If you own property in an up-and-coming area or own residential or commercial property that could be redeveloped into a "higher and much better use", then you've pertained to the right place! This post will help you sum up and hopefully demystify these 2 methods of improving a piece of genuine estate while taking part handsomely in the upside.
The Development Ground Lease
The Development Ground Lease is an agreement, usually varying from 49 years to 150 years, where the owner transfers all the advantages and burdens of ownership (elegant legalese for future earnings and expenses!) to a developer in exchange for a regular monthly or quarterly ground lease payment that will vary from 5%-6% of the reasonable market price of the residential or commercial property. It permits the owner to enjoy a good return on the worth of its residential or commercial property without having to sell it and does not require the owner itself to handle the tremendous threat and complication of constructing a brand-new building and finding occupants to occupy the new structure, abilities which many genuine estate owners merely do not have or wish to find out. You might have also heard that ground lease rents are "triple web" which suggests that the owner sustains no costs of operating of the residential or commercial property (besides earnings tax on the received rent) and gets to keep the complete "net" return of the worked out lease payments. All real! Put another method, during the term of the ground lease, the developer/ground lease tenant, handles all responsibility genuine estate taxes, building and construction expenses, obtaining expenses, repairs and upkeep, and all running expenses of the dirt and the new structure to be constructed on it. Sounds respectable right. There's more!
This ground lease structure also allows the owner to delight in a sensible return on the existing worth of its residential or commercial property WITHOUT having to offer it, WITHOUT paying capital gains tax and, under existing law, WITH a tax basis step-up (which lowers the amount of gain the owner would eventually pay tax on) when the owner dies and ownership of the residential or commercial property is moved to its beneficiaries. All you quit is control of the residential or commercial property for the regard to the lease and a higher involvement in the revenues stemmed from the brand-new building, however without many of the risk that chooses structure and operating a brand-new structure. More on threats later.
To make the deal sweeter, the majority of ground leases are structured with periodic increases in the ground lease to protect against inflation and likewise have reasonable market price ground rent "resets" every 20 or two years, so that the owner gets to take pleasure in that 5%-6% return on the future, ideally increased value of the residential or commercial property.
Another positive characteristic of a development ground lease is that when the brand-new building has been constructed and leased up, the property owner's ownership of the residential or commercial property consisting of the rental stream from the ground lease is a sellable and financeable interest in genuine estate. At the very same time, the designer's rental stream from running the residential or commercial property is also sellable and financeable, and if the lease is prepared properly, either can be offered or funded without threat to the other celebration's interest in their residential or commercial property. That is, the owner can obtain cash against the value of the ground rents paid by the designer without affecting the designer's ability to fund the building, and vice versa.
So, what are the drawbacks, you might ask. Well first, the owner offers up all control and all prospective profits to be obtained from building and operating a new structure for in between 49 and 150 years in exchange for the security of minimal ground lease. Second, there is danger. It is predominantly front-loaded in the lease term, however the risk is real. The minute you transfer your residential or commercial property to the designer and the old building gets demolished, the residential or commercial property no longer is leasable and will not be producing any revenue. That will last for 2-3 years up until the new building is constructed and totally tenanted. If the developer stops working to develop the building or stops halfway, the owner can get the residential or commercial property back by cancelling the lease, but with a partially built building on it that generates no income and worse, will cost millions to finish and lease up. That's why you should make absolutely sure that whoever you lease the residential or commercial property to is a knowledgeable and knowledgeable contractor who has the monetary wherewithal to both pay the ground rent and finish the building of the structure. Complicated legal and service solutions to supply security versus these risks are beyond the scope of this article, however they exist and require that you find the ideal business advisors and .
The Development Joint Venture
Not satisfied with a boring, coupon-clipping, long-lasting ground lease with restricted involvement and limited benefit? Do you want to take advantage of your ownership of an undeveloped or underdeveloped piece of residential or commercial property into an amazing, brand-new, larger and better investment? Then maybe an advancement joint endeavor is for you. In a development joint endeavor, the owner contributes ownership of the residential or commercial property to a restricted liability company whose owners (members) are the owner and the designer. The owner trades its ownership of the land in exchange for a portion ownership in the joint venture, which portion is identified by dividing the fair market price of the land by the overall project cost of the new building. So, for example, if the worth of the land is $ 3million and it will cost $21 million to develop the new structure and lease it up, the owner will be credited with a 12.5% ($3mm divided by $24mm) interest in the entity that owns the new structure and will take part in 12.5% of the operating revenues, any refinancing proceeds, and the revenue on sale.
There is no income tax or state and local transfer tax on the contribution of the residential or commercial property to the joint endeavor and for now, a basis step up to reasonable market value is still readily available to the owner of the 12.5% joint venture interest upon death. Putting the joint venture together raises numerous concerns that must be negotiated and resolved. For example: 1) if more money is needed to end up the structure than was initially allocated, who is accountable to come up with the extra funds? 2) does the owner get its $3mm dollars returned initially (a concern circulation) or do all dollars come out 12.5%:87.5% (pro rata)? 3) does the owner get a guaranteed return on its $3mm investment (a choice payment)? 4) who gets to control the day-to-day service decisions? or major choices like when to refinance or offer the brand-new building? 5) can either of the members move their interests when wanted? or 6) if we develop condominiums, can the members take their earnings out by getting ownership of specific houses or retail spaces instead of cash? There is a lot to unload in putting a strong and fair joint endeavor agreement together.
And then there is a threat analysis to be done here too. In the advancement joint venture, the now-former residential or commercial property owner no longer owns or controls the dirt. The owner has actually acquired a 12.5% MINORITY interest in the operation, albeit a larger project than before. The risk of a failure of the task does not just lead to the termination of the ground lease, it could lead to a foreclosure and possibly total loss of the residential or commercial property. And then there is the possibility that the market for the brand-new building isn't as strong as initially projected and the new structure doesn't create the level of rental earnings that was expected. Conversely, the building gets developed on time, on or under budget plan, into a robust leasing market and it's a crowning achievement where the value of the 12.5% joint venture interest far exceeds 100% of the value of the undeveloped parcel. The taking of these threats can be considerably reduced by picking the same qualified, experience and financially strong designer partner and if the anticipated benefits are big enough, a well-prepared residential or commercial property owner would be more than justified to handle those threats.
What's an Owner to Do?
My very first piece of recommendations to anybody considering the redevelopment of their residential or commercial property is to surround themselves with experienced experts. Brokers who comprehend development, accountants and other financial advisors, advancement consultants who will deal with behalf of an owner and of course, great skilled legal counsel. My 2nd piece of advice is to make use of those specialists to identify the economic, market and legal characteristics of the potential deal. The dollars and the deal capacity will drive the choice to develop or not, and the structure. My 3rd piece of recommendations to my clients is to be real to themselves and attempt to come to an honest realization about the level of danger they will be willing to take, their capability to discover the ideal developer partner and after that trust that designer to control this process for both celebration's mutual economic benefit. More easily stated than done, I can ensure you.
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Final Thought
Both of these structures work and have for years. They are particularly popular now since the expense of land and the cost of building and construction materials are so expensive. The magic is that these development ground leases, and joint endeavors offer a more economical way for a designer to manage and redevelop a piece of residential or commercial property. Less costly because the ground rent a developer pays the owner, or the earnings the developer show a joint endeavor partner is either less, less risky or both, than if the developer had purchased the land outright, and that's an excellent thing. These are advanced transactions that require sophisticated professionals dealing with your behalf to keep you safe from the dangers fundamental in any redevelopment of real estate and guide you to the increased value in your residential or commercial property that you seek.
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Development Ground Leases and Joint Ventures - a Guide For Owners
susieashton05 edited this page 2025-06-18 09:25:58 +02:00