Are Commercial Ground Rents A Good Alternative To Traditional Investments?
Commercial ground rents are a great alternative to traditional property finance and allows owners of real estate to keep possession of their property and at the same time capitalise financially. To achieve this, they sell the freehold and take a long lease on the building, allowing them to stay in the building with very few restrictions and pay annual ground rent, at much lower market price of renting similar space, to the new freeholder. There can also be an agreement written into the lease to buy back the asset for a nominal amount at the end of the term.
Investing in commercial ground rents are popular among retail investors and institutional investors because it offers them an alternative to investing in other stocks, bonds, or mutual funds and offers long term secured, cash flows, often linked to Retail Price Index uplifts, with relatively low risk as there is no exposure to the financial or commercial property markets cycles.
What is a Ground Rent?
The term “ground rent” refers to a situation in which one party retains full ownership of a portion of the property. In contrast, another party, typically a leaseholder, holds a long-term leasehold agreement on that land.
The person who holds the lease is normally the owner of any buildings or structures that are located on the land, and they are the ones who are responsible for paying any rents that are associated with the building or buildings.
The freeholder requires the leaseholder to pay agreed-upon ground rent for the buildings to continue to be located on the land.
To put it another way, the leaseholder who owns the buildings situated on that land is responsible for paying ground rent to the freeholder.
How Long Do Ground Rents Typically Remain in Effect?
In most cases, there will be a lease in place, and its duration typically ranges from 20 to 999 years; however, in the UK, a lease for 99 years is probably the most typical.
Investing in Ground Rents to Generate Income
An investment in ground rent can involve either commercial or residential real estate. It is typically one of the least difficult property investment vehicles to get involved in because the leaseholder is responsible for performing a significant portion of the labor normally performed by the investor.
When it comes to achieving financial success, many investors have discovered that the route of investing in ground rent is quite rewarding for them. On the other hand, it is important to note that the opportunities for achieving higher financial returns for a more extended period and for growing annual profits are not likely to be quite as plentiful.
When you invest in ground rents, you will only own the land, severely restricting your ability to add significant value to the property. This is in contrast to other forms of direct property investment, which allow you to make strategic alterations to the buildings or the leasing profile of a property to increase its income or capital value.
There is typically no opportunity for you to make improvements. As a result, there is no opportunity for you to make future financial gains throughout the lease because the buildings occupying the property belong to the leaseholder.
Investing in Leaseback Arrangement in Hotel
The use of hotel sale leasebacks as an alternative to more conventional forms of financing may prove to be the most beneficial option, particularly in the current environment. Hotel sale-leasebacks have been widely used in the hospitality industries of Europe and Australia for over a century, and they are slowly gaining popularity in the United States. By entering into this agreement, the owner of a hotel who is selling it can enter into a lease with the hotel’s new owner. After the title has been transferred, the parties will sign a lease, typically between 20 and 40 years in length. During this time, the seller will maintain a brand flag and management rights while agreeing to make monthly payments to the owner. The lease typically includes options to renew or repurchase the property, and it can be expanded or extended according to the lessee’s requirements.
The Difference Between Commercial Ground Rents And Leasebacks
Ground Rent Paid
Instead of considering the going rate for the property’s rent, the initial rent payment is based on a percentage (usually 8%-15%) of the operators earnings before interest, tax, depreciation and amortisation or predicted earnings before interest, tax, depreciation and amortisation. The annual ground rent would also normally have an uplift clause, typically linked to the Retail Price Index.
Length of Lease
Unlike sale-and-leaseback deals, where the period is typically between 20 and 30 years, long-term leases can last anywhere from 100 to 250 years. A buyback option, where an operator can purchase the freehold for its nominal value after the expiration of the lease, is becoming more common in arrangements. Another point to consider is that commercial ground rents typically do not include early exit options.
Retaining the Leasehold Interest
Unlike in a sale and leaseback operating company, where the leaseholder retains a significantly smaller amount of income and value in the leasehold interest, in commercial ground rent transactions the leaseholder retains the vast majority of both, representing an asset that may be leveraged or disposed of outright.
Value of The Freehold
This is determined not by the asset’s current market value but by a significantly higher multiple of the agreed-upon rent. Over-collateralisation of income and capital value allows deals to be completed with smaller asset owners or those without a major financial “covenant” supporting the revenue stream, as opposed to sales and leasebacks.
Legal Recourse for Bank Defaults
There is no “default trigger” in the event of insolvency, unlike with bank financing. To add, the bank can step in and fix any ground lease defaults. Sub investment grade property rich, cash-flowing enterprises are ideal candidates for commercial ground rent deals. Historic ground rent structures have favored long-standing, stable real estate firms because rents are geared off earnings before interest, taxes, depreciation, and amortisation.
Elimination Of Collateral Risk
No parent company guarantee is typically needed because each property is evaluated on its own merits and has its own ground lease.
Who Would Typically Buy Commercial Ground Rents?
Commercial ground rents are appealing to pension funds and insurers as it provides them with long term income streams, with inflation linked uplifts throughout the investment term and they also represent an attractive alternative to stocks and shares and government bonds.
Ground Rent Sales have been selling commercial ground rents and residential ground rents for over 15 years and have over 200 active ground rent investors looking for this type of investment. Please call on 0208 1331221 or send an email to sales@groundrentsales.co.uk if you have any ground rent investments you are considering selling.
