Modeling Ground Lease
Hello everyone, this topic came up in the past a few times but I would like to get a clarification as the situation is a bit different than in previous posts. I am a novice and preparing a model to evaluate the development, where developer acquires 25 yr lease on land (paid upfront in mo 0), with a potential extension for another 25yrs at a higher rate. How should I model that above or below NOI items to properly evaluate the investment? Thank you
Thank you, everyone. Just to give a little bit of a background - i am trying to analyze potential real estate development which is overseas - no debt involved- - 25year land lease paid all upfront) we are talking pennies on a dollar compare to the US land lease), with potential of another 25yr extension
Would be above, and that GL is WAY too short.
If this is for a future development site...you'll have an issue obtaining debt as the term is too short.
Others on here are better positioned to speak on the debt side...but I believe lenders want the term for the debt to conclude at least 2 years (and more typically 5 years) before the ground lease expires.
To answer your question...the ground lease is an operating expense and above the NOI.
Couple other notes: You'll take a 25bps hit or so on the exit cap on a ground lease vs. fee simple ownership. And the lease payments are fully tax deductible...so it can make sense to view those deals on a post-tax basis.
Lenders want you to be able to refi, so they want term to satisfy that. Under 50-years is next to impossible.
This should be modeled as the following:
99 Year Term 2% Annual Increases 10 Year resets starting at Year 11 at greater of CPI or 2% compounded annually
You can run sensitivities of annual CPI at 2.5%, 3%, etc..
It is above the line.
To add on...we always try to structure with lease escalations that take effect at each 5 year period. The increase tends to be between 10-15%. For example...say the initial annual rate is $200k. At the end of the first five year period...the annual rate is increased to $220k for the next five year period. The makes it a bit easier to model.
As mentioned...CPI can be used in lieu of a fixed annual increase. Whenever we use CPI as the escalation metric...we include an annual floor and ceiling in order to provide some certainty when modeling. The last one we did had an annual CPI floor of 1.75% and ceiling of 4%.
To piggyback on what is being said... An institutional exit will also be impossible. You'll be selling to a corner of the market that will not optimize your residual.
As recommended above, I'd highly recommend renegotiating the GL term.
Assuming that is not possible then you'll need to UW your exit from YOUR buyer's point of view. ie; their residual is 0 upon giving up the dirt at GL exp.
A ground lease is never paid in full correct? If you enter a 99 year lease with the landowner and read about a company paying 150m over the course of 99 years, it’s essentially the sum of the lease term correct? How can you quote a price of total GL payment when the increase resets are derived at a future date?
If you acquire a ground lease, is the land purchased upfront? What are the general financing terms? Similar to a property being bought? Thanks
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