Situations Where Ground Leases Work

Property owners in trouble have some options outside of distressed sales. One option could be selling your asset to investors but staying on the land in a ground-lease structure.

Right now, hospitality and retail look like the sectors most amenable to these structures. 

“We’ve seen a mix of asset classes [interested in its 99-year ground leases],” says Dan Amer, Director at Miami-based Kawa Capital Management, which completed 20 ground lease transactions totaling nearly $1 billion to date. “Some of the highest increase in request volume for us this year is in hospitality and retail because those have just been the hardest hit sectors.”

Ground leases can also work for other sectors, like office. Earlier this year, Kawa completed a $273 million ground-lease transaction with Brandywine. “They owned a portfolio of suburban offices in a joint venture with a group called Sculptor Asset Management,” Amer says. “That’s our largest transaction in 2020. We are really asset class agnostic, but certainly, the most immediate needs from groups that approach us this year have been in hospitality and retail.”

The strategy also makes sense in most markets, according to Amer. “Ground lease transactions in New York City are more competitive in terms of the groups bidding to buy the land and the lower cost of capital associated with them,” Amer says. “Then we also see ground lease deals in the tertiary and suburban markets because those operators may be walled out of conventional financing.”

Amer says Kawa has served as an indirect source of construction financing for development deals in some instances.  

“We may come in as a land partner for developers in which case we’re buying the land from the third party that is selling it to the developer,” he says. “So we’re not buying it under a sale leaseback with the operator. We’re buying it from the preexisting landowner.”

Developers can also put a mortgage against the property to get a higher financing level versus only selling out the land. 

“The combined package of a landowner going to a bank to get a mortgage against the leasehold is a better financing solution than what these groups do today, which is a fee simple loan from a bank plus getting a second lien or a mezz loan against their property,” Amer says. “They’re going to pay a higher combined interest rate doing that versus doing the ground solution. Plus, the permanent capital is going to have a lot of weight with groups.”

The ground-lease structure has a lot of merit for operators that want to maximize their return on equity capital, according to Amer. It also works well for long-term holders, including people who want to pass the asset onto future generations.

“There certainly are a lot of family real estate operators that passed the portfolio on from one generation to the next generation as a source of cash flow for the family,” he says. “For those groups, the ground-lease structure is always going to have a lot of merit.”