Unsubordinated Ground Lease Financing

~ Geoffrey R Nauth

Ground leases are an important component of many commercial real estate deal structures, particularly in major CBD’s. Bifurcating a property’s land or fee from the leasehold improvements has become an important financing structure for commercial real estate investors to maximize leverage and increase equity returns for well-located multi-tenant, multi- family, single tenant and hospitality real estate.

Typically:

  • The leased fee component of a property is transferred to a new single purpose entity which enters into a 99 year ground lease with the SPE owner of the leasehold estate;
  • The ground lease is structured as an absolute net lease;
  • The leased fee is financed through a 30 year fixed rate senior secured note issue;
  • The senior secured note is funded by the private placement of ground lease pass- through trust certificates with institutional investors;
  • The leasehold estate is financed through a commercial bank loan, insurance company loan or a CMBS loan;
  • The aggregate financing proceeds for the bifurcated structure are in excess of the loan to value achieved under a traditional financing;
  • The typical allocation of the land component of a building relative to the property’s stabilized cap rate is from 35 to 45 percent yielding ground rent coverage of 3.5 to 5.0 times.

Program Advantages:

  • The higher program leverage results in a lower equity investment and a higher return on invested equity when compared to a traditional financing;
  • Under a refinance or recapitalization, the proceeds can be sufficient to repay existing debt and withdraw project equity while continuing to benefit from any future upside of the property;
  • In an acquisition scenario, the acquirer achieves higher “all-in” debt leverage utilizing a ground lease and separate leasehold financing having a lower blended cost of funds than a senior or mezzanine financing structure;
  • The fee component of a property is financed non-recourse at 100% loan-to-value at a fixed rate for a 30 year term;
  • The private placement is priced at a very low fixed interest rate based upon a “A” or “AA” senior secured private placement rating;
  • The leasehold interest can be financed at attractive rates through commercial banks, insurance companies and the CMBS markets;
  • Unlike a traditional senior debt with a mezzanine component with all debt typically expiring coterminously, a ground lease provides low cost permanent capital with no balloon risk;
  • Tax advantaged execution allows the ground lessee to depreciate 100% of the leasehold improvements and deduct 100% of the ground lease rent.

Contact Midwest Credit Lease LLC to see if your development would qualify for an unsubordinated ground lease financing.