LEASE AGREEMENT REFERENCE GUIDE 380: GROUND LEASE STRATEGIES $49.95

Product Overview This LARG contains the following items: Rent Kickers in Ground Lease Deals, The Ground Lease: An Old Friend Gets Better, and the Lease Clause Critique: The Subletting Clause in the Ground Lease. Number of Single Spaced Pages: 12

 

Excerpt

 

 

Ground leases can make a great deal of sense as a development vehicle when traditional acquisition and financing of a parcel cannot be negotiated. In some cases, owners of highly desirable real estate can become emotionally attached to their property, and will not entertain offers to sell the piece outright. In the case of owners with property that has dramatically appreciated, the tax bite may be just too large to consider sale of the piece. In these sorts of cases, the long term ground lease can be precisely the right business arrangement to provide for development of the parcel.

Often, ground lease deals are done for "in-fill" parcel developments, after the highest and best use for the property has radically changed, e.g., in the case of a race track or airport. In such cases, if development has surrounded the property, the property is especially prime for development. The owners of such property have great leverage, since if development is done in a professional manner with a market driven plan, the overall success of the development is virtually assured. For this type of deal, the owner of the real estate may be in a position to demand a participation in project revenues in addition to the minimum rent payable under the ground lease.

Kicker Alternatives

Such participation (often referred to as a rent "kicker") can take many forms:

• Payment to the landlord of a percentage of the gross project revenues (with certain defined exclusions). This is quite similar to a garden variety retail percentage rent deal. Developer tenants frequently try to negotiate a recapture of all or a portion of development costs in this sort of deal to offset the effect of the landlord's participation in project revenues.
  
• Payment to the landlord of a percentage of the net cash flow of the project. The lease clause that follows is a variation of this deal since the percentage of the landlord's participation is based upon the proportion the stipulated value of the real estate (i.e., the landlord's "investment" in the deal) bears to the total investment by the tenant in developing the parcel plus the real estate value.
  
• Payment to the landlord of a percentage of the project book income. This is a different approach to the "cash flow" participation above, since the participation is based upon income rather than cash flow.

Kicker Relationship to Minimum Rent

Obviously, the structure of the landlord participation in project revenues is closely tied to the business deal setting the minimum rent payable to the landlord under the ground lease. Traditionally, the most common ways to compute minimum rental under ground leases have included the following:

• A fixed rent schedule whereby the minimum ground rent is stipulated in a schedule for the entire lease term.
  
• A stipulation of the initial minimum rental which is subject to adjustment periodically based upon an appraisal of the ground. For example, if the initial value of the parcel is appraised at $2 million, the tenant would pay ten percent of the appraised value of the real estate (excluding buildings and improvements) in annual minimum rent. The real estate value would be reappraised every ten years and the revised annual minimum rent would equal ten percent of the new appraised value of only the real estate. In this sort of deal, the precise assumptions of the appraisal must be set out in the ground lease (e.g., is the fair market value to be computed based upon only the proposed development plan of the tenant, or can other uses be considered by the appraiser in determining fair market value?)
  
• The initial ground rent could be stipulated, but subject to some sort of index increase (e.g., the CPI or other financial index measuring inflation and/or purchasing power).

Cash Flow Example

The lease clause that follows provides for additional ground rent payable to the landlord based upon project cash flows. The landlord receives a percentage of the project's positive cash flow (i.e., Annual Project Revenue less Annual Project Expenditures). The precise percentage the landlord receives is computed by dividing a stipulated value for the real estate by the sum of the real estate's initial value and the tenant's investment in developing the piece. Paragraph 13.1(a) sets out that concept in a fairly simple way. It also clearly provides that if there is no positive cash flow (i.e., if Annual Project Expenditures exceed Annual Project Revenue) that no additional rent will be payable by the tenant.

The key provisions of the clause that follows are the definitions found in Section 13.3 used to describe the landlord's participation in project cash flows. Paragraph 13.3(a) defines Annual Project Revenue, which includes all proceeds received by the tenant from the operation of the project excluding security deposits, unearned rent, refunds and reimbursements by the tenants for utilities, taxes and common area maintenance pursuant to subleases in effect for any lease year. Section 13.3(b) defines Annual Project Expenditures. These items are basically cash payments by the tenant under the ground lease. They do not include non-cash expenses such as depreciation, but do include a five percent fee on operating costs for the tenant's management efforts, and a sum equal to six percent of annual project revenues as a developer's fee.

Note that the landlord's share of project cash flows (called "Landlord's Proportionate Share") is defined by referring to the "Landlord's Value" (stipulated at $5,550,000) and the Tenant's Value which is meant to cover all cash investments in the project by the developer tenant. Section 13.3 (e) defines elements that make up the Tenant's Value.

(continued)

End of Excerpt

 

 

Related Products

See Agreements Concerning Commercial Ground Leases