Commercial Grade is a post by John Cicero, MAI who provides commentary on issues affecting real estate appraisers, with specific focus on commercial valuation. John is a partner of mine in our commercial real estate valuation concern Miller Cicero, LLC and he is, depending on what day of the week it is, one of the smartest guys I know. …Jonathan Miller

On June 12, 2008 the Court of Appeals of the State of New York decided a lease dispute case, 936 Second Avenue, L.P. v. Second Corporate Development Co.

The issue, according to the New York State Bar Association, was

whether the net lease itself must be considered by appraisers in valuing the demised premises for purposes of establishing the net rent for a renewal term of the lease. The lease encumbering this property specified that upon exercising a renewal option the new net rent would be equal to 7% of the “value of the demised premises.”

For the purpose of setting this new rent lessor and lessee each retained an appraiser. Lessor’s appraiser concluded to a value that was more than double lessee’s opinion of value. Apparently the primary difference was that lessee’s appraiser took into account the renewal lease terms (i.e. appraised the leasehold interest) while the lessor’s did not. The Supreme Court had ruled that the lease should not be considered in estimating the property value for the purpose of determining the new rent, however this was overturned on appeal. The Appeals Court essentially decided that since the lease did not specifically state that the lease encumbrance should be excluded from consideration, it should not be.

I am not a lawyer, but to me this is a completely illogical decision based on circular reasoning.

To say that the parties must base a lease rate on the value of a property that is presumed to be encumbered by a lease defies common sense and real estate economics. I am fairly certain that when the lease was drafted in the 1960’s it did not specifically state that the lease be excluded from consideration because it was just unfathomable to both parties that it would not be.

The irony is that the Court concluded that

absent an agreement to the contrary, the effect of a net lease must be considered in valuing property for the purpose of setting rent for a renewal lease term. Such a rule comports with precedent, appraisal practices and common sense.

Well, I can’t speak to precedent, but as far as appraisal practices and common sense, I’d have to respectfully disagree with our esteemed Justices.

Webmaster’s note: I have experience with circular reasoning as well. On family vacations via car, my sons have a song that goes like this:

I know a song that gets on everybody’s nerves,
everybody’s nerves,
everybody’s nerves,
I know a song that gets on everybody’s nerves
and this is how it goes…

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2 Responses to “[Commercial Grade] Justice Is. Confused”

  1. Edd Gillespie says:

    I have read and re-read your comments o make sure I understood what the court seems to be requiring.

    I think more than circular reasoning is involved here. It is ignorance. One or more of the appraisers involved failed to explain valuation methodology and real estate economics adequately to the court.

    My suspicion is that the appraiser who used the lease to come up with a market value for the property on which the terms of the lease are based may be the prime culprit.

    It doesn’t seem right to blame the court when it follows the advice of the experts before it. We obviously have a long way to go in training appraisers.

  2. John Cicero says:

    Ed, You’re right. That’s why I say that justice is confused. These are complex valuation issues and somehow the judge was not made to understand them. Having testified as a valuation expert I have been very impressed with how much technical info judges do seem to grasp; in this case, however, he or she just didn’t get it.