A land owner typically has one of several motivations for choosing to implement a ground lease instead of an outright sale for a parcel of land. The most common motivation is to preserve the opportunity to participate in the appreciation in land value over the term of a ground lease without the financial risks of developing.
Other examples exist for the owner where the:
- Land has a low basis for tax purposes and owner receives rental payments without having to pay capital gains for the appreciation in value of the property.
- Property is encumbered in debt in excess of the tax basis. The owner may want to avoid a sale where such a large portion of the sale proceeds, if not all, will satisfy the debt that the taxes payable will require of the net cash.
- Tenant is of quality credit; the owner may encumber the interest in the land to secure a loan to be amortized by the rent payments under a ground lease. This would allow the owner to realize a large percentage of a sale or refinance for liquidity purposes without experiencing adverse tax consequences.
- Land owner (i.e. hospital systems), may have concerns over how nearby tracts will be built in the future. Utilizing a ground lease can exert more control over the development than through the use of restrictive covenants through outright sale of a tract.
- Land owner may not want to be associated with the development risks of improving the land and, rather, may defer these risks but remain a participant in future income.
The tenant usually has a select few reasons to ground lease.
The most frequent reason for ground lease is not having to obtain the cash for the purchase price of land. This motivation is to avoid having to relinquish the resources necessary for day-to-day business operations within the property. Essentially, the tenant is amortizing the cost of improvements and land payments over a period of time. But, ultimately, the aggregate amount of ground lease rentals will exceed the total of interest and principal payments required to pay for the outright purchase.
As for the structure and motivation, the landlord wants:
- Tenant to occupy and pay rent for a long initial term;
- To limit the tenant’s renewal options;
- Rent payments to be adjusted frequently;
- Rent payments to be fair market value (or higher).
The tenant wants:
- Obligations for occupancy and rent for a short period of time;
- Wants numerous options to renew at rates already negotiated;
- No adjustments to rent.
Outside of the healthcare arena, the future of the ground lease and its success in matching interested parties are highly dependent the banking system, who can marry multiple components; land, tenants and developers. Within the healthcare transactional market, we expect that the ground lease will remain a source of control, and competition, for location-centric healthcare providers.
For historical healthcare real estate examples, studies, additional structures or request for attorney assistance, please contact Robert S. “Bob” Lowery at 713.701.7900.