Market rent is the rent a property would command in the open market if leased at arm's length between a knowledgeable landlord and tenant, typically expressed on a net or gross basis per square foot per year depending on the lease structure common in the market. Contract rent, also called in-place rent, is the rent actually specified in an existing lease, which may be above or below market depending on when the lease was signed, the tenant's bargaining position at origination, and how market conditions have moved since execution.
The distinction between market rent and contract rent is foundational to CRE valuation because the two interests (the leased fee estate, which the landlord owns subject to the lease, and the fee simple estate, the value as if unencumbered) may differ materially when market and contract rents diverge.
A property leased at below-market rent carries a leased fee value that is lower than its fee simple value by an amount equal to the present value of the rent differential over the remaining lease term. If a property leases at $18 per square foot net in a market where comparable space leases at $24, the tenant holds an economic interest (the leasehold value) equal to the present value of that $6-per-foot annual benefit.
A buyer acquiring the leased fee interest is acquiring the right to receive $18 rather than $24 until the lease expires, plus the right to receive market rent from the reversion. The leased fee buyer is therefore paying less than a fee simple buyer because the current income stream is below market, but benefits from the reversionary upside when the below-market lease terminates.
This reversionary value, sometimes called bump potential, is what makes value-add investors willing to acquire leased fee interests at below-fee-simple prices and hold through lease expiry.
Reversionary analysis within a discounted cash flow model is the primary tool for quantifying the impact of below-market leases on value. A properly constructed DCF models in-place rents for the contractual term of each lease, then transitions to market rents at renewal or re-leasing following expiry, applying a downtime and re-leasing cost assumption for the vacancy between the expiring lease and the new one.
The discount rate applied to the reversionary cash flows should reflect the certainty of the contracted income stream versus the uncertainty of future market rent levels; some appraisers use a lower discount rate for the in-place income and a higher rate for reversionary income to reflect this risk differential explicitly. The terminal value (typically the capitalized value of the NOI at the end of the explicit DCF period) should be based on stabilized market rent rather than in-place rent if the leases are rolling over during or shortly after the DCF horizon.
Above-market leases create the opposite risk profile and require equal analytical attention. A property leased at above-market rent earns more than a comparable stabilized asset today but faces income decline at renewal if the tenant exercises options at FMV or vacates in favor of alternative space.
If the above-market lease is with a creditworthy tenant under a long-term commitment, the excess rent has present value to the landlord (the equivalent of an in-place premium), but the terminal value at lease expiry reverts to market rent, producing a declining income profile through the DCF horizon. The greater risk with above-market leases is tenant credit: an above-market lease with a financially distressed tenant may be worth less, not more, than a market-rate lease with a creditworthy tenant, because the probability of early termination, subletting at a loss, or lease restructuring must be factored into the valuation.
Institutional buyers of net-leased single-tenant properties routinely underwrite tenants' credit profiles alongside rent-to-market comparisons, because the premium paid for an above-market lease is only as valuable as the tenant's ability to pay it.
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