The metaphor used by almost every professor to introduce first year real estate students to explain property rights is a bundle of sticks. But that metaphor is tired – and old. So I decided to use a bundle of cigars.
I explained in a previous post how ownership of commercial real estate is an illusion. In that post I stated…
“…the material components of land and building materials, has no intrinsic value. What is valuable, or can be, are the rights associated with real estate.”
If each of the cigars in a bundle represents a right, four will always belong to the government. These include:
- Police Power
- Eminent Domain
Whenever you buy property, the government always keeps these four cigars. The rest are yours to do with as you wish. These rights are called the “Fee Simple Estate“. When most people purchase a home they purchase the Fee Simple Estate. This is the highest possible level of ownership, subject only the the four powers of government. Some people (or businesses) may decide to sell a portion of their ownership rights (for example, the right to occupy the land or all or part of the building improvements). These rights normally extend for a definite period of time specified in a lease agreement.
When this happens, they become the landlord or “lessor”. The bundle of rights kept by the lessor is referred to as the “Leased Fee Estate“. The rights of a lessor typically consist of the right to receive rental income stipulated in a contract for a certain period of time and the right to receive full ownership at the expiration of the lease when they revert back to the lessor (i.e. the reversion). The cigars sold to the tenant , the lessee, are referred to as the “Leasehold Estate“.
An appraisal is an effort to form an opinion of the value of one of these bundles, the Fee Simple, Leased Fee, or Leasehold Estate. In the weeks to come, I will provide more detail about how we form that opinion and how to avoid some common mistakes we see when people buy or sell these rights.