Ground Leases Are Becoming A Popular Finance Tool, And Big Players Are Jumping Into The Space
Ground leases have been a part of U.S. real estate for centuries, but the profile of the typical user is changing.
Owners that held pieces of property for generations often wanted to preserve their families’ assets, using ground leases to keep control of the land while turning over day-to-day operations to tenants that signed lease deals of up to 99 years.
Now developers are discovering ground leases are useful tools when assembling capital stacks. That is helping new hotels, retail and apartments, among other projects, sprout up across the country.
“Pre-Great Recession, the debt market was very frothy,” said Terri Adler, a partner in the New York-based real estate law firm Duval & Stachenfeld, adding developers could finance even ambitious commercial real estate projects with a lot of borrowing, and on easy terms. “Those days are very much long gone."
According to Adler, borrower costs are increasing, leading to a hunt for additional sources of capital.
“And capital is expensive,” she said. “Any time you have distress in the marketplace, you have people looking for ways to fill in holes.”
Ground leases have been especially popular in regions where a handful of families held title to the same land for hundreds of years, according to Adler, especially in Hawaii and New York City, where famous landmarks such as the Chrysler Building are covered by long-term ground leases.
But across the nation, developers that want to create new multifamily, hospitality, retail and other structures are increasingly seeking out investors to buy their land and lease it back to them. They can then use proceeds from the sale as one more layer in a capital stack, along with a mortgage, mezzanine debt, loans and equity.
“Our client will come in, buy the dirt and lease it back to the developer,” Adler said. “It’s just another layer of debt that allows a sponsor to put a deal together.”
“This financing structure offers owners/operators predictable, long-term financing for any real estate asset class and project type,” said Axiom Capital Advisors principal Jose Sasson-Lerner.
Sasson-Lerner in February helped broker a deal for Kawa, an Aventura, Florida-based investment manager that acquired the ground lease of a 434-room hotel on more than 16 acres near Orlando.
How widespread this strategy has become is difficult to know with any precision, Adler said. No one is tabulating just how many ground leases are signed each year or how owners and developers are using such deals.
“It’s a little hard to track,” she said.
St. Louis-based Twain Financial Partners started using ground leases to help developers in early 2020, just before the coronavirus hit, according to Business Development Officer Erik Lintvedt.
“Normally, our first point of contact is a developer that comes to us and is asking for a solution,” he said. “We’ve done a lot of new construction projects and ones that involve significant rehab of existing buildings.”
The firm completes such deals nationwide, but much of its focus is on the Midwest, he added. This year, Twain financed a $10.5M ground lease in Nashville, Tennessee, that developer RevPAR Development is using to help construct a 129-room select-service hotel. Construction began in June, and RevPAR President and CEO Pete Patel said he expects to complete the project by mid-2024.
Linvedt said developers that sell their land sites and then sign ground lease agreements can significantly cut down the amount of equity they need to raise.
“That’s always the most expensive capital,” he said.
“If you’re building a $10M project, Twain will give you 30% of that value for the dirt,” Linvedt added.
In other words, instead of financing the project with a $7M loan and $3M in equity, a developer would typically be able to clinch the deal with a combined $3M ground lease, perhaps a $5M loan and about $2M in equity.
Adler said the strategy of using ground lease deals as financing vehicles is becoming more popular for two reasons: Rising construction costs are making it more challenging to break ground, and big players in the world of real estate finance are jumping into the space.
Regis Group and Ares Management Corp. in November 2020 formed a joint venture called Haven Capital with the aim of capitalizing more than $1B of ground leases across most real estate sectors in the nation’s top 50 markets.
In October, Haven Capital provided a $14M ground lease for The Young Cos., a New Rochelle, New York-based developer, that will use it, along with a separate construction loan, to finance the development of a 75-unit apartment development, as well as more than 7K SF of commercial space, at 600 North Ave. in New Rochelle.
Kawa officials said in February they had completed 23 ground lease transactions valued at nearly $1B, including ones for retail properties, hotels, office and land used to produce solar energy.
Linvedt said he has noticed more players getting into such ground leases and expects others to join in as they get comfortable with the technique.
“There is always some kind of learning curve, and the more groups out there doing this, the more competitive it’s going to get,” he said.