Understanding Ground Leases

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					Understanding Ground Leases
By Tony Petosa, Nick Bertino, and Creighton Weber, Wells Fargo Multifamily Capital

In a conventional commercial real estate loan transaction, the borrower is the fee
simple owner of a piece of property and a lender agrees to lend money to the
borrower. There are different structures, however, that can complicate a
mortgage loan. One such structure is a ground lease. By understanding how a
ground lease can affect a loan, borrowers are better able to achieve their financing
goals.

What is a Ground Lease? Typically, a ground lease is a lease whereby the
owner of the land (ground lessor) leases or gives the right of use of land to a
tenant (ground lessee) for a long period of time (usually more than 30 years) to
develop the land in an agreed upon fashion so that both the ground lessor and
ground lessee share in the resulting cash flows.

Why is it so important to understand leasehold issues? To begin with, it
may affect the investor’s decision to buy. For example, an investor should know
the length of the remaining lease term, what happens to the improvements at the
end of the lease term, and how increases in the ground lease payments are
determined. These are the main issues an investor should understand before
deciding to buy.

A leasehold may also affect the investor’s ability to obtain financing on the
property. Lease provisions regarding such matters as future rent increases and
the expiration date of the lease may impact the willingness of a lender to finance
the proposed acquisition, or, at the vary least, affect the loan terms. Generally,
lenders prefer leases that provide certainty as to what the future lease payments
will be. For example, a stated percentage increase is preferred to an increase
based on future reappraisal.

Loan terms such as amortization period are also a function of the length of the
ground lease, as the loan needs to fully amortize prior to lease termination. Lease
provisions such as lender notification and rights to cure on default are critical to
loan underwriters. Lease terms may also affect the investor’s ability to resell the
property in the future as sale capitalization rates can rise substantially as
leasehold properties near lease termination.

How to overcome leasehold issues? There are a few methods to address
leasehold issues. The investor could investigate the option of obtaining a shorter-
term, fully amortizing loan to pay the loan off prior to the lease expiration date.
Or, the investor may approach the ground lessee/seller about financing the
purchase with a seller carryback in which the seller, in essence, acts as the lender.
The investor can also inquire whether the ground lessor is willing to extend the
lease term. Finally, the investor can inquire whether it is possible to purchase the
fee interest and “merge” the leasehold interest in a single transaction.

A ground lease is not necessarily an obstacle to achieving an investor’s financing
goals. With some analysis, an investor may find financing alternatives that,
though may be different from the initial goal, may end up fulfilling the investor’s
ultimate financing objective.

Tony Petosa, Nick Bertino, and Creighton Weber specialize in financing
manufactured home communities (“MHC”), offering Fannie Mae, portfolio, and
correspondent lending programs. Petosa and Bertino can be reached at
760/438-2513; 760/438-8710 fax; and via email, tpetosa@wellsfargo.com,
nick.bertino@wellsfargo.com; and Weber can be reached at 248/723-3119;
248/723-3135 fax; and via email, cweber@wellsfargo.com