Topic 8

VALUATION of LEASE
INTERESTS
 INTRODUCTIONS

Lease Interests is a form of real property, arising from a

contractual relationship between a lessor, one who owns
the property leased to another, and a lessee, or tenant,
one who typically receives a non-permanent right to use
the leased property in return for rental payments or
other valuable economic consideration.

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• To avoid misunderstandings or misrepresentations, valuers
and users of valuation services should recognize the
important distinction between the physical and the legal
issues involved in considering the value of lease interests.
• A piece of real estate may comprise one or more property
interests, each of which will have a Market Value provided it
is capable of being freely exchange.
• It is considered proper to value different property interests in
the same piece of real estate separately and then to
aggregate their values as an indication of the real estate’s
total value.
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• Lease contracts establish unique legal estates that are
different from fee simple, or freehold, ownership.

• The relationships between legal interest in the property

can be made more confusing by the different terminology
used to describe the various interests. This Guidance
Note (GN) seek to address and clarify these issues.
 SCOPE
This GN sets out definitions, principles, and important
considerations in the valuation of and related reporting for lease
interests.
This GN is to applied with particular reference to IVSs Concepts
fundamental to Generally accepted Valuation Principles to IVSs 1
and 2, and IVAs 1, 2, 3.

This GN applies in countries where a lease holds an interest in land

and/or buildings, which is regarded as a separate legal estate.
Definitions
Freehold Interest
- a fee simple estate, representing the perpetual ownership in land
Freehold subject to leasehold or Lease Interest/s
- representing the ownership interest of a lessor owning real estate that
is subject to a leases to others
Ground Lease
- 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
Headlease or Master Lease
- a lease to a single entity that is intended to be the holder of subsequent
leases to sublessees that will be the tenants in possession of the
leased premises
Definitions
Headleasehold Interest
- has the same meaning as Sandwich Lessor Interest. The holder of a
headlease or master lease
Lease
- a contract arrangement in which rights of use and possession are
conveyed from a property’s title owner in return for the promise by
another to pay rents as prescribed by the lease
Leasehold or Lease Interest
- also known as Lessee Interest, Tenant’s Interest, or Leasehold Estate
The ownership interest that is created by the terms of a lease rather
than the underlying rights of real estate ownership
Definitions

Lessor Interest
- the interest held by the lessor in any of the circumstances set
out in Lease Interest, Headlease and Headleasehold Interest

Marriage Value, Synergetic, Plottage Value or

Merge Interests Value
- the excess value, if any, produced by a merging of two or more
interests in a property, over-and-above the sum of the values
of those individual interests
Definitions
Rent Types
Market Rent
- the estimated amount for which a property, or space within a property,
should lease on the date of valuation between a willing lessor and a
willing lessee on appropriate lease terms
Contract Rent or Passing Rent
- the rent specified by a given lease arrangement
Turnover Rent or Participation Rent
- any form of lease rental arrangement in which the lesser receives a
form of rental that is based on the earnings of the lessee
Sale and Leaseback
- a simultaneous sale of a real estate and lease of the same property
to the seller
 Hierarchy of Property Rights
YEARS
0

Freehold or Fee Simple The absolute right to sell, lease/let, or use the subject
Entity A absolutely held by Entity A property in perpetuity, subject only to country restrictions

Lease Interest, The right to occupy and use the property for specific
Entity B Leasehold or tenancy period and for a specific consideration as a set out in a
held by Entity B lease between Entity A and Entity B

Sublease Interest, The right to occupy and use the property for a specific
period and for a specified consideration as set out in a
Subleasehold, or
Entity C lease between Entity B and Entity C
Tenancy held by
The rights specified in the subordinate lease cannot
Entity C
exceed the rights granted in the lease between A & B

The right to occupy and use the property for a

specific period and for a specified consideration as
Subordinate
set out in a lease between Entity c and Entity D
Sublease
Entity D Interest held The rights specified in the subordinate lease
by Entity D cannot exceed the rights granted in the lease
between B & C
 Relationship to Accounting Standards

Leased property is accounted for differently from

freehold property, plant and equipment under
IFRSs/IASs.

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 GUIDANCE
Leasehold or lease Interests are valued on the same general
principles as freeholds, but with recognition of the differences
created by the lease contract encumbering the freehold interest,
which may cause the interest to be unmarketable or restricted.

Leasehold or lease Interests are often subject to restrictive

covenants or alienation provisions.
Freeholds subject to an operating lease are for accounting
purposes generally considered investment property, and as such
are valued on the basis of Market Value.
In some countries a lessee may ha a statutory right to purchase the
lessor’s interest, usually the freehold, or may have an absolute or
unconditional right to renewal of the lease for a term of years.
The importance of the distinction between the physical matter and
the legal interest in it is critical to valuation.

Each legal interest in a property shall be valued as a separate

entity and not treated as though merged with another interest.
Restricted or onerous lease covenants may adversely affect the
Market Value of a lease interest, The valuer must draw attention in
the Valuation Report to the existence of such circumstances.

Inter-company Leases
Where a property is subject to a lease or tenancy agreement
between two companies in the same group, it is acceptable to take
account of the existence of that agreement provided the
relationship of two parties is disclosed in the report, and that the
agreement is on arm’s-length in accordance with normal
commercial practice.
Leasehold Alterations
• When valuing any property interest that is subject to lease, it is
important that Valuers establish whether any alteration or
adaptations have been made to the property by the lessee. If so the
following questions should be addressed:
a) Has the lessee complied with any lease conditions or restrictions
relating to the alteration?
b) What is the impact of any state laws on the rights of the parties in
relation to the alterations?
c) Are the alterations obligatory or voluntary?
d) Is there any obligation on the lessor to compensate the lessee for the
cost or value of the work, or on the lessee to remove the alterations at
the lease end?
• Leasehold Alterations fall into two main categories:
a) Obligatory Alterations- these usually arise where property is
leased in a basic state or constructed to a “shell” specification
that is not suitable for occupation without the lessee
undertaking further building or fitting-out work.

b) Voluntary Alterations- these arise where a property is

leased in a completed state ready for immediate occupation,
but where the lessee elects to undertake work to improve or
adapt the accommodation to suit the lessee’s own particular
requirements.
Negative Market Values
Where lease interests are liabilities to an undertaking, they
may have a negative Market Value.

General
Due to the relative complexity of leasehold or lease interest
valuations, it is essential that the client or client’s legal advisor
provide the Valuer with either copies of all the leases or, for multi-
tenanted property, typical sample leases together with a summary
of lease terms on the other leases.
 Topic 9
VALUATION of PLANT,
MACHINERY and EQUIPMENT
 INTRODUCTIONS

Plant, Machinery and Equipment

• Collectively constitute a general class of tangible property

assets.

• Have particular characteristics that distinguish them from

most types of real property and that influence both the
approach to and reporting their value.

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 SCOPE

This GN focuses on the application of the approaches,

principles and bases described in the Standards to valuation
of plant, machinery, and equipment.

This GN applies to the valuation of the plant. machinery,

and equipment assets of both private sector and public
sector entities.
Definitions
Fair Value
- the amount for which an asset could be exchanged between
knowledgeable willing parties in an arm’s-length transaction.
Market Value
- the estimated amount for which a property should exchange on the
date of valuation between a willing buyer and a willing seller in a arm’s-
length transaction after proper marketing wherein the parties had each
acted knowledgeably, prudently and without compulsion
Plant and Equipment
- tangible assets, other than realty, that:
a) Are held by an entity for use in the production or supply of goods, or
services, for rental by others, or for administrative purposes
b) Are expected to be used over a period of time
Definitions
The categories of plant and equipment are:

Plant
- assets that are inextricably combined with others and that may
include specialized buildings, machinery and equipment
Machinery
- individual machines or a collection of machines. A machine is an
apparatus used for a specific process in connection with the operation
of entity
Equipment
- other assets that are used to assist the operation of the enterprise
or entity
Definitions
Finance Lease
- a lease that transfers substantially all the risks and rewards incidental
to ownership of an asset.

Operating Lease
- a lease other than finance lease

Property, Plant and Equipment

- tangible items that:
a) Are held for use in the production or supply of goods, or services, for rental
by others, or for administrative purposes
b) Are expected to be used during more than one period
 Relationship to Accounting Standards
• Under International Financial Reporting Standards (IFRS), Property,
Plant and Equipment may be included on an entity’s balance sheet
at either cost less depreciation less impairment or at fair value at the
date of revaluation less depreciation less impairment.

• The valuation approach and assumptions applicable to a valuation of

plant, machinery and equipment for inclusion in a financial statement
may be different from those appropriate for another purpose.

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 GUIDANCE
• Valuation of plant, machinery and equipment can be carried out using any of the
following approaches:

Sales Comparison Approach

Due to the lack of direct sales evidence the use of the sales comparison
approach is often limited to individual free-standing machines such as
lathes and generators and motor vehicles

Cost Approach (depreciated replacement cost)

Machinery and equipment valuations are usually carried out using the
Depreciated Replacement Cost approach to reach a valuation conclusion

Income Capitalization Approach

This approach in the of machinery and equipment is not adopted. It is rarely
possible to identify an income stream and allocate it to individual asset.
 GUIDANCE
• The most appropriate basis of value is Market Value. However, Market Value
simply stipulates that an exchange is assumed to take place on an arm’s
length basis between knowledgeable and willing parties; it is silent as to how
the particular asset is to be presented for sale or any of the other specific
circumstances that could have a fundamental effect on the valuation.
Examples of assumptions that may be appropriate in different circumstances, or
for different valuation purposes:
 That the plant, machinery and equipment are valued as a whole, in-
situ and as part of the business as a going concern
 That the plant, machinery and equipment are valued in-situ but on the
assumption that the business is closed
 That the plant, machinery and equipment are valued as individual
items for removal from their current location
 GUIDANCE
• Those assumptions is not comprehensive because of the diverse nature
and transportability of much plant, machinery and equipment, Market
Value will need appropriate qualifying assumptions to describe the state
and circumstances in which the asset is offered to the market.
• Other factors that can affect the Market Value of plant, machinery and
equipment include:
 the cost of installation and commissioning where plant,
machinery and equipment are valued in situ
 where they are valued for removal, any allowance made for the
costs of decommissioning, removal, and possible reinstatement
following removal , and which party is to bear those costs
 GUIDANCE

• Factors such as finite sources of raw materials, the limited life of

the buildings or limited tenure of the land and buildings housing the
plant, and statutory restrictions or environmental legislation can
also have a significant impact on the value of plant and equipment.
• Some plant, machinery and equipment connected with the supply
or provisions of services to a building will normally be included in
any exchange of the real estate interest.
• Intangible assets fall outside the definition of plant, machinery and
equipment. However, intangible assets may have an impact on the
value of plant, machinery and equipment.
 GUIDANCE
• An item of plant, machinery and equipment may be subject to
financing arrangement, such as a finance lease.
• Plant, machinery and equipment assets are more likely to be
subject to forced sale circumstances than real estate interests.
• Materiality
Information is material if its omission or misstatement could
influence the decisions or assessments of users of that
information.
Materiality with regard to the valuation of items of low value
depends upon the nature or size of the item in the particular
circumstances.
 GUIDANCE
• Inspection of Mobile Asset
It may be impractical due to the location of certain assets, for all
assets to be inspected. This may be because the assets bare mobile
assets and /or located in remote and inaccessible areas.
• Sampling Techniques for ‘Low-Value’ Items
Plant, machinery and equipment valuations for major public or
corporate clients generally include a multitude of individual assets, many
of which considered individually sometimes collectively, represent an
insignificant part of overall asset base. In such circumstances, full
comprehensive inspections of each and every item may not be practical
or necessary and it may be possible to reliably determine the value of
such assets on a group basis using sampling techniques.
Thank You!
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