Ground leases are fast-becoming a popular commercial real estate financing tool, offering sponsors a roster of benefits akin to perpetual loans. Mutual benefits to both parties involved in the ground lease are a main draw in the growing popularity of this emerging indirect form of financing, with the added appeal of potential depreciation and tax benefits for sponsors. To make the most of this tool, sponsors should look to partner with a capital solutions provider that has the flexibility to meet sponsors’ capital needs, and the experience to ensure certainty of execution.
Ground leases have traditionally been defined as long-term real estate arrangements whereby a fee (or land) owner agrees to lease land to a lessee (or leasehold owner) for the lessee to construct upon and benefit from.
The next generation of ground leases, “Ground Lease 2.0”, provides a much higher degree of flexibility for sponsors and developers, positioning them as counterparties and providing them capital with a long-term view of their value-add approach. Through this lens, as a long-term fixed income instrument secured by real estate, the ground lease provides qualities comparable to an interest-only loan, without a stated maturity, although a repurchase option may be structured.
“Ground leases have been very common in certain countries such as the U.K., but in the U.S. they are something that is relatively new. A number of players have entered this space in the past few years, but few are equipped to provide developers a financing strategy offering true flexibility with a future-forward and holistic view of the asset’s value,” said Jacques Holzmann, director of investments at Kawa Capital, a national capital solutions provider and independent asset manager. Founded in 2007, the firm now oversees $1.9 billion in assets under management and has executed more than $1 billion worth of transactions in ground leases since entering the space over six years ago.
What are the benefits of Ground-Lease 2.0?
For a developer, ground-lease 2.0’s bifurcation approach can be a conduit to recapitalize an asset or portfolio to create liquidity for another acquisition. It creates value by providing an indirect form of interest-only financing at a lower rate than most fee simple cap rates.
In exchange, the ground owner enjoys a predetermined, fixed stream of passive ground-rent income, similar to a triple-net lease. Ground-rent payments typically have fixed annual increases and remain senior within the capital structure.
Flexibility, Creativity and Experience are Key Ingredients for Ground-Lease Success
Kawa Capital’s ground lease platform is actively deploying capital seeking a diversified set of asset classes and geographies – it is accelerating this approach by expanding with new transactions in gateway cities as well as secondary and tertiary markets.
“We’re leading Ground Lease 2.0 with unmatched depth-of-experience and organizational creativity. Our team takes a unique, dynamic approach to each deal, development or income -producing. We tailor with an eye to the sponsor’s short and long -term business plans over the life of the asset,” said Michael Corridan, managing director of originations at Kawa Capital. Besides offices and residential towers, Kawa works closely with developers to structure ground lease agreements for hospitality and retail properties, including shopping centers as they reposition.
While most ground leases end up being in the 30-40% range of total capital stack needed for a property, Kawa’s flexibility enables it to structure deals beyond 70% loan-to-cost, Corridan explained.
Kawa’s ground lease platform is further elevated by its institutional capital and independent asset management experience, which reduces execution risks and frictional costs. This is important for any counterparty, but especially for the new wave of firms that are jumping into ground-lease transactions with increased verve. New entrants into the structure might assume notable execution risk if they enter without a partner that is both flexible and experienced.
The ability to navigate banks, life companies, agency lenders and the CMBS market is another key differentiator when selecting a ground-lease investment partner. In the past 10 years, the CMBS market has seen more and more loans secured through leased fees and lender protocols are becoming increasingly complicated to shield against risk, according to research by Morningstar. It’s critical to partner with an investor that stays on top of new CMBS requirement standards for financeable leasehold positions.