50 Year Ground Lease - Reversionary Considerations

[PS111222333444]

Thank you for the input!

 

[Deleted member 152047]

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.

Hallelujah!! Someone else brought some common sense to the table. Well said GoBears!

 

[Terrel L. Shields]

Primarily I use DCF for a wasting asset. Oil and gas assets. But beyond 10-15 years at most cap rates, the value beyond is dismally small. A simple inflation factor would be far more significant in estimating any remaining reversionary value. I know a 99 year leased development which failed in the depression. An investor took over operations. His grandson now owns the unsold lots and former golf course. He lives in the "clubhouse" and is a judge. As developed lots expire, he simply deeds them back to the occupant. Not worth the effort to negotiate a buy out of the improvements since the original lot leases were not explicit. The long term land lease makes no sense to me except perhaps airport hangars, railroad spurs etc.

 

[Deleted member 152047]

Came across an interesting ground lease on an MOB that I am working on. The building is a multi-story, multi-tenant, Class A, medical office building in one of the highest rent and lowest cap rate areas in the US. The ground lease is 50 years with no extensions and the reversionary value is to be calculated by taking the cost at completion and deducting the amount of depreciation allowed under GAAP. The landlord would pay the tenant the net book value at the end of the lease. Only problem is, you can depreciate the building at a faster rate than 2% per annum...so zero net book value at the end of 50 years and landlord take possession of the improvements. Score 1 leased fee interest.

 

[glenn walker]

I think the building will be standing in 40 years but will the tenant : ) LOL

 

[NachoPerito]

The present value of the reversion after 50 years at an 8% discount rate is only 2% of the reversion. Don't spend too much time on it.

 

[Deleted member 152047]

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.

Never say never, had to run a 39-year cash flow as a test of reasonableness. The landlord secured a sweetheart land lease with no extensions. Also, to your point @Gobears81 the landlord wisely addressed capital expenditures by setting a cap ex fund that they control. The tenant has to contribute $X per annum, which increases at 3% every year. This is really looking like the landlord wants this building in 39 years (and yes they will still be there).