Ground leases are long-term lease agreements between a land owner and an investor/developer who wishes to construct a building on the property. These leases can benefit both parties but come with risks.
This model allows you to calculate a ground lease investment’s unlevered (before debt) returns. Enter your acquisition cost, and the model will provide the corresponding returns.
No Required Down Payment
When you invest in a ground lease, you are leasing land and not buying it. This reduces upfront costs and frees up capital for other investments.
When structured correctly, a ground lease can be a triple-net (NNN) property where you pay monthly land rent, and the tenant pays for property taxes, insurance, and maintenance expenses. This structure also means no development costs and a higher value when the lease expires.
Investors should be careful to ensure that the lease specifies that any improvements constructed on the land revert to the landlord. This is critical to protect the investment. Moreover, the lease terms should stipulate that the lender retains insurance proceeds from casualty and condemnation.
No Development Costs
When investing in a ground lease, you will only pay rent for the land. Any improvements built on the property will be owned by the company or individual that owns the land.
This means you won’t have to invest in the building, meaning you can save on development costs. This is a significant benefit when looking for a ground lease investment.
While a ground lease does require you to pay income taxes on the rent, it avoids capital gains taxes that would otherwise ensue when you sell outright. This is another reason why ground leases are attractive to investors. In addition, you can typically find a ground lease with escalation provisions.
Lower Tax Burden
Ground leases do not require a full down payment, which can benefit investors who want to take advantage of the real estate market but may need more financial means to purchase a property outright. Moreover, the rent from this type of lease is often tax-deductible.
Investing in ground leases can also mean lower taxes for the tenants, as they’ll be paying taxes on their rent at income rates rather than capital gains rates. Depending on the location of the property, this can result in higher tax implications for landlords, who’ll still make money when they sell but will lose their capital gain status.
To determine a proper valuation of a ground lease investment, you’ll need to calculate the discounted present value of all the future cash flows (ground lease payments and reversion value at the end of the lease) using a discount rate. Choosing the proper discount rate is crucial to ensure your investments perform well.
Increased Value of Land
If you invest in a ground lease, you may have access to plots of land that would otherwise be difficult or impossible to find. This often leads to more substantial returns as tenants pay higher rent to occupy property in a desirable location. Depending on the terms of the agreement, you may also be able to depreciate the buildings and improvements on the property, which could help to reduce your tax burden.
For significant investment funds that are looking to add long-term real estate investments to their portfolios, a ground lease can provide significant financial benefits over a long period. It also offers greater flexibility than an outright fee simple purchase. In addition, a subordinated ground lease can put you at a lower priority than the landlord’s lenders in case of default.
Flexibility
A ground lease gives the investor/developer access to prime real estate without purchasing it. However, they are contractually obligated to a long-term stream of lease payments that can last up to 99 years.
Landowners also benefit from ground lease investments by gaining access to a steady income stream that increases with CPI. This gives them a way to preserve capital and free up other assets that can be used for growth.
Leveraging a ground lease investment with debt (using the “Leveraged Ground Lease Returns” model) allows investors to receive more returns than they would otherwise achieve with an outright purchase of property. This is particularly helpful when lenders are being cautious with lending.
