Expert: Jim Avancena, CPM - 5/23/2008

Question
QUESTION: Hi Jim,
My husband is a doctor who was in a practice with two other partners who own their own building where they practiced and did surgery.  He is now seperating from them.  
There was an appraisal on the building.  The dispute is whether to use the actual rent premium that is twice the written contract premium to include on the appraisal value.  The other side claims that there is no written contract so there is no guarentee of the higher rent rate therefore the lower rate should be used.  We claim that the higher rate has been the actual rent for a few years and that the proof of the actual rent payment on the account should be enough without the written documentation.  The fact that the landlord is the same party as tenant should be counted in considering the absence of the written contract.
I would appreciate your thought on this.

Thank you so much.
Susan Danforth

ANSWER: Mrs. Danforth:

I think semantics is disrupting my understanding of your question and it would help if I had a bit more background about the activities you are involved with.

What does an appraisal have to do with your husband separating from the other two practitioners?  What does the rent premium have to do with the "contract premium"?

When you use the expression "rent premium", would that also mean "rent rate"?  Does "contract premium" mean the same as "Lease Rate"?  

There are so many transactions that could be underway. Is your husband getting his own - separate - lease in the same building and he is disputing the tenant/owners fair market rental rate for his new space?

I can tell you that the fact that the landlord is also a tenant should be considered in the absence of the written contract; but more on that after I get some more information from you.

Please don't let my problem understanding your question turn you away from getting this figured out.  It sounds like this is important.  I have been involved with MANY medical real estate matters involving leases and appraisals in my career.

Simply send another question and give me more details following a description of what your husband is trying to do.  

My thanks.

-Jim



---------- FOLLOW-UP ----------

QUESTION: Hi Jim,
I am sorry that my questions were not clear.  
I will try to explain better this time.
My husband and two other partners own their own building where they practice and perform surgeries.  They have three corporations that they are principals.  There is the corporation, I will call it A, that they formed to practice medicine.  They formed a corporation, I will call it B, for the surgery center where they perform surgeries.  They own a corporation , I will call it C, that is for the real estate that they own.  The three doctors(partners) own all three corporations together.  C is the landlord to A and B.  A and B are the tenants to C.  Although the names of these corporations are different, they are all owned by the three doctors.  Therefore, the landlord is in fact the tenant.
My husband who was one of the doctors who owned 1/3 of the A, B, and C corporations is involved in being bought out.  In order to determine the value of C for the purpose of buy-out, we had to use an appraiser.  One of the considerations in determining the value of C is using the rent that C is receiving from A and B.  As I mentioned before, the discrepancy is that the actual rent that C is receiving is 2x more than what is written on the lease agreement.  The lease contract states that the rent is based on $18/square foot but the rent that's been actually paid is $36/square foot.  The appraiser is aware of the discrepancy but said that he can only use the $18 rate since there is no guarantee of the $36 without a written contract.
Obviously, C would be valued more with $36 versus $18, which would make our buyout $ more.
My argument is that the $36/square foot should be used in this case, even without the written contract because the tenant is also the landlord and a written contract does not have to exist.  My attorney who is very highly regarded does not think that we can go any further on this issue without a written contract but I just can't agree with that.  
I would appreciate your input.  
I hope that my situations and questions were more clear this time.
Again, thank you and my apologies for the confusion.

Susan Danforth

Answer
Mrs. Danforth,

Now I understand the situation!  Your clarification makes it all clear.

I wish I could give you and answer that is helpful to your position, however I doubt that it will be.  Firstly, I do not understand why your husband and the others would be paying at the rate of $36/sf when the lease stipulates $18/sf?

Your appraiser should use whatever the current market rent would be if the premises were put on the market and leased today.   That might be $36/sf, but it also could be $18/sf.   Fair Market Value (FMV) to rent the premises is whatever a reasonable person would rent it for if they needed that type of facility.  So it could be $24.00/sf.  Your appraiser will research many things to determine the fair market rent at this time.  

Having made the comments above, there are some other things to keep in mind.  

When someone purchases a property, they base what they pay for the property on what they believe the future benefits will be from owning the property; that is, the value of the property depends upon on what it will earn for the owner.  If there is good reason to believe that another tenant would be willing to pay $36/sf to rent the premises, then your expectation of value may be correct.  

Additionally, there may be something about the premises that make it more valuable and worth a higher rental.  For instance, if the premises contains specialized medical equipment that cannot be moved and is of great value to others, the added assets and value of similar contents should be considered.

Sometimes there are unique circumstances that have a significant impact on valuation of the property.  I leased medical space in Texas at one point for a medical vendor that was directly across the street from a local hospital, and very convenient for the hospital patrons. Just before the time our lease was up for renewal, the local government passed legislation that eliminated the opportunity for anyone else in the area to develop anymore commercial property in the future.  Limiting the amount of commercial rental space in the area in the future made the rental value of the premises jump up by 40% overnight.

I believe that your appraiser is likely on the right track.  I am sorry I don't have good news for you.

Best regards,

-Jim