Ground lease under the chain, or fee simple with the building on it

Question

Two offerings on my desk this week, same national dollar-store tenant archetype, same small midwest trade area, roughly the same check.

One is fee simple, 9,200 square foot box, 14 years left, 6.9 on the ask. The other is the ground only. Tenant built and owns the improvements, 45 years of term with bumps, 5.6 on the ask, and I own dirt with a building sitting on it that I did not pay for.

The case for the ground position is that I can't be handed a roof, a parking lot, or a structural claim, my basis is in land that doesn't depreciate, and if the tenant ever stops paying I'm senior to their leasehold. The case against is that 130 basis points is a lot of yield to give up for a reversion I will probably never see, and at 45 years my exit is always a sale to someone else pricing the same low coupon in whatever rate environment exists then.

The case for fee simple is obvious. More current income, and at year 14 I actually control what happens to a real building. The case against is that all the physical risk the lease pushes to the tenant comes back to me the day they leave, and I own a purpose-built box in a town with three plausible replacement tenants.

My own answer keeps flipping depending on whether I underwrite a hold or a resale. Curious where the room lands.

karen_whitfield · Answer

arbor, the reversion at 45 years isn't yours in any practical sense. It's your heirs' problem or your buyer's discount. So price the ground deal purely as a coupon plus escalators, and once you do that the land story stops carrying the argument for you.

What I'd actually want to see is the escalator schedule side by side. A 5.6 that steps 10 percent every five years is a different animal from a 5.6 with CPI capped at 1.5. Flat or near-flat ground rent for four decades is a slow bleed you feel in year 20, not year 2.

derekj19 · Answer

Dumb question from the outside. On the ground position, if the parking lot fails or the pylon sign comes down in a storm, who is the person the tenant calls? Nobody, right? Because they own the improvements. That sounds like the whole reason someone would accept 5.6.

tylerbrooks9 · Answer

beacon, that's right, and it's why I like the shape of it. The part that gave me pause when I looked at a similar structure is financing. Lenders treat a leasehold and a fee ground position very differently, and some won't touch a ground lease position at all without seeing the improvements assignment and a lender protection clause in the lease itself. I'd get the term sheet language in writing from your lender before you assume the ground deal levers the way the fee deal does.

Unlevered, I'd take the boring one and sleep. Levered, I don't know.

paulgrant17 · Answer

I'm still working out the basics here, so: at the end of the ground lease, do the improvements come to the landowner automatically? Or does the tenant have some right to remove or get paid for them? I assume it's whatever the lease says, but is there a normal version?

ehernandez74 · Answer

wren, it's the lease. Most versions I've read say improvements revert to the fee owner at expiration with no compensation, and some give the tenant a removal right during a window. Read the surrender clause and don't guess from the summary page, and if the language is doing something unusual that's an attorney question, not a forum one.

arbor, I voted fee simple, and my reason is boring. Fourteen years of a corporate lease, then I own a building I can repurpose or sell. The ground deal asks me to accept a bond coupon with none of a bond's liquidity. If I wanted 5.6 I'd want to be able to get out in a day.

Ground lease under the chain, or fee simple with the building on it

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