Looking at acquiring the leasehold interest of an office building. Regarding the valuation, do buyers generally (i) place a cap rate on the NOI, incorporating ground lease payments into opex, or (ii) place a cap rate on the NOI, excluding ground lease payments from opex, and then separately value the ground lease with a cap rate that might be a bit compressed from the leasehold uses (given the subordination benefit the ground lease gets over the leasehold uses), and reducing the fee simple value by the separately valued leased fee value?
Would appreciate input from the guys who have direct experience with this.
I've primarily used DCF analysis using our desired rate of return to determine the gross transaction proceeds available. Then back out your transaction costs and capital improvements to determine an acquisition price. I'm in a bit of a niche asset class that doesn't see too many leasehold transactions, and certainly not enough to determine an appropriate cap rate spread between fee simple vs 30-, 50-, 70-year remaining leasehold, but we'll take a look at the implied cap rate as a sanity check. Also, any unique terms of the lease agreement (e.g. leasing restrictions), which are likely more prevalent if you're leasing from the public sector, may influence whether a "market" cap rate is appropriate for the transaction.
I assume option "i" that you referenced is a common approach for leases with a substantial remaining term and in assets and markets that see enough leasehold transaction volume. Would be interested to hear if option "ii" is an approach regularly used by anybody here.
Definitely agree that funds take the same approach you mentioned to determine a leasehold purchase price, however, you still need to assume a sale price down the road, most likely using one of the methods above (yes, you can run a dcf for the next buyer, but that's just a pain).
I'm inclined to think most people go with option "i", but curious to see if anyone has used "ii" in the past, as it could have a meaningful impact in a low cap rate market with high land/ground lease values. For future comments, lets just assume its a long-term ground lease with 5-10% escalations every 3/5 years tied to an inflation index and no market resets.
My boss used method ii to value the leasehold interest of one of our properties when negotiating buying out the partner.
Interesting. Thanks for sharing.
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