The valuation approaches for taxable possessory interests are similar to the conventional approaches to value – the comparative sales approach, the income approach, and the cost approach – that are generally accepted and used in the valuation of a fee simple interest. However, the conventional approaches must be modified to accommodate the finite duration of a taxable possessory interest and the corresponding fact that a portion of the fee simple interest in those rights, the reversionary interest, is retained by the government owner and is non-taxable.
While any of the sales comparison, income, or cost approaches to value may be used by the Assessor in valuing taxable possessory interests, the income approach is the most commonly relied upon method of valuing them.
In the income approach, a taxable possessory interest is valued by discounting the future net income that the interest in real property is capable of producing during the anticipated term of possession. Where both economic rent and a reasonable term of possession can be determined, estimating the PI value involves capitalizing the potential rental income stream (less anticipated vacancy, collection loss and management expense from a landlord's point of view). The resulting figure is the value of the taxable Possessory Interest.
Capitalizing the economic net income for the term of possession measures only those rights possessed by the tenant and excludes any non-taxable rights retained by the governmental landlord.
A term of possession for the taxable possessory interest must be determined, using such evidence as the actual contract or rental agreement itself, any history of prior use by the current tenant, the government entity's current policies, or the history of other past or current tenants’ use of the same or similar rights to determine a reasonable term of possession.
It is not uncommon for holders of Possessory Interests to construct facilities on the leased property that will revert to the government owner when the lease expires. In that case (presuming actual rent is economic rent), the valuation of the taxable possessory interest rights using an income approach should reflect both the actual rent plus an imputed rent for the added improvements for the term of possession, or, the actual rent plus the value of the leasehold improvements built by the tenant.
Capitalization rates used in PI assessments reflect the landlord's perceived risk and are typically derived from sales of similar fee-owned properties. These derived rates are then adjusted to further reflect those risk considerations specific to each individual Possessory Interest situation.