Ground Lease?
Can someone help me with what exactly a ground lease is?
-Are they generally negatives or positives?
-What tends to be the structure of them?
-Do they make a deal more or less attractive when trying to re sell
-What are the risks involved?
-would you model them as any other lease in Argus ?
thank you all, love the spread of knowledge on this site
Brief rundown: Ground leases sever the building from the land underneath. You can buy and sell them separately, and when the lease expires, usually all improvements that were severed return to whoever actually owns the land. This makes them less attractive from an acq standpoint, as after your hold period, the next owner will only have so many years before they just lose the asset. Usually, if it's a new lease, they run for 99yrs so it's not too much of a concern. Additionally, if you can get some sort of certainty from the owner of the dirt that they'll renew a lease, that helps as well.
We were looking at an asset that's on a ground lease from a university, due to expire in 7 years and they have already indicated they would not renew. This made it a more complicated deal, debt had to be low and fully amortizing because there'd be no balloon sale to pay it off, and it still had to cashflow to our returns (it didn't, and I don't know if it even traded). This meant the seller took a hit on the price, because there was no residual value.
Of course, if you're buying the ground lease and not the leasehold interest in the improvements, that is more similar to a NNN lease where you get a fixed payment and then a building at the end.
You may not know, but is this type of scenario modeled any differently than a regular acquisition, assuming the ground lease is 50+ years?
Honestly, probably not too different but you need to be ready to defend an as-normal exit value assumption to IC. I'd prob UW maybe 25bps higher exit cap than if it was a normal deal just to build a buffer for the next buyer getting concerned by having less years on the lease for their exit - also good to sensitize and make sure a lot of the IRR/MOIC isn't tied up in the terminal value which is even shakier on one of these than a normal deal.
35 years is typically where things shift in terms of underwriting. Once you're under 35 years it's looked at almost exclusively as the NPV of the future cash flows (vs. just capping and assuming into perpetuity).
If it's over 50 years a deal on a ground lease is going to trade at some spread to market cap rates (we assumed 25-50) but nothing different otherwise.
Equity investor POV:
Ground lease deals are like girls with boyfriends. She may be cute at first glance but when you hear that it won’t be ALL yours you gotta think twice. The second thought I’d often where we say “nah, there are enough girls out there without a 99-year ground lease to some other dude.”
But if she’s really special maybe it’s worth the worth the brain damage and you go through with it.
I work in a niche sector and 80% of our developments are on ground leases. We pass through the ground rent as opex typically. If we are setting up a new ground lease it will be like others have mentioned: 99 years with y1 rent payment = to 5% of the dirt appraised value. When you sell a property the depth of buyer pool drops dramatically if there is less than 40 years left on the ground lease due to improvements reverting to lessor at end of ground lease term. Happy to address any specific questions you might have.
Ground leases are popular in my market for public entities who do not want to be seen selling publicly owned land to private developers. The ground rent can range from 5-10% of the headline rent of the building, but there's typically no land payment. Typically seen as less attractive given you only own the building and not the freehold, so this can heavily limit your rights on what you can do with the building. From what I've seen there's no standard ground lease format, so it's important to thoroughly DD it to see if there's any quirks to it. As noted above, as term runs down so does level of interest, particularly from buyers with lower cost of capital.
One other things in addition to what others have said, you really need to make sure you understand the reset provisions in the ground lease and how they are calculated. They typically have a small reset every 5 years and a potentially big one every ~20. The small one usually just updates vs. cpi (3%/year with a true up every 5 or something like that), but the big one can totally reset the lease amount and completely blow up your deal.
This right here. Ground leases without an FMV reset are a lot simpler and can just be viewed as getting an additional layer of financing on the land + some sort of premium on your exit cap. When they do have the FMV reset it becomes a huge PITA to underwrite and structure.
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