Leasehold vs Freehold Valuation
A lease splits one property into two interests. Here is how to value each, and what they are worth together.
A freehold owner holds the property for ever. A lease splits that ownership in two: the lessee holds the right to use the property for the term, and the lessor holds the right to the rent plus the property back at the end. Each interest is a separate asset, and the Land and Building exam expects you to value both.
The legal frame is in the Transfer of Property Act: a lease is a transfer of a right to enjoy property for a time or in perpetuity, for a premium or rent (s.105); a lease for more than a year needs a registered instrument (s.107); and a lease ends when the lessor's and lessee's interests vest in one person (s.111(d)). That last rule is why merging the two interests can create value.
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Freehold, Lessor and Lessee Compared
Freehold, let at full rent
Income
Full rental value
Duration
Perpetual
Usual method
Net rent × years' purchase in perpetuity, or sales comparison
Lessor's (freeholder's) interest under a lease
Income
Rent reserved for the term, then full rental value
Duration
Term, then reversion for ever
Usual method
Term and reversion: rent × YP for the term, plus full rent × YP in perpetuity deferred
Lessee's (leasehold) interest
Income
Profit rent: full rental value minus rent paid
Duration
Unexpired term only
Usual method
Profit rent × YP for the unexpired term, single or dual rate
| Interest | Income | Duration | Usual method |
|---|---|---|---|
| Freehold, let at full rent | Full rental value | Perpetual | Net rent × years' purchase in perpetuity, or sales comparison |
| Lessor's (freeholder's) interest under a lease | Rent reserved for the term, then full rental value | Term, then reversion for ever | Term and reversion: rent × YP for the term, plus full rent × YP in perpetuity deferred |
| Lessee's (leasehold) interest | Profit rent: full rental value minus rent paid | Unexpired term only | Profit rent × YP for the unexpired term, single or dual rate |
Worked Example: A Commercial Building on a Long Lease
Illustrative figures. Full rental value ₹10,00,000 a year net; rent reserved under the lease ₹2,00,000 a year; 20 years unexpired. Freehold yield 8%; leasehold remunerative rate 9%, sinking fund at 4%.
Lessor: term
Working
₹2,00,000 × YP 20 years at 8% (9.818)
Value
₹19,63,600
Lessor: reversion
Working
₹10,00,000 × YP perpetuity at 8% deferred 20 years (12.5 × 0.2145 = 2.682)
Value
₹26,82,000
Lessor's interest
Working
Term + reversion
Value
₹46,45,600
Lessee: profit rent
Working
₹10,00,000 − ₹2,00,000
Value
₹8,00,000 a year
Lessee's interest, dual rate
Working
₹8,00,000 × YP 20 years at 9% and 4% (8.092)
Value
₹64,73,600
Freehold with vacant possession
Working
₹10,00,000 × YP perpetuity at 8% (12.5)
Value
₹1,25,00,000
Marriage value
Working
₹1,25,00,000 − (₹46,45,600 + ₹64,73,600)
Value
₹13,80,800
| Interest | Working | Value |
|---|---|---|
| Lessor: term | ₹2,00,000 × YP 20 years at 8% (9.818) | ₹19,63,600 |
| Lessor: reversion | ₹10,00,000 × YP perpetuity at 8% deferred 20 years (12.5 × 0.2145 = 2.682) | ₹26,82,000 |
| Lessor's interest | Term + reversion | ₹46,45,600 |
| Lessee: profit rent | ₹10,00,000 − ₹2,00,000 | ₹8,00,000 a year |
| Lessee's interest, dual rate | ₹8,00,000 × YP 20 years at 9% and 4% (8.092) | ₹64,73,600 |
| Freehold with vacant possession | ₹10,00,000 × YP perpetuity at 8% (12.5) | ₹1,25,00,000 |
| Marriage value | ₹1,25,00,000 − (₹46,45,600 + ₹64,73,600) | ₹13,80,800 |
The Factors Behind the Numbers
- Years' purchase (YP), single rate
- The present value of ₹1 a year for n years at rate i: (1 − (1 + i)^−n) ÷ i. At 8% for 20 years, 9.818.
- YP in perpetuity
- 1 ÷ i. At 8%, 12.5.
- Deferred (reversion) factor
- YP in perpetuity × present value of ₹1 in n years, (1 + i)^−n. At 8% in 20 years, 12.5 × 0.2145.
- Dual rate YP
- 1 ÷ (i + s), where i is the remunerative rate and s the annual sinking fund to replace capital at the accumulative rate. For a wasting leasehold income: 1 ÷ (0.09 + 0.0336) = 8.092.
- Marriage value
- The gain when the lessor's and lessee's interests merge into a freehold worth more than the two separately. Often split between the parties in negotiation.
Quick practice on loss assessment and valuation basics. No signup.
Leases Granted by Public Bodies
- check_circleMany urban plots in India are leasehold from a development authority or a state body, usually for a long fixed term or in perpetuity.
- check_circleThe lease deed may require the lessor's consent to transfer, a transfer charge or a share of the gain, and may permit conversion to freehold on payment. Read the deed: these terms come off the value.
- check_circleA long lease at a nominal ground rent with free transferability trades close to freehold. Restrictions on use or transfer widen the gap.
How the Valuation Examination Tests This
This is income-approach territory (7 marks) and a favourite case-study shape. Expect to compute a lessor's or lessee's interest from a rent, a term and a rate. The traps: valuing the lessee on the full rent instead of the profit rent, forgetting to defer the reversion, and using a perpetuity YP for a terminable leasehold income.
FAQs
What is the difference between leasehold and freehold property?expand_more
Freehold is ownership without a time limit. Leasehold is a right to use the property for a term under a lease (TPA s.105); at the end the property returns to the lessor.
How is a lessor's interest valued?expand_more
By term and reversion: the rent reserved capitalised for the remaining term, plus the full rental value capitalised in perpetuity and deferred to the end of the lease.
What is profit rent?expand_more
The full rental value of the property minus the rent the lessee actually pays. It is the income the lessee's interest is worth, and it lasts only for the unexpired term.
Why use a dual rate years' purchase for leaseholds?expand_more
A leasehold income ends with the lease, so the investor needs to recover capital as well as earn a return. Dual rate YP sets aside a sinking fund at a safe accumulative rate to replace the capital by the end of the term.
Next steps
- Income Approacharrow_forward
- Rent and Cap Ratearrow_forward
- Transfer of Property Actarrow_forward
- Preparationarrow_forward
Timed and scored, with negative marking.