50 Year Ground Lease - Reversionary Considerations

[PS111222333444]

Back to my question - is the reversionary value of the improvements something that should be factored in this DCF? My experience with land leases has typically involved the improvements being removed at termination and at the expense of the lessee. These improvements are of wood frame and are located within a major MSA.

 

[Deleted member 152047]

I have never seen a bank branch, NNN investor, retail investor, office investor, or medical investor run a 50 year DCF. How can you test reasonableness when the approach is not reasonable? Are you accounting for economic cycles in your DCF? To PS's point, how are you estimating your reversionary value (not that it matters to the PV, but it is a weakness in methodology)? This all goes back to the economic life are you estimating that your structures will be around forever?

 

[PL1957]

Back to my question - is the reversionary value of the improvements something that should be factored in this DCF? My experience with land leases has typically involved the improvements being removed at termination and at the expense of the lessee. These improvements are of wood frame and are located within a major MSA.

If you are appraising the leasehold, there is no reversion. If you are appraising the leased fee, there may be a reversion or there may not.

 

[Deleted member 152047]

Back to my question - is the reversionary value of the improvements something that should be factored in this DCF? My experience with land leases has typically involved the improvements being removed at termination and at the expense of the lessee. These improvements are of wood frame and are located within a major MSA.

Run your 50-year DCF and have fun, I give up!

 

[Deleted member 152047]

I thought we were talking about the LF the entire time. I think you just arrived at the heart of the problem PL.

 

[PL1957]

I have never seen a bank branch, NNN investor, retail investor, office investor, or medical investor run a 50 year DCF. How can you test reasonableness when the approach is not reasonable? Are you accounting for economic cycles in your DCF? To PS's point, how are you estimating your reversionary value (not that it matters to the PV, but it is a weakness in methodology)? This all goes back to the economic life are you estimating that your structures will be around forever?

Take a look at virtually any REIT that focuses on NNN properties. You will see them running a DCF on everything, even drug stores, as part of their NAV process.

 

[Deleted member 152047]

I agree, just never seen one go out 50 years.

 

[PS111222333444]

The lessee wants to buy the land from the owner/lessor. What the lessor has to sell is the Leased Fee Interest. The owner of the Leased Fee will get the buildings back in 40 years. Will they have value, who knows!

 

[Elliott]

I know a situation where a large condo project was put on a 50-year land lease with a reversion. The condo owners were happy as clams for the first 20 years, only paying modest land rent. Then they started to worry and started negotiating with with the leased fee estate because of the reversion. The condos started to go down hill, lenders wouldn't finance. Finally $2 million was paid to the estate and the condo owners got a $20,000 per unit assessment. I thought, those reversions are worth something.

 

[Gobears81]

Back to my question - is the reversionary value of the improvements something that should be factored in this DCF? My experience with land leases has typically involved the improvements being removed at termination and at the expense of the lessee. These improvements are of wood frame and are located within a major MSA.

That is where you determine economic life. According to M & S, typical building lives for Class D office buildings are between 40 and 50-years (depending on quality), which fits the remaining lease term. Though, a set of depreciation comps from the marketplace would be more ideal in this case. The likelihood that they exercise the option is, in part, based on the economic life. Two other things to think about - one is the behavior of the potential buyer: depending on the market, many would just tell you that they are effectively buying a long-term lease and aren't giving considerable emphasis to the reversion. In particular, not sure what discount rate you are using, but the PV of $1 at an 8% rate over 40 years is $0.046, whereas it is $0.021 over 50 years, so some variance in the reversion will not make a significant difference in the final value.

Also, tenants often defer needed capital expenditure items in lieu of bandaid repairs when the lease is nearing expiration on this type of case. For example, if they need a roof with 4 years to go, they will probably opt to patch or do what they can without replacing the roof. Personally, I have usually projected full depreciation of the building upon lease expiration in these types of cases, but there are plenty of actual cases where the building has some value at the end of the lease.