Reduced equity requirements
By selling off part of your property (the land) you are left with a smaller asset to finance and therefore need less equity to control the deal. Additionally, the mortgage on the property will be smaller thus requiring less capital from the loan guarantor.
Improved yields
The leasehold component of the property is valued at a higher cap rate than the “fee simple” asset. This allows the equity in the leasehold to increase their in-place yield, potentially increasing cash-on-cash returns and total transaction IRR.
Tax benefits
Ownership of a leasehold provides two potential tax benefits:
- Depreciation: the entire asset is depreciable. Under the traditional ownership structure, the land component of the real estate never depreciates. When you only own the leasehold, the depreciation expense, relative to the entire asset, increases and reduces taxable income.
- The ground rent is a taxable expense. This further reduces any taxable income during your ownership period.
This sounds too good to be true
If ground lease financing is so beneficial, why isn’t everybody doing this?
This will not work for every property. The best candidates are:
- Properties at-or-near stabilization: this type of financing is very sensitive to in-place cash flow
- Core or core-plus: locations that can demonstrate continued demand and with barriers to entry
- Major MSAs: properties in primary and secondary markets
Additionally, we recognize that this financing has a negative stigma due to a few very poorly structured transactions done in the past. For example, the implosion of values at New York’s Chrysler Building generated a lot of negative press coverage. Most, if not all, of these failures were due to poorly designed ground leases that imposed unrealistic rent escalations or utilized “fair market value” type rent resets. We will never use such resets in our leases and are committed to showing you a fair and balanced ground lease proposal.
Who is taking advantage of this financing option? Some of the largest real estate owners in the country! For example, L&L, RFR, Dilweg, and Dinerstein Companies.