What are ground leases, and do they command a premium?

This article was written by our asset management expert, Noah Shaffer. Please visit here to learn more about how net lease asset management services can help protect your investment.

A net lease ground lease amounts to ownership rights to the underlying land and the income stream tied to the leased fee rights.

At its basic level, a ground lease occurs when real estate ownership interest in the ground, and real estate ownership interest in the improvements located on that ground, are separated into leased fee and leasehold interests.

Retail tenants choose to utilize ground leases to avoid allocating capital towards an undepreciable item. Land is unable to be depreciated, but ground lease rent payments may be deducted for tax purposes. In this sense, ground leases help ensure that real estate expenditures of the tenant, from property tax and utility payments, to buildout and improvement costs, are tax deductible.

7-Eleven as a Comparison

The comparison below clearly identifies investor perception of reduced risk in ground leases. Both sites are located in similar suburban locations with strong demographics.

7-Eleven Virginia 7-Eleven Colorado
Lease StructureGround LeaseFee Simple
Years Remaining9.520
Sold Cap Rate5.18%5.32%
Sold Price$3,570,000$1,950,000
Tenant Credit RatingAA-AA-

In this case, the investor paid a 14 basis point premium on the Virginia ground lease, despite having nearly 11 fewer guaranteed years remaining on the lease.

A Nationwide View

The difference is much more pronounced on a national level. Here is what I found when I analyzed 291 ground leases and 774 “absolute” net leases for sale. 

Net lease ground lease trends

Investors are paying a 58 basis point premium for ground leases with 2.3 years fewer remaining. Thus, the perceived risk of future expenditures associated with the improvements on a property clearly influence the risk profile of a net lease property for investors.

In short, investors are willing to pay for the reduced risk associated with ground leases.

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