Overcoming the Complications of a Ground Lease

Ground-up leases are typically complicated—but they don’t have to be a deal breaker. Boston Properties and Canadian Pension Plan’s acquisition of the 47-acre Santa Monica Business Park included a ground lease with an option to buy the land in 10 years. The ground lease did add a layer of complexity to the deal—which was the largest office transaction in Los Angeles in the second quarter—but the challenges were not burdensome enough to affect the outcome of the deal.

“A ground lease introduces an additional set of contractual rights and obligations to diligence and satisfy, both to consummate the transaction itself and thereafter following acquisition of the Leasehold interest,” Roth, a partner at the firm that represented the joint venture in the acquisition of the property, tells GlobeSt.com. “Any ground lease will address the assignment or other transfer of the ground tenant’s position, and the buyer and seller parties both need to make sure the safe harbor or other conditions to an effective transfer are satisfied.  In this case, where a combination of ground leasehold interests, improvements and separate fee interests were part of the transaction, the complexity added was not insignificant.”

Santa Monica Business Park is 47 acres, which sounds like it would add more significant complexities to the deal; however, Roth says that the size does not have a bearing on the potential difficulties of a ground lease. “The size of the ground lease parcel does not, in and of itself, add to the complexity inherent in a transaction with a ground lease,” he explains. “However, the size does make for a broader set of real estate diligence issues to be reviewed and qualified.”

This particular purchase included an option to buy the land in 10 years, which had previously been built into the ground lease. The provision actually incentivized—in part—the buyer’s interest in the deal. “The timing of such existing right certainly had an impact on the seller’s decision of when to go to market with the deal, as well as an impact on potential buyer’s investment strategies and willingness to invest in the site,” explains Roth.

In Los Angeles, deals with ground leases attached are not common, especially on large transactions of this size, according to Roth. It is important that buyers considering a purchase with a ground lease attached fully review the details of the lease. “A full and detailed review and analysis of all of the provisions of the ground lease, correlated with their impacts on the NOI to be derived from the subject target site, need to be a gating item,” says Roth. “The same is fundamental to any underwriting assumptions that ultimately support the economics of the greater transaction.”