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Why Ground Lease REITs are Building In Popularity
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As more residential or commercial property owners in need of liquidity use ground leases to open capital, investor could enjoy the benefits.
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Numerous openly traded property trusts (REITs) have dealt with obstacles in the previous year, with returns largely trailing stock market indexes. But REITs that are focused on ground leases - owning the land without owning the buildings that sit on it - have actually been an exception.
Splitting the ownership of commercial land from the buildings that rest on it isn't a new idea. In some ways, it's the exact same financial structure that medieval royalty used with its topics. But the democratization of ground leases and their growing appeal is reflective of other sort of securitization throughout the economy - developing narrower and more focused return characteristics to match the requirements of various classes of investors.
And with industrial office real estate, in particular, in a prominent state of post-lockdown turmoil, the ability to produce a de-risked property property has actually been warmly welcomed by financiers.
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At present, Safehold (SAFE) is the sole openly traded ground lease REIT pure play. It will likely be one of several on the marketplace in the coming years, prompting other more traditional REITs to diversify their holdings with land leases.
We've already seen this with a mega-deal including Real estate Income and Wynn Resorts. In a deal valued at $1.7 billion, Wynn Resorts sealed a sale/leaseback arrangement with Real estate Income, a conventional REIT, for its Encore Boston Harbor development, a hotel, casino and theater job 6 miles south of Boston.
Unlocking capital when in requirement of liquidity
Residential or commercial property owners are using ground leases to open capital in areas where liquidity is lacking. With local banking tightening up financing - even with the specter of lower rates of interest - we are now seeing land lease queries shoot up. In my own land lease specialty practice, we are fielding more questions from owners and designers in all property sectors.
One needs to just take a look at numbers touted by Safehold. Tim Doherty, Safehold's head of investments, said in a news release that the business has actually broadened land lease deals from 12 in 2017 to 130 in 2022, with the value of the portfolio at more than $6 billion. He attributed the growth to a brand-new level of sophistication in the land lease market, adopting methods such as predictability of lease payments, a relocation that causes more efficient rates. Over the last three months of 2023, Safehold stock was up almost 40%.
Growing popularity of ground leases has actually not gone unnoticed. Three years ago, Dallas-based Montgomery Street Partners started a $1 billion REIT targeted on investments in the country's top 50 markets. High interest from institutional financiers prompted Montgomery Street to broaden the pool to $1.5 billion in 2022.
Murray McCabe, a handling partner of Montgomery Street Partners, stated in a news release, "The strong demand we have actually seen for GLR's (ground lease REIT) follow-on equity offering verifies our technique and validates that ground leases have actually developed to end up being an acceptable and traditional funding tool."
Clearly, ground lease investment funds are one of the emerging patterns in real estate. Ares Management and realty private equity company The Regis Group formed Haven Capital in 2020 to catch growing land lease need to, in their words, provide "a more efficient kind of funding" that helps unlock property value.
These current developments, together with general financing trends within the property market, develop a pattern that's difficult to overlook: Land lease activity, which has actually grown to a more than $18 billion market in 2022, will only see more offers revealed over the next ten years. By one estimate, the marketplace might be close to $2.5 trillion in the United States alone, supplying a considerable runway for growth.
How does a land lease work?
Long a staple of household workplaces trying to find a constant income and foreseeable stream from long-held vacant parcels in preferable places, the land lease has ended up being widely accepted because the vehicle presents a win-win scenario for both the structure owner and the landowner.
How does a land lease run? Typically covering a term of 50 to 99 years with renewal alternatives, a land lease REIT or sponsor gets the land from the structure owner. This plan enables the designer to release essential capital, directing it towards areas with higher return potential. Simultaneously, the structure owner retains complete control of the asset while divesting the land below it, which, though useful in the advancement process, supplies little return to the general job. The lease is customized to fit the project.
The Boston Harbor Development serves as an illustration of the long-standing usage of land leases in the hospitality industry. Additionally, this method has actually found popularity in retail, fitness and health centers and fast-food outlets. Now, numerous markets are recognizing the value of this idea. Ground lease payments consist of predetermined annual lease increases.
" Proof of concept continues to spread out," Safehold's Doherty said.
As the advantages to a job's capital stack become readily apparent, ground leases will acquire wider acceptance and be routinely employed as an essential component in the genuine estate market. Predictions recommend that ground leases will end up being mainstream within the next 5 to 10 years, providing a spectrum of financial investment opportunities for astute gamers.
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This short article was written by and provides the views of our contributing adviser, not the Kiplinger editorial personnel. You can check adviser records with the SEC or with FINRA.
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Jim Small is the Founder/CEO of Sante Real Estate Investments, an impact-based property company. For over ten years, he has partnered with ultra-high-net-worth people and household workplaces to get and manage countless multifamily assets throughout the U.S. and Europe, producing constant returns and favorable social effect.
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