LEASE AGREEMENT REFERENCE GUIDE 380: GROUND LEASE STRATEGIES $49.95
Rent Kickers in Ground Lease Deals
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.
Such participation (often referred to as a rent "kicker") can take many forms:
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:
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.