Working on a potential acquisition and wanted to get some insight from the board.
Opportunity to acquire land which is leased to a developer who already developed a Class A office property. 75 years remaining on the ground lease, which resets payment every 5 years. 10% times appraised value of land, with the stipulation that the new lease payment can never go less than the previous. So if the market goes backwards and land value decreases in 5 years, owner still gets benefit of highest value.
The land value will be reset at the end of this year for a new lease payment from 2016-2020.
The purchase of the land can be financed with debt, the existing office building already has a conduit loan in place that matures in 2 years.
With respect to subordination, is this something that is outlined specifically in the ground lease agreement? In other words, if the office building drops down in occupancy, and there isn't enough cash flow to pay the conduit loan on the improvements and pay the ground lease payment, does the conduit lender automatically get priority? If the building went totally dark, and the conduit lender foreclosed, would the land owner have the right to demand the ground lease payment from the lender since they took title back? What cure rights would the land owner have, or would they be out of luck until the occupancy went back up and the cash flow was available to pay them?
Yes. Subordination of the ground lease will always be spelled out in the ground lease as well as in the loan documents.
If a ground lease is subordinated, if the borrower defaults on the mortgage, and the bank forecloses, the ground lessor loses the land alongside the groundlesee losing the improvements.
If a ground lease unnsubordinated, then the lender has to pick up the payments of the ground lease or risk losing the building. Generally in this case, the lender will make the borrower escrow for the ground lease payments, so when they do foreclose, there is hopefully some money in the bank to help with the payments.
Thanks MrCheese. My understanding is that the majority of ground leases are subordinate variety, is that correct?
So then, if I owned the land portion without any mortgage on that portion, and the owner of the building (who had a CMBS loan against the improvements) lost all his tenants, couldn't pay me my ground lease rent nor the CMBS debt payments, then the CMBS lender's cure rights would be taking over possession of the building AND taking ownership of my interest in the land as well?
A lot are subordinate (and for obvious reasons that is the preferred method for lenders), but there are a fair amount (especially in NYC and education/institution owned land) that aren't.
Yes. As the ground lessor, you subordinated your right to the land to the CMBS lender. In theory, you should have gotten paid a higher than normal lease rate on the ground lease to compensate for the risk.
Usually though, as a lender, you are going to have reserved for these holes in a rent roll so they shouldn't happen unless a tenant blows out unexpectedly.
Interesting. Most leasehold deals that I have underwritten have shown the ground lease payment equal to 4-5% of the "value" of the land. In many cases, the ground lease payments are based on a schedule, flat for 5 years, then a fixed % increase, flat for five, and so on.
In some cases, the land value is reappraised every so many years, and a fixed % of the new appraisal is used as the new ground rent.
That being said, if I was buying a ground lease, and if subordination meant that I could potentially lose my land to the lender on the improvements, a 4-5% yield on my money for the land wouldn't be worth the risk. I am still having trouble theoretically understanding how a lender on the improvements could lay claim to the land portion. I understand, in cases where the property's cash flow isn't sufficient to pay both the lender and the ground lessor, the lender takes priority, but to actually take ownership of the land?? Is that really the way it works?
I have never seen a ground lease that is subordinate to any leasehold mortgage where two unrelated parties own the leasehold and fee but that's probably because they don't show up that often in the market...because that's not very marketable.
I HAVE seen ground lessors sign a subordination agreement with the ground lessee mortgagee but that only lasts the life of that particular mortgage and involved a restructure of the ground lease so the ground lessor was paid for the subordination risk.
I've actually seen subordinated ground leases a fair amount where the parties aren't related. Usually it is because the ground lease is really old and the developer of the leasehold was able to secure subordination from someone who really didn't know any better. Other times it is because the land is otherwise unusable (the ground lease is on 20k SF of a city block and that is the only portion of the block that the borrower doesn't own. The ground is under the parking structure or is landlocked in a weird place.)
At the end of the day, it all comes down to $ and if you think there is risk in the asset.
I know of a deal where the ground lease (in Florida) gives the ground lessor a cut of NCF as a kicker. The building was a build to suit for a credit tenant as a world headquarters (initial plans were for a spec multi tenant tower, so nobody modeled it as single tenant originally). Initial lease was 20 years with a 20 year extension. They are probably 5 years from the end of the initial term and the tenant has already renewed. The ground lessor basically turned their ground lease into an equity position, but isn't a related party to the mortgage borrower.
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