Has anyone ever dealt with a ground lease?

Question

I just received a $20M verbal offer from a well known commercial Realtor to lease one of my properties for 50 years. It's higher and longer than their last offer of $15M over 25 years. They are bringing their client into Austin to meet with me next week to present a formal offer.  It sounds like a lot of money, but somehow, I feel like I'm going to end up with the short end of the stick...I have to live to be almost 107 years old before I could do anything with the property...that's not very likely. My kids would be in their mid 80's by the end of the lease, so I guess SCORE for our grandkids!   Today the property is worth around $7M, so it seems like the ground lease should be higher to me.  It's a decent amount of income, so I'd like to not screw this deal up.  Any advise would sincerely be appreciated.

Joel Owens · Answer

So the ground lease stays the same through the whole term?

I would want rental escalations in there.

I have other clients in Austin with retail projects ongoing.

The 7,000,000 what kind of cap rate are you putting on that? Remember that the commercial broker represents the developer. I know some great commercial attorneys locally there.

The MAI appraiser is NOT going to know how to structure the lease and terms to protect your interest.

When we do deals this size it is a battle between each attorney back and forth redlining the agreements fighting over every word. Sometimes it takes weeks to hammer it down. This is a massive decision you should not take lightly.

I might know the broker or developer.

Christopher Telles · Answer

In a long term lease of this nature getting to value is only part of the equation. There are lease terms that can and will potentially impact the direct financial obligations/benefits of the land owner, and you wouldn't want an appraiser to provide guidance on these matters.

If professional guidance is needed the best resources would be an accountant to look at long term financial analysis, perhaps assisted in the negotiations by a good real estate attorney, but maybe because of a professional predilection its my opinion a good experienced commercial broker will deliver the most benefit to the landowner.

If going the broker route a good way to insure you have a quality experience broker representing you in the transaction is to seek out a broker that is a member of either SIOR or CCIM. You'll be able to find these brokers by searching for brokers having this designation on the respective website of each organization. Just google the acronyms and you'll see their websites pop up.

Curtis W. Sutherland · Answer

Awesome information, Tony!  Thank you!

Curtis W. Sutherland · Answer

Thank you sincerely, Joel.

Joel Owens · Answer

"I contacted a real estate attorney this evening for help with the lease when the time comes."

I can tell you this from personal experience to PLEASE do not use a general practice attorney. They WILL make mistakes due to lack of knowledge with this type of real estate that can cost you hundreds of thousands to even millions of dollars.

I have seen it firsthand by sellers we have dealt with while I was representing a buyer on commercial transactions.

The problem with general practice attorneys is they know just enough to be dangerous. You need a specialist attorney that only does commercial real estate and eat, lives, and breathes it day in and day out.

Just like I do nothing but commercial real estate my level of underwriting a specific niche of real estate is much deeper than a general practitioner.

We have a project in Austin with a client of mine that is close to the 30 million plus range.

An 8 cap will depend on various metrics with are the leases at or below current market? If the leases are overvalued then a cap drop can occur with correcting the leases when the options hit. I understand about the taxes. Texas is a no income tax state as you are well aware. To do that property taxes are really high around 3% to 4% whereas in Georgia we are around 1 to 1.25% of going values.

With NNN strip centers the owners are constantly fighting tax assessments to get lowered in Texas. Even thought tenants pay base rent and then CAM on top they cap the leases to a certain percentage. Having higher CAM and property taxes puts pressure on the tenants to not be able to absorb the rental increases so the landlords fight to keep  CAM costs as low as possible.

I have many clients in Texas. We like strips in Texas over multifamily because of the high taxes we can push onto the tenants for the most part.

The attorneys I mentioned before only do commercial real estate and are specialists like me. Make sure you get a specialist and vet the attorney you talk to for pedigree and track record.

Curtis W. Sutherland · Answer

Yep, Christopher, you are correct: Its a lot of money. I paid $350,000 for the property in 1991. Today its worth around $7,000,000. Six months ago they offered me a ground lease for 25-years at $25,000 a month and I passed. Today they offered 50-years at $20,000,000. It's kind of like winning a small lottery :)  thank you sincerely for your very sound suggestions!  I guess at this point I'll just wait to see their written offer, but before signing anything I think you're absolutely correct: pay the upfront cost to make a bundle on this deal.  Thsnk you again!

Christopher Telles · Answer

That's a big number if you mean $20M = $20,000,000 (aka $20MM).

Any ground lease should be based on value of the land. You haven't provided enough details to allow for a proper assessment of value. Is the lease paid monthly or annually? Is it a true NNN lease? What are the local comps for land leases in the area of your property. How does this lease look on a DCF basis?

If you don't know some of this information or you don't know how to analyze this data then you should probably hire some local professional advisors to assist you in looking at the financial ramifications of this lease to you.

Since this a long term lease with significant financial ramifications I would recommend you either consult with your accountant before negotiating the lease if you can assess the real estate information on your own and or hire a reputable local commercial broker to help you assess both the real estate data that will provide you with the information to make informed decisions when negotiating the lease.

If the CRE broker bringing you the offer will represent both sides of the transaction then you could, although I might not want to, require they provide you with the relevant real estate data you will need to properly assess this potential ground lease.

I would also recommend you look more towards getting professional advise and get comfortable paying for it up front rather than potentially costing yourself substantial money by trying to save in fees or commissions.

You've got some real money at stake. Just my 2 centavos!

Larry Flanagan · Answer

The cap rate for a long-term ground lease will be lower than any other property type out there.

Curtis W. Sutherland · Answer

Thank you, Christopher!

Curtis W. Sutherland · Answer

I'm not taking it lightly at all, Joel. It's an aweful lot of money. Stretched over 50 years it will likely go to at least three generations and maybe four. I woukd have thought an 8% cap rate would be reasonable. They did mention escillations every five years. I want to make sure its a true NNN lease...my taxes on this property increased 122% this year.  It would still be undervalued on the tax rolls if the went up another 500% next year. I contacted a real estate attorney this evening for help with the lease when the time comes.  Honestly the whole deal is making me a bit nervous. I realize any mistake I make on this could effect my family for generations.  I'm closing on a $300K house tomorrow...no stress at all with that one.  It seems to be more in my comfort zone :) Thank you sincerely for your response!

Has anyone ever dealt with a ground lease?

Most Popular Reply