Question

1. Why probate is required in the tenancy in common and not in joint tenancy?
2. What is the difference between the contract rent and the market rent? Why is this distinction more critical for investors purchasing existing office buildings than for investors purchasing existing apartment complexes?
3. What is the difference between the potential gross income and the net gross income.
4. Define the types of accrued depreciation and give an example of each type.

Answer 1

Part A

If property is owned as Joint Tenants the Rule of Survivorship applies. This means that if one of the co-owners dies, the survivor/s will automatically inherit the deceased’s share equally between them, regardless of what the Will or the Intestacy Rules say.

So if for example three friends, Albert, Bob and Charlie, own a painting as Joint Tenants and Albert dies, Bob and Charlie will automatically become the surviving owners of that painting, even if Albert’s Will made a gift of the painting to his son.

Another important aspect of a Joint Tenancy is that everybody has an equal share of the property. In the above example, Albert, Bob and Charlie will own a third of the painting each, so if they decided to sell they would each be entitled to a third of the net proceeds.

If property is owned as Tenants in Common the Rule of Survivorship does not apply, which means that if one of the co-owners dies then the provisions of their Will (or if there is no Will, the Rules of Intestacy) will determine what happens to their share.

With Tenants in Common, it’s possible for the parties to own unequal shares of the property. To continue the above example, if the painting is owned as Tenants in Common, Albert might own 60% of the painting, Bob 35% and Charlie 5% (perhaps to reflect their respective contributions to its purchase). If Albert dies, the gift in his Will to his son will take effect and he will inherit Albert’s 60%.

Part B

Contract rent refers to the actual rent paid under existing lease contracts executed between owners and tenants. Market rent refers to the potential rental income a property could receive on the open market as of the effective date of an appraisal. The distinction is particularly important for investors in office buildings because commercial leases tend to be for multiple years, unlike apartment leases. Existing leases at below market rates will be included in the calculation of potential gross income, which will depress the appraised value of the property relative to the appraised value assuming market rental rates.

                                                                                                                                                   

Part C

Gross income is the total amount you earn (typically over the course of a year) before expenses. Think of gross income as the profit you’ve made from the services you provide—the sum of all your client billings before any deductions, taxes, or withholding.

Net income is the profit your business earns after expenses and allowable deductions.

Part D

Depreciation of real estate is a loss in value to a property due to any cause. Accrued depreciation is depreciation that has already occurred. This loss in value is equal to the difference between the replacement cost new of the improvements and their market value. Depreciation may be due to the physical wearing out of a building, functional problems of the building, or locational problems that affect the property. After estimating the accrued depreciation you can then deduct it from the replacement (or reproduction) cost of the building(s) on a property. The resulting figure is the depreciated cost of the improvements.

There are three types of depreciation: physical deterioration, functional obsolescence, and external obsolescence.

Ø Physical deterioration of a building and its equipment includes physical wear and tear, disintegration, decay or rot, or physical damage of any kind caused by the elements.

Ø Functional obsolescence refers to deficiencies, super adequacies, or simply undesirable features found in a building. It is depreciation that is attributable to an item or feature within the subject property that is no longer useful or functional. This impaired feature results in loss of value (depreciation) for the entire property. Functional obsolescence is caused in part by changing market requirements and can appear in several different forms, including outdated architectural design, layout problems, lack of modern facilities, and super adequacy.

Ø External obsolescence is attributable to external adverse conditions that affect a property. It takes place when influences that are external to a property adversely affect that property. These external influences can be locational or economic.

· Locational obsolescence is caused by the physical location of the subject property and its proximity to a negative influence. Heavy traffic noise, such as that generated by freeways and airports, may cause locational obsolescence. Recurring smoke, dust, and noxious odors from sources external to a property, like a dairy farm or sewage plant, also tend to have an adverse influence on the value of a property.

· Economic obsolescence occurs when changes in the local economy affect the subject property’s value. Some cities rely on one major industry or employer. If the industry shuts down or the employer ever moves, a devastating impact on real estate values could result.