Has anyone here used a ground lease to improve returns on an SFR acquisition?

[Gordon Wolf]

I work at Cedar, a ground lease company, so disclosing that upfront. But I wanted to share something we see a lot and get the community's take.

A ground lease separates the land from the building at closing. Cedar buys the land and the investor acquires only the improvements. Because you are not financing the land, the loan is smaller, monthly debt service drops, and cash-on-cash and IRR both improve on the same deal.

Here is a quick example on a $500K SFR at a 7% cap rate with a 6.75% mortgage:

Traditional: $125K equity, $29K annual mortgage, $5,813 cash flow, 4.65% CoC.

With Cedar: Same $125K equity, $15K annual mortgage, $10K ground rent, $9,968 cash flow, 7.97% CoC.

The other thing worth knowing: since you own only the improvements, 100% of your invested capital is depreciable. No land allocation eating into your depreciation basis.

Has anyone structured a deal this way or looked into it? Curious what the community thinks and whether the ground rent is a concern for people underwriting these.

[Greg Scott]

That is a creative idea.  Here are the reasons I would be concerned about doing that.  Please disagree if you think I'm wrong.

First, you've created a unique animal. Since you brought up cap rates on a SFR, I presume that means I'm forced to use a DSCR loan and can no longer get agency financing. I'm also assuming that it now appraises more like a commercial property and sales comps are no longer relevant.

I always start with the end in mind.  How would I sell this thing?  Presumably I've limited my purchasers to mostly investors. In other words, I've cut out a huge portion of the buyers pool.  This means I would get a lower price at eventual sale.

Now, this also introduces a layer of complexity.  How are property taxes calculated?  Does the ground lease have an escalation clause?  If there is a cloud on title, how is that handled?  How are disagreements handled?  What happens at the end of the ground lease.

Even if it benefit me short term, I don't think I would do this.