How to calculate ground leases? - example included
Made up the numbers so it might be not realistic, but can anyone explain how to calculate the yearly number if you're the buyer and what you can afford to pay.
There's a 10,000 SF lot with a 15,000 SF existing building, the land has as of right commercial max BSF of 40,000 SF (FAR is 4x). Zoning allows for retail/office (C zoning), and the lot is not overbuilt.
Ownership is asking $500,000/yr for 99 years, let's ignore adding in an option to purchase.
My question is how do you calculate the $/yr number? Let's say in this market's air rights go for $100/BSF, so the site is worth ($100 x 40,000 SF) = $4,000,000.
Where do you get the $/yr number from here? Am I going about this the right way?
It seems you'll need to project rents, so if you're paying ($500,000/40,000) = $12.5/sf/yr in ground rent you'll have to have retail sales/rents to support more than that plus other costs. If anyone can clarify that would be helpful.
I think you're over-complicating things. Ground lease payments are usually structured as a % of total revenue with % increases based on set % annual bumps, CPI growth, or re-adjustment to a FMV rent at some point in the future. The rule of thumb for ground lease payment is 10-20% of total rent. For a ground up project the sizing metric for the ground lease payment would be % of your proforma stabilized rent or the in-place $ rent amount if there's an executed lease.
Isn't it just a % of the value of the land? So the land value is $5M and a fair price is usually 4-6% of that ($250k/yr) then add in the increases/resets?
So the lessee can pay that and build what they want/reap benefits above the payment.
Yes to a certain extent but you're thinking about it backwards. Land value is a function of stabilized proforma income, construction cost and target return-on-cost. It makes more sense to structure the ground lease payment as a % of the income stream rather than as a % of land value. When evaluating opportunities developers are solving for a land value based on the construction cost, target returns and proforma income (net of round ground lease payment)....not the other way around.
Got it, thanks.
You're not solving for land value, you're solving for what land cost your project can afford. The value of the land is independent of it's affordability to your capital constraints.
Not sure exactly what you mean by land cost vs. land value. Land value is simply a function of the highest and best use for the site, development costs, proforma rents/expenses, and an appropriate return-on-cost % given the risk-profile of the asset.
Yeah, I always look at it as earning a yield on the contributed land value that is close to the yield of what's built, but a bit more conservative to account for the additional security
I think the way you should view ground lease is as a form of financing, or part of the capital stack, which is really what it is.
In short, you have a fixed or variable payment in exchange for not buying the land. In a proforma, the ground lease payment is effectively just another debt payment. It functions the same way from a capital standpoint, you either buy land out right at a fixed price, or 'rent' it and pay the ground rent.
As to what is 'fair', well that is up the 'market' and will vary greatly city by city and asset type by asset type.
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