Anyone know if there is a rule of thumb for determining how much ground rent should be on a retail property? I'm looking at an empty retail lot that the owner wants to keep with a ground lease on it but is willing to sell any retail improvements. I'm trying to get an idea of what the ground rent should be given that I know the approximate construction costs, retail rent, and operating costs. I know what I can afford to pay based on my DSCR, but curious if there's a guiding principle.
Is there a "% of revenue" rule of thumb, or, like, I don't know, a "% of NOI" rule of thumb?
The rule of thumb I've always looked at is 20% of NOI, per lender feedback. Obviously the lower the better, but that seems to be the lender threshold.
You can also just goal seek your ground rent as a stabilized annual operating expense, and see how high you can do to hit the lowest stabilized yield you can live with
We did a recent deal for a large retail center in Hawaii (quite a notable center too) and the ground lease had the operator paying 7% of the property's appraised fair market value (land + property), increasing 15% every 5 years for 99 years -- and every 30 years, the property was to be reappraised.
Let's just say the Ground Lessor got the better end of the deal, because nearly 50 % of the operator's OpEx was the ground rent.
This is typically how I've seen it done. You (an appraiser/independent broker) set a FMV of the land, then usually it's a % return on that. 7% seems high to me given the interest rate environment, I've seen anywhere from 4-6% depending on location, term, etc. Then usually as mentioned above it's fixed for quite a while and resets every x years with a fixed % increase and one or two FMV resets along the way. A lot of times there will be a max/min clause as well that dictates the increase/decrease at the reset intervals.
Exactly.
Avoid FMV resets at all costs. If its a must, make the uses for the FMV reset calculations as specific as possible to avoid disaster rent hike scenarios.
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