Ground Lease Payment Question
I am doing a case involving a public/private development. The public entity owns a ground lease which we will be developing on. The case asks us to estimate the annual ground lease payment the developer should negotiate. Can anyone provide any insight into how I may go about estimating the ground lease payment? We were not given any value of the land either. Thanks.
I am working on a similar deal. I basically ran the land value at $0.00 and added a line item to my non-controllable operating expenses that equals some monthly payment for the ground lease. You basically just toggle this operating expense/ground lease value to solve for the yield you need to hit. That's if you are just looking at NOI yields. If you need to run this based on IRR, probably want to talk to a broker to understand how your exit cap would be negatively impacted by the ground lease based on the extent of the term. For 99 years assuming a sale at like year 6, i would guess maybe 15-20 bps dilution to be safe.
If looking at this from the ground lessor's perspective, a common way to do it is take what the FMV of the land is, then assign a yield/return to it based on the market currently. So for example, if land values in the area are $25/SF, you'd take whatever a market cap is in the area and then assign a premium to it. From the owner's perspective this means usually 50-100 bps below what a market cap would be for a building. So if a given market is a 5 cap let's say, then they probably get a 4.00% return. So 4% x $25 PLSF is $1 PLSF in annual rent. If you're evaluating it from the ground lessee's perspective, a common way to look at it is the NPV of the cash flows based upon a predetermined discount rate. So for example, let's take a 5 acre site. Assume 45% coverage for an industrial building (45% x 5 acres = 98K SF approx). For argument's sake let's say that market rents for that building are $0.6.0 /sf/mo NNN. So your NOI on a market deal would be $706K (rounded). Using the land value formula above, the ground rent would be ~$218K. So your actual NOI after ground lease payment is 488K. Then usually, the rent is fixed for a set time (5-20 years from different deals I've seen/done) and then resets based on a max/min clause in the lease depended on either FMV of the land or compounded CPI increases, etc. Usually, to see if the deal pencils from the developer/ground lessee perspective, I then extrapolate the rents out to whatever the term is (99 years or whatever) and then assign a discount rate to it to arrive at a NPV. If the NPV of those cash flows is greater than what my construction/stabilization costs are, or conversely, if the IRR is above a certain threshold (usually 100+ bps from what a fee-deal IRR would be) then the deal is accretive. There are obviously a lot of sensitivities you need to do on this with respect to market rents, land values, rent resets, etc. to see if this is a good deal to do.
EDIT: I wouldn't recommend capping the deal when underwriting your exit since all of the value is locked up in the yield (there is really no residual value). Anyone that would buy this subsequently is going to price it more like a coupon/yield play. Cap rate generally assumes an income stream into perpetuity.
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