Take Care With Ground Leases Structures

More institutions are growing comfortable with the ground lease business.

Recently, Montgomery Street Partners announced the launch of a $1 billion ground lease REIT. This came after Ares Management and Regis Group teamed up to sponsor ground lease Haven Capital, which has  an initial capacity in excess of $1 billion.

As institutions develop more interest in offering ground-lease vehicles, corporations seem more amenable to selling their dirt underneath their assets.

CEO Jay Sugarman of Safehold, a publicly-traded REIT focused exclusively on ground leases, thinks the opportunity in ground leases—a $7 trillion business—is enormous when the buyer offers a solution that is more capital efficient and can reduce risk.

If that happens, ground leases will become more popular with CFOs. “The entire corporate net lease business has enabled corporations to deploy capital into their core operating business,” Sugarman says.

Then another entity that values the physical asset can deploy its capital into the underlying real estate assets. “Whether it’s data centers, cell towers, warehouses or cold storage facilities, the operating business fundamentally has a different investor pool and capital needs than the underlying real estate,” Sugarman says.

If a corporation can sell its assets, Sugarman says it can become more capital efficient and eliminate debt and maturity risk.

“It has been a dramatic efficiency for corporations, and you’ve seen more and more industries go ‘asset-light,’” he says. “When they let the most efficient capital buy the real estate and they go find the most efficient capital to support their operating business, everybody wins.”

Sugarman says that it requires several skill sets, along with investment-grade ratings, to set up a ground-lease program successfully.

Sugarman also sees danger signs in some ground leases.

“Often, we see new ground leases that are too high price,” he says. “They eat up too much of the cash flow. They are not value enhancing.”

Ground leases that are too expensive can be harmful to everyone involved. “The ones that are too high in price are going to create problems down the road,” Sugarman says. “There are probably 25 or 30 provisions that need to be understood and correctly structured.”

Sugarman says the right structure can lead to a win-win. “If you start putting in place the wrong structures and the wrong-sized ground leases with the wrong pricing, you make these things too expensive,” Sugarman says. “They are value destroyers.”

Sugarman says the proper structure has to consider the leasehold lenders, the investment markets and the sellers of the real estate. “You need to understand their needs and their desires,” he says. “What are they concerned about?”