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Feasibility Study And Ground Rent Estimate

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Helpless

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Nov 12, 2014
Professional Status
Certified General Appraiser
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California
We have a client who owns an open air lifestyle shopping center. The retail property is over 90 percent leased. There is a vacant 1-acre parcel/pad site within the center which the client/owner wants to ground lease to a multifamily rental developer. The client owns the retail center and pad site as fee simple.

The client wants a market study showing the market rents and operating income for a proposed apartment project on the site. In addition, the client wants to know approximate costs to build and if the project would be feasible for a developer. Finally, the client wants to know what market ground rent he could command if this parcel was put out to market as available for apartment development. All zoning is in place and allows multifamily.

In my test for feasibility it seems I would have to run a cash flow for the hypothetical apartment developer that would include a ground rent payment. How would I establish the ground rent for the site?

1. Research local land sales ?
2. Research local ground leases for apartment projects and apply those terms to the revenue/cash flow of the proposed apartment project?
3. Research land capitalization rates? For this last option, what am I capitalizing? The ground rent payment I come up with in step number 2 to determine the land value?

Note: This is not an appraisal but I think appraisers are good at coming up with a methodology that will work. Thanks for any input.
 

NachoPerito

Senior Member
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Jul 25, 2012
Professional Status
Certified General Appraiser
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1. Determine the value of the land.
2. Determine an appropriate rate of return for that investment. It would be a low risk investment because if the rent stops coming in then they can take the property, the rate should be on the low side.

I have never seen a ground lease for an apartment project.
 

Howard Klahr

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Oct 4, 2004
Professional Status
Certified General Appraiser
State
Florida
How would I establish the ground rent for the site?
I*R/V - Solve for the missing variable
1. Research local land sales ?
2. Research local ground leases for apartment projects and apply those terms to the revenue/cash flow of the proposed apartment project?
3. Research land capitalization rates?
All of the above
For this last option, what am I capitalizing?
See I*R/V above
 

Gobears81

Senior Member
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Nov 7, 2013
Professional Status
Certified General Appraiser
State
Illinois
1. Determine the value of the land.
2. Determine an appropriate rate of return for that investment. It would be a low risk investment because if the rent stops coming in then they can take the property, the rate should be on the low side.

I have never seen a ground lease for an apartment project.
Not challenging or disputing anything that you said, but why is it that determining market rent based on the value multiplied by appropriate rate is acceptable for land, but not for improved properties? Also, do appraisers find that determining market rent based on a rate utilized by developers is more appropriate than the capitalization rate exhibited on the re-sale to investors? For example, a property gets leased by a developer based on 8% of its land value, but due to the strength of tenant/ length of lease, is resold for a 5.5% cap rate
 
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NachoPerito

Senior Member
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Jul 25, 2012
Professional Status
Certified General Appraiser
State
Washington
Not challenging or disputing anything that you said, but why is it that determining market rent based on the value multiplied by appropriate rate is acceptable for land, but not for improved properties? Also, do appraisers find that determining market rent based on a rate utilized by developers is more appropriate than the capitalization rate exhibited on the re-sale to investors? For example, a property gets leased by a developer based on 8% of its land value, but due to the strength of tenant/ length of lease, is resold for a 5.5% cap rate

For improved properties you can get lease comps. I have never seen a ground lease for a property where the highest and best use is an apartment building so I am assuming that they don't exist.

The 8% to 5.5% is the profit for the middle man finding the CVS or Wendy's. If the land owner could do it directly then they would, but 8% without the AAA tenant is the same as 5.5% with a AAA tenant.

Same problem arises when you see ground lease rates for fast food franchises. Say you have 30,000 square feet worth $30/SF or $900,000. A reasonable rent would be $55k per year, but somehow Wendy's pays $100k per year for a ground lease then an investor comes back and pays $2.0M for just the ground lease with a 20-yr term to Wendy's. The property went from $900k to $2.0M by just adding the lease, but not adding any improvements because the tenant paid everything.
 

Michael S

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Joined
Mar 18, 2009
Professional Status
Certified General Appraiser
State
New Mexico
For improved properties you can get lease comps. I have never seen a ground lease for a property where the highest and best use is an apartment building so I am assuming that they don't exist.

The 8% to 5.5% is the profit for the middle man finding the CVS or Wendy's. If the land owner could do it directly then they would, but 8% without the AAA tenant is the same as 5.5% with a AAA tenant.

Same problem arises when you see ground lease rates for fast food franchises. Say you have 30,000 square feet worth $30/SF or $900,000. A reasonable rent would be $55k per year, but somehow Wendy's pays $100k per year for a ground lease then an investor comes back and pays $2.0M for just the ground lease with a 20-yr term to Wendy's. The property went from $900k to $2.0M by just adding the lease, but not adding any improvements because the tenant paid everything.

A colleague appraised a garden-style apartment complex on about 10 acres of ground leased land here in Albuquerque. The rent wasn't that much but an investor ended up buying the leased fee and leasehold interests and made about a million dollars instantly just by reassembling fee simple title. The ground lease only had about 25 years left and was starting to impact the availability of financing and the cap rate for the leasehold interest (improvements). The buyer overpaid substantially for the leased fee interest. Fee simple the dirt was worth less than $10/SF but it sold for almost $20/SF and worked out to about a 4-5% cap rate. Still, it worked out in their favor as they got the leasehold interest at a discount.
 

NachoPerito

Senior Member
Joined
Jul 25, 2012
Professional Status
Certified General Appraiser
State
Washington
A colleague appraised a garden-style apartment complex on about 10 acres of ground leased land here in Albuquerque. The rent wasn't that much but an investor ended up buying the leased fee and leasehold interests and made about a million dollars instantly just by reassembling fee simple title. The ground lease only had about 25 years left and was starting to impact the availability of financing and the cap rate for the leasehold interest (improvements). The buyer overpaid substantially for the leased fee interest. Fee simple the dirt was worth less than $10/SF but it sold for almost $20/SF and worked out to about a 4-5% cap rate. Still, it worked out in their favor as they got the leasehold interest at a discount.

Smart move by that guy. Ground leases where the term is less than 40 years require a discount.
 

Howard Klahr

Senior Member
Joined
Oct 4, 2004
Professional Status
Certified General Appraiser
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Florida
The buyer overpaid substantially for the leased fee interest. Fee simple the dirt was worth less than $10/SF but it sold for almost $20/SF
Smart move by that guy. Ground leases where the term is less than 40 years require a discount.
Actually, "ground" leases with a limited remaining term reflect a premium as compared to the fee simple interest, not a discount. Especially if the leasehold improvements have a remaining economic life beyond that of the lease term.
 

NachoPerito

Senior Member
Joined
Jul 25, 2012
Professional Status
Certified General Appraiser
State
Washington
Actually, "ground" leases with a limited remaining term reflect a premium as compared to the fee simple interest, not a discount. Especially if the leasehold improvements have a remaining economic life beyond that of the lease term.
Yes! got it backwards. I was thinking of the owner of the improvements on a ground lease not the owner of the ground.
 

RebelNYC

Junior Member
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Aug 6, 2009
Professional Status
Certified General Appraiser
State
District of Columbia
Ground leases are very common in any high demand market where land is scarce. I can't even count the number of apartment buildings I have done on ground leases. I am working on one right now.
 
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