are ordering the appraisal, what interest do I ask for and why? For lending purposes, if the property is under contract with a lease being terminated to owner occupancy, you’d order “fee simple.” If the property is under contract, has a lease in place with leasing (investing) being the intended use, then “leased fee” is ordered.

You might ask why it makes a difference. Credit decisions are key for financial institutions and they need to know the property rights of the collateral for underwriting purposes. The property rights, intended use, occupancy, condition, encumbrances, and zoning may be all be part of the loan decision.

There are many scenarios in real estate, which is why it is best to consult with a someone who understands the bundle of rights of ownership.

 What if I order an appraisal the wrong way?

In most cases, ordering the incorrect appraisal is just a misunderstanding. However, keep in mind that getting this wrong can cost time and money to correct. The scope of work for the appraiser may change and an incorrect order may impact value if it is for the incorrect property interest. 

If you order an appraisal that gives a value opinion of the fee simple interest, the appraiser may not think to ask you about leases and rent rolls. He or she may assume there isn’t a lease in place. The appraiser may have to go back and review leases and rework the income analysis.

To save yourself time and money, consult with a professional team that knows which questions to ask and can help you with the appraisal ordering process. 

Why does your regulator care?

The value may be significantly different in the collateral if the property interest is ordered incorrectly.  Risk reduction is key and it starts by knowing and understanding the property rights of each property subject to lending criteria. 

Avoid any mishaps with banking regulations by making a distinction between the leased fee and the fee simple interests from the start. Not only will you save yourself valuable time and money on the front end, but you’ll rest easy knowing you’re doing the right thing appraisal after appraisal. For more information on all things appraisal management, contact us today.