50 Year Ground Lease - Reversionary Considerations

[PS111222333444]

My subject has 40 years remaining on an initial 50 year subordinated ground lease. The tenant has constructed office buildings and the improvements revert to the landlord upon termination of the lease. I’ve estimated the PV of the cash flows, estimated the future value of the land and subsequent PV of the land upon reversion. What considerations should be made regarding the reversion of the improvements which will have an actual age of 50 years?

Thanks for the input.

 

[Meandering]

What considerations should be made regarding the reversion of the improvements which will have an actual age of 50 years?

City Hall, 260 Broadway New York, NY 10007 Built 1812

The Flat Iron Building 175 5th Ave, New York Built 1901


Consider the quality of the existing structure, and competent management will continue to maintain and modernize as needed.


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[Deleted member 152047]

The tenant has constructed office buildings and the improvements revert to the landlord upon termination of the lease.

Are there no options? I find it hard to believe that anyone would construct multiple office buildings without any renewal options, unless the buildings are not expected to have an economic life beyond the remaining lease term. Marion is right on this one, but no one is going to build the Flatiron building based on a 40 year leasehold with no options.

I would also be VERY careful trying to estimate a reversionary value 40 years into the future. If you manage to do that, please give me a call and let me know what the lotto numbers are next week.

 

[PS111222333444]

One, ten year option. Advise on how to value the improvements 50 years hence would be helpful...

 

[Deleted member 152047]

One, ten year option. Advise on how to value the improvements 50 years hence would be helpful...

You are approaching it in the wrong manner. I would NOT run a 50-year DCF, how do you support it? From a review perspective, I could discredit the appraisal in about 4 questions. You need to go to the market and look for cap rate premiums for leased fee vs. leasehold sales. There are plenty out there. It is difficult to opine what your premium might be, but if you are appraising some shoddy frame office buildings with minimal revenue potential, then your premium will be high. If you have a Class A multitenant office building that would be purchased by a sophisticated investor, the premium is likely less (I doubt this is the case). There is no magic potion, you asked a very broad question without much background information. Go to the market and forget the DCF, that is not how buyers or investors purchase these things.

 

[PL1957]

You are approaching it in the wrong manner. I would NOT run a 50-year DCF, how do you support it? From a review perspective, I could discredit the appraisal in about 4 questions. You need to go to the market and look for cap rate premiums for leased fee vs. leasehold sales.

IMO, any attempt at trying to find a meaningful "cap rate premium" in the market will be futile, as it would vary widely depending on factors such as tenancy, occupancy, remaining lease term, ground rent, etc. In addition, a leasehold interest with no reversion is by definition a wasting asset - an overall rate has the implication of income into perpetuity, something that's clearly not the case here.

Go to the market and forget the DCF, that is not how buyers or investors purchase these things.

I respectfully beg to differ. I can show you 50+ leasehold property sales at airports that were purchased strictly on a DCF, with no reversion. These ground leases had anywhere from three to 50 years left ... a DCF is the safest and most conservative way of solving this valuation problem.

 

[PS111222333444]

I beg to differ NP_MAI. Please ask your four questions.

 

[Deleted member 152047]

IMO, any attempt at trying to find a meaningful "cap rate premium" in the market will be futile, as it would vary widely depending on factors such as tenancy, occupancy, remaining lease term, ground rent, etc. In addition, a leasehold interest with no reversion is by definition a wasting asset - an overall rate has the implication of income into perpetuity, something that's clearly not the case here.
I respectfully beg to differ. I can show you 50+ leasehold property sales at airports that were purchased strictly on a DCF, with no reversion. These ground leases had anywhere from three to 50 years left ... a DCF is the safest and most conservative way of solving this valuation problem.

The futility of this approach depends on the asset that you are appraising and the market that your asset is located. I don't appraise properties on airports, so I don't know how investors in that market value those assets. I do appraise a lot of medical office that is subject to a ground lease and premiums can be proven. My point is that PS needs to look at the asset and determine what the economic life of the improvements is. If the economic life is 50 years, this conversation is pointless. I seriously doubt that he is talking about a Class A multitenant professional office building located in a primary market as a developer in that space is not going to go into a deal without options.

 

[Deleted member 152047]

BTW, just for giggles, take what you think might be a reasonable depreciated value of the improvements in 50 years and tell me what the PV is. Its probably less than a rounding error.

 

[PL1957]

The futility of this approach depends on the asset that you are appraising and the market that your asset is located. I don't appraise properties on airports, so I don't know how investors in that market value those assets. I do appraise a lot of medical office that is subject to a ground lease and premiums can be proven. My point is that PS needs to look at the asset and determine what the economic life of the improvements is. If the economic life is 50 years, this conversation is pointless. I seriously doubt that he is talking about a Class A multitenant professional office building located in a primary market as a developer in that space is not going to go into a deal without options.

I used the airport example because it was at my fingertips ... I've seen/valued lots of leaseholds without reversion - branch banks, NNN retail, single and multi-tenant retail ... IMO, you can't provide a reasonable valuation on a leasehold unless you look at a DCF, at least as a check for reasonableness.