While many people do not consider the possible use of a ground lease or land lease, ground leases offer a great way to retain a long-term ownership interest in real property that can significantly benefit heirs, while providing a current income stream. Vacant land that an owner may not be able to develop on his own can also reach its full development potential sooner using a ground lease. Most ground leases are negotiated with a provision that calls for the short-term development of the land, and once developed land owners / landlords have a relatively small risk of loss.

In Las Vegas, ground leases are used periodically but they have not been a mainstay in the real estate market. Given the cash crunch caused by the “Recession of 2008,” however, more land owners are considering them. Waiting for an end user to purchase a property, when most cannot get bank financing, can be costly. A ground lease provides and alternative to waiting that appears to be promising in the current economic climate.

Establishing a base return rate for a ground lease is not as difficult as one might imagine. Discovering the current market value of a property to be leased is the first step, and it is usually accomplished via an appraisal. With regard to the rate of return, if you were to sell a property for cash and invest the proceeds with as little risk as possible, you have established a base or minimal return figure. The near risk free rate paid on government treasury bonds is usually the base rate. Since more risk is associated with a ground lease than with holding government bonds a risk premium is usually added to the base rate.

One of the biggest issues associated with a ground lease in Las Vegas, as elsewhere, is position or subordination. If a developer is going to borrow money to improve a site, the lender generally wants to be in first position. Since the underlying land owner sees this request for subordination as a way to separate him from the land asset, and the bank feels its investment is larger and should be superior to the underlying land owner, some ground leases fail to materialized due to this security issue. Ground leases are most attractive to land owners when no financing is required for the development of improvements.

Another difficulty establishing a ground lease is the provision regarding rental adjustments. The Consumer Price Index (CPI) adjustments is often built into building leases, and at times CPI adjustments are adopted in ground leases. CPI adjustments provide the tenant with some assurance that they will not be caught up in a revaluation due to an explosive land market. The downside of using a CPI adjustment for the land owner is that the land may dramatically increase in value over time and the land owner will be stuck with the contract terms negotiated based on a much lower value.

Once established, the sum of the net present value of the income stream from a ground lease plus the discounted value of the remainder are the basis for value. So poorly structured ground leases can destroy the value of a parcel of real property.

Thus, ground leases can be detrimental to an owner or tenant if not well crafted. I have personally evaluated a real property encumbered by a 99 year lease with a 60 year term remaining that provided the leased fee owners with a return so low that their heirs could not afford to pay the tax bill. I can’t think of anything worse than being conveyed an asset worth several million dollars that just costs you money every month and that will likely not provide you with a benefit during your lifetime.

The opposite side of the coin is a lease that favors the owner so much that the tenant cannot afford to pay the monthly rent. Driving your leasehold tenant into bankruptcy is also not the best scenario for a long-term lease relationship.

Under certain circumstances a ground lease can be beneficial to both a landlord / owner and a tenant. Recent market changes in Las Vegas have opened land owners to the possibility that a ground lease may be a valuable tool to get a deal transacted. Great care must be taken to develop terms and legal provisions (with the aid of your attorney) that will remain reasonable over the life of the lease. Thus, the use of a ground lease in Las Vegas is being considered by owners and developers as a serious alternative to traditional land sales.



Passive Income