Thread Repost. Retail Ground Lease Rent. How To Determine?
Hey Guys,
I wanted to repost this thread as I have not gotten a single response since I posted last week. I am new to this community so I don't know how active members are here but I am surprised there wasn't a single reply from anyone. Is there really no one out there that knows the answer to this?
Your method of asking the question makes answering it difficult, IMO. Here is your original post:
First of all, ground leases can be based off of a % of NOI, but they also can not be. So a national tenant self performing could also have such a deal, or they may not. It is more likely than not that a national tenant will not agree to report sales, much less pay their lease as a % of those sales, but I’m sure someone on this forum has signed a national tenant to percentage rent so as always, “it depends.”
It all comes down to the deal itself, which is subject to negotiation between land owner and whomever leases the land, so it can vary wildly from deal to deal.
If it's not based off of a % of NOI then what would it be based off of? What is the system of pricing used to negotiate or determine rent?
The value of the land itself.
People do 99 year ground leases. They’re not calculating out 99 years of retail sales.
Based on the most helpful WSO content, here are some insights on determining ground lease rent for retail properties:
Avoid FMV Resets:
Cap Rate Considerations:
Ground Lease Payment to NOI Ratio:
Rent Increase Structure:
Tenant Perspective:
Market and Occupancy Costs:
These points should help you get a better understanding of how to determine ground lease rent for retail properties. If you need more detailed advice, consider reaching out to professionals or exploring more threads on WSO.
Sources: Calculating Ground Lease: Rule of Thumb?, Retail IS/Acquisitions: What should you know?, Types of RE Leases - A Primer, Modeling ground lease payments into a pro forma, HOW DO YOU DETERMINE YOUR UNIT MIX?
If I were you, I'd model this as follows.
The tenant should pay a % of their revenue or some minimum rent. In your model, you can input the minimum rent and an estimate of their revenue with some growth rate assumption. A MAX formula would make it fairly easy to model which one of those would be in effect in a given year given the revenue assumption.
I think it would be difficult for you to come up with a revenue assumption on your own. You'd need some guidance from a potential tenant/broker to make sure you're in the right ballpark.
This is an interesting suggestion but as you mentioned in your last sentence where would I get the numbers from? It is very unlikely that a tenant will open their financials like that.
That's the tricky part.
If a tenant is suggesting that they pay a % of their revenue, then they need to provide an estimate. It's unreasonable for you to come up with a reasonable estimate as to how much virtually any retailer makes at an average location, let alone a specific location in a specific market. Asking for a figure shouldn't be an issue if its something they're proposing. If they're unwilling to provide that but still proposing that structure, its a bit odd.
A few methods:
1. You figure out the market value of the land attributable to the ground lease and price based on your required return on the land value - my rule of thumb is typically start negotiations at 10%, floor is your cost of capital. This is my preferred method.
2. As already mentioned here, you base it off a % of estimated gross revenue when the lease is signed (this is obviously easier if you have depth in retail and know the tenants as you can look at their other comparable locations).
3. On rare occasions a tenant might just agree to do a % of sales outright on an ongoing basis. I've only ever seen this once personally.
Thank you for your very detailed reply CREnadian.
I have heard others mention the method of using a fixed rate of return on land value as a way of determining ground rent. Where I struggle with this method is with what you wrote above when you said, "figure out the market value of the land." The market value of the land would have to be very high to make this pencil out and I don't see how that's possible without improvements and leases in place. When I have looked at ground leases for sale on Crexi many of them are being listed around 2.8 million and up which suggests the ground is worth that much. I do not understand how they could value those properties at that kind of price, especially the smaller ones before the property has been repositioned. If you could shed some light on this it would be very much appreciated as the high valuation does not follow logic for me.
I'm not sure I follow your question - when you say ground leases for sale on Crexi, do you mean you're seeing land for sale that already has a ground lease in place with an operating tenant on it?
Do you see a lot of 15-20 year ground leases for a newly developed building? The developer has a TON of risk here it seems like as you have an asset that's for sure worth $0 in 20 years and 20 years of cash flow maybe you break even and on an NPV basis you're negative.
Is there something I'm missing here?
I'm not sure I follow? A ground lease is just that, you're leasing the ground, not the building thereon. If there's already a building then it's just a NNN lease.
A ground lease would be a tenant leasing the land and building their own building thereon. It's generally low risk to the developer and if the tenant defaults you just get their building for free.
Based on you're comments it sounds like this isn't really a ground lease, it's really just a NNN lease for an outparcel on a building that hasn't been built yet.
No, it's not a leasehold estate interest, it's a leased fee interest.
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