Understanding Ground Leases in regards to property investment sales
I am a bit confused on how ground leased properties work in the long run...

Suppose a developer ground leases land (99 year ground lease) and builds an apartment building. When the construction loan comes due, they decide to sell the building rather than refinance.

* 1) Does the buyer treat the ground lease rent like any other OPEX line item?
* 2) What does the buyer, buy? They cannot get a deed/title for the property, since it is not owned by the developer? 
* 3) Going off of my last question, is financing more expensive since the buyer is not technically buying the property?
* 4) Let’s say the buyer buys, holds 10 years, sells, next buyer holds for 10 years, so on and so forth. What happens when there is 10-15 years left on the ground lease? Who would want to buy that, since the building will revert back to the landowner at the end of the ground lease?

Thanks!

[{"id": "d9ibc6b", "text": "It depends on what your ground lease stipulates. In my state a ground lease is like any other lease, except you're leasing just the land and you're responsible financially for building, maintenance, insurance, property taxes etc. Sometimes the building goes to the landowner at the end of the lease and sometimes there's a buy back option, it just depends on what was negotiated and what the lease contract says. But I should say I'm not very experienced with 99 year leases. The longest one I dealt with was 40 years. ", "replies": [{"id": "d9id8a8", "text": "I udnerstand that...my question is more geared towards selling a building that is on a ground lease. You are not selling title of the property, since the title belongs to the land owner. So you are essentially selling the lease. Do conventional banks, CMBS, etc. lend money for lease purchases? Is it at a higher interest rate?", "replies": [{"id": "d9ig8x7", "text": "Sorry my other comment was supposed to be a reply to this one.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "d9ig631", "text": "This could be an example of a sub lease, depending on the local/state rules. If someone enters into a ground lease, typically it means the land and any improvements reverts back to the original owner of the land at the end or in the event of defaulting on a payment. \n\nBut if the original lessee builds a building and then sells it (assuming thats allowed in the original lease), then the person who buys the building would probably pay a pro rata share of the original lessees rent payment. This is just a guess and varies from state to state.", "replies": [{"id": "d9ijfbt", "text": "&gt; But if the original lessee builds a building and then sells it\n\nThis is where I am confused. How can you sell title to a building, without title to the land? there is no title or deed to the building, since the parcel is owned by the land owner, right? There is no Assessment parcel number associated with the building. How can a lender lend money without a title/title insurance? My guess would be much higher cost of financing, is that correct to assume?", "replies": [], "depth": 2}], "depth": 1}, {"id": "d9ig76f", "text": "Depends on the lender. Generally, ground leases are very unattractive from the lenders point of view because it is considered additional (and higher priority) structural financing and puts the lender's security at risk. There will be significant structure around cure rights in the event of the borrowers default on the ground lease (and mortgage). Depending on how the lease is structured, it could be unfinanceable (too short of term remaining, rent as a % of NOI is too high, etc) which would significantly impact the value of the leasehold interest.", "replies": [{"id": "d9ik0hn", "text": "Thanks for the response. You mentioned a few terms:\n\n&gt; There will be significant structure around **cure rights** in the event of the borrowers default on the ground lease\n\nWhat are cure rights? \n\nAlso, is the ground lease higher priority of payment than the mortgage, or the other way around?\n\n&gt; Depending on how the lease is structured, it could be unfinanceable (**too short of term remaining**\n\nThis brings up something I cannot wrap my head around.  If Bob buys a building on a ground lease with 18 years left on the ground lease, and plans to hold for 10 years, then Bob goes to sell it 10 years later but nobody wants to buy it because they cannot finance it (because there are only - say - 8 years left on ground lease), then Bob would not buy the building in the first place. \n\nSo if Bob, or anyone else, would not buy the building with 18 years left on it, then NO 10 year holders would buy the building when there are 28 years left on it, because they know that nobody will buy it at 18 years left, because THOSE buyers would not be able to sell with 8 years of term left. This can go back to infinity, right?\n\n", "replies": [{"id": "d9ivk8d", "text": "Like other leases, GLs have options to extend.  In the absence of an option, the buyer would be screwed and would eventually forfeit the improvements.  That doesn't happen too often though as the options are typically there.  GL lease payments are senior to mortgage payments which makes 1st TDs essentially 2nd TDs which does have an effect on financing.  However, a buyer of improvements on a GL has the ability to use the entire purchase price as the basis for depreciation where a fee simple buyer can only depreciate the improvements portion of the deal so there are advantages for these buyers.  This is why a fast food restaurant pad is trading at 4% cap levels.  The credit is usually good which helps the financing piece, and the depreciation piece provides a great income tax shield for other income.\n\nMany GLs are on city owned land (here in San Diego there are many major developments on the waterfront that are on city GLs) and I expect this is true elsewhere.  Cities want that revenue to continue and are glad to continue these leases in most cases.  ", "replies": [{"id": "d9iy1hi", "text": "Thanks for the explanation. What does TD stand for?\n\n&gt; However, a buyer of improvements on a GL has the ability to use the **entire purchase price** as the basis for depreciation where a fee simple buyer can only depreciate the **improvements portion** of the deal so there are advantages for these buyers.\n\nCould you possible elaborate on this a bit more? If a developer enters a ground lease, builds a building, and sells it - you are saying the buyer can use that purchase price as their depreciation basis. However, if there was no ground lease, and the developer built a buiolding on his own land and sold the land and building, would'nt the building itself be considered the \"improvement\", thus the basis for depreciation (which would be a similar amount as the first scenario?)\n\n&gt; his is why a fast food restaurant pad is trading at 4% cap levels. The credit is usually good which helps the financing piece, and the depreciation piece provides a great income tax shield for other income.\n\nI tend to view pad-site restaurant ground leases as single tenant net lease deals of their own class. In an example of a spec apartment building built on a ground lease, would financing be more favorable due to the depreciation bit you discussed? Are there any terms/processes of financing that differ due to you buying a leasehold interest over a fee simple interest?", "replies": [{"id": "d9j1dmo", "text": "TD = Trust Deed.  \n\nWRT to depreciation if you buy a $10M shopping center and the land value is $4M, then you can only depreciate the remaining $6m over 39 years.  If you bought a $10M shopping center on a GL, you can depreciation the entire $10M and also count the GL payments as OPEX.  I'm not saying this is a superior investment strategy for everyone, but there are people that this is good for.\n\nI don't see a lot of MF on GLs here in my area, but perhaps that's a thing elsewhere.  Clearly the risk in these GL deals is forfeiting the improvements due to an expiring lease or exorbitant GL payments.  This risk has to be accounted for one way or the other.  There is no question that financing GL deals is more challenging due to this factor, but it happens every day.  \n\nOne of the factors behind doing a GL as the property owner is a recognition that the dirt you own is really freaking valuable and is likely to be for a very long time.  So they develop it, flip the improvements, pocket some $, and receive a long term dividend.  Like anybody else, they want to keep a paying entity on there, and so setting traps and blowing people out of their improvements isn't something that happens a lot.  But it does happen, and you just need to cover all the bases going in to be sure that it can't happen to you.", "replies": [{"id": "d9jv0mi", "text": "The depreciation bit makes more sense now, thank you. Sorry to keep hounding questions at you, I guess my only misunderstanding is the whole concept with the title/deeds:\n\n&gt; GL lease payments are senior to mortgage payments which makes 1st TDs essentially 2nd TDs which does have an effect on financing.\n\n\nIn a conventional ownership structure, a developer buys land and builds a an apartment building. He takes it to the market and finds a buyer. He transfers his deed to the buyer, and the buyer uses a title company to create a deed of trust (TD) with a bank for financing. But in the case of a ground lease, if a developer leases land from an owner, and builds a multifamily building, then decides to sell it, what \"title\" does the developer have to offer? The buyer will need some sort of deed to bring to the closing table in order to create a deed of trust with the bank, right?\n\n ", "replies": [{"id": "d9k1wjf", "text": "Rather than Fee Simple I believe it would be a Leasehold interest. ", "replies": [], "depth": 7}], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}, {"id": "d9k2376", "text": "Cure rights are the rights of each party in a contract to \"fix\" a breach in their agreement. Example- mortgage payment is due on the 1st, but if you miss the deadline you might have a period to cure the default before the lender can foreclose.\n\nTypically, ground leases are not subordinated to the mortgage because the land owner does not want to lose the land and it's not their loan. In this case, if the borrower defaults on the loan, the lender forecloses on the leasehold and becomes the new ground leasee. The ground lease takes priority, and the lender typically makes it an event of default on the loan if the borrower defaults on its ground lease, and the lender will want cure rights on the ground lease to protect its collateral for the loan (the leasehold).\n\nYour last question is a good one. Typically, the lease will have extension options so that's one way to build in some buffer. It's not so much that no buyer will touch a short ground lease, the problem is that your financing options are limited so this will impact demand for the leasehold. All things being equal, a leasehold interest is worth less than fee simple interest (out right ownership of the land). But, at the right price, a series of future cash flows, whether it's for 5 years or whatever, can be worth something. \n\nAt the end of the day, if you have a 99 year ground lease that is coming up on expiration and the land owner wants to continue to monetize its holding without the risk of investing in an expensive building, the parties will likely extend or make a new long-term lease which gets rid of the timing issue. This is very common in NYC where these rich families have owned the land forever and there are billion dollar office buildings on top of them. ", "replies": [{"id": "d9k8lna", "text": "Wow, thank you for the thorough explanation. This makes a lot of sense, and others had also mentioned that the extension options are critical to financing.", "replies": [], "depth": 4}], "depth": 3}, {"id": "d9k23aa", "text": "Cure rights are the rights of each party in a contract to \"fix\" a breach in their agreement. Example- mortgage payment is due on the 1st, but if you miss the deadline you might have a period to cure the default before the lender can foreclose.\n\nTypically, ground leases are not subordinated to the mortgage because the land owner does not want to lose the land and it's not their loan. In this case, if the borrower defaults on the loan, the lender forecloses on the leasehold and becomes the new ground leasee. The ground lease takes priority, and the lender typically makes it an event of default on the loan if the borrower defaults on its ground lease, and the lender will want cure rights on the ground lease to protect its collateral for the loan (the leasehold).\n\nYour last question is a good one. Typically, the lease will have extension options so that's one way to build in some buffer. It's not so much that no buyer will touch a short ground lease, the problem is that your financing options are limited so this will impact demand for the leasehold. All things being equal, a leasehold interest is worth less than fee simple interest (out right ownership of the land). But, at the right price, a series of future cash flows, whether it's for 5 years or whatever, can be worth something. \n\nAt the end of the day, if you have a 99 year ground lease that is coming up on expiration and the land owner wants to continue to monetize its holding without the risk of investing in an expensive building, the parties will likely extend or make a new long-term lease which gets rid of the timing issue. This is very common in NYC where these rich families have owned the land forever and there are billion dollar office buildings on top of them. ", "replies": [], "depth": 3}, {"id": "d9kl0qa", "text": "&gt; So if Bob, or anyone else, would not buy the building with 18 years left on it, then NO 10 year holders would buy the building when there are 28 years left on it, because they know that nobody will buy it at 18 years left, because THOSE buyers would not be able to sell with 8 years of term left. This can go back to infinity, right?\n\nno.  You are making a mistake of thinking there either is value or there isn't.  The truth is the value changes with the term of the lease and renewal opportunities.  Someone will always buy it at a certain price.  Hell if it expires tomorrow someone will pay me to go salvage shit out of it or to have a killer paint ball tourny.  \n\nSo if there is 32 years left and I am pricing for a 10 year old, the value after 10 years (22 years left) is what I am looking at for my terminal value.  This is not 0.  Someone buying with 22 years left, who is doing the same, will look at a 12 year value, and going on until the 2 year value.  ", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "d9ijdnf", "text": "check out 500-512 Seventh Ave in NYC for an ongoing case study.  \n\nthe property can be split up into the fee simple estate (the land) and the leasehold estate (the improvements). the owner of either piece can then opt to leverage their investment. From the land side, it's pretty straight forward assuming you're comfortable with the improvements, owner, operator, etc.  \n\nFor a leasehold mortgage, the ground rent due is treated like any other operating expense. 500-512 Seventh is why a lender will have their own internal policy on how to handle the length of the ground lease. Typically you don't see a $100M loan on a property when the ground lease expires so close to the maturity of the leasehold loan. It's a pretty significant roadblock to the exit.  \n\nDepending on the owner of the land, the lender may take a stab at pricing in the risk of the borrower's ability to extend or renew the terms of the lease on their leasehold loan, which is what I assume happened here.", "replies": [{"id": "d9iksid", "text": "Thanks, I will check out that property.\n\n&gt; Typically you don't see a $100M loan on a property when the ground lease expires so close to the maturity of the leasehold loan. **It's a pretty significant roadblock to the exit**.\n\nI posed this question to another comment as well, but this concept seems to be a retroactive cycle. If I were to buy a ground leased building with 18 years of term left, for a 10 year pro forma hold, then I will be assuming an exit with 8 years left of term on the ground lease. We can assume nobody would buy that, because no bank would finance a building that reverty back to the land owner in 8 years.\n\nSo If I know that nobody is going to buy the building at 8 year term left and that there is no exit strategy, then I will decide not to buy the building in the first place. Other buyers would presumably think the same. So since myself, and nobody else, wants to buy the building at 18 years left of term, then nobody buying on a 10 year hold will want to buy it at 28 years left of term (because *they* will not have an exit strategy either). This can theoretically continue back to year 1 of the ground lease. Am I missing something here?", "replies": [{"id": "d9ikzbz", "text": "go in with a plan to renew or restructure the lease, or negotiate the lease while you're working on the acquisition.  \n\nIf you're playing with someone else's capital, it's all about that annual return...  I don't know if that's really the thinking, but maybe. ", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "d9rm792", "text": "Sorry for my lackluster comment, just trying to help guide you towards people with experience and answers.\n\nI would contact a broker from Honolulu, Hawaii. The land is mostly owned by 3-5 Hawaiian families and practically every high rise commercial building there is a ground lease. They are experts in regards to your question.", "replies": [], "depth": 1}]