Land Leases – What NYC Buyers Should Know
August 21, 2018 by Georges Benoliel
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Ground leases are relatively common in a New York City commercial real estate lease. Some of New York’s most unique properties,
like the Chrysler Building, carry one. While searching for an apartment, buyers sometimes find a listing that’s too good to be true. It’s very similar to all the others except it’s much cheaper. They notice the maintenance is much higher than other listings. Chances are, they’re dealing with a land lease. What is a land lease, why do they exist, and how do they affect apartment owners in New York City? These are all fundamental questions for anyone considering a building with a land lease.
Ground lease definition
“Land leases” are also called “ground leases.”In a ground lease, the landowner leases it to a developer. The developer will build something valuable on it. This is very common for commercial leases. The landowner collects the rent payments.
The term of an unsubordinated ground lease is typically very long (for example, 99 years). The developer pays the ground lessor a fixed rental payment.
This payment resets at various points during the lease term, typically according to the market value of the land (without considering the value of the improvements).
At the end of the lease term, the ground lessor (with land ownership) can take the land back with all improvements, but the leases are often renewed.
How can you check if a building has a ground lease?
An excellent
real estate attorney will inform you of this material fact during legal and
financial due diligence. However, you
can find out yourself by looking at the building’s annual financial statements.
If the building has title to the land it sits on; you’ll be able to see land as one of its assets in its balance sheet. You will also be able to see lease payments as an expense in its income statement. The notes section in the building’s financial statement will also mention the land lease, if there is one. The original offering plan will say the subordinated ground lease as a unique risk if there is one.
Lastly, you may be able to find evidence of the land lease by searching for land lease agreements through public records on
ACRIS.
What Problems Arise From A Land Lease?
There are two tremendous obstacles a buyer of a land lease building needs to overcome.
- First are higher monthly payments. The property issues the monthly payments to the landowner. Monthly charges on a land lease building are often significantly higher than other apartments. Depending on the land lease, they can even be multiples larger. Just like if you were renting an apartment, all of this money goes to the underlying landowner. There is no associated tax deduction, nor does the money go to capital improvements.
- And secondly, land lease buildings have a smaller buyer pool. Most buyers find the high monthly charges and uncertainty associated with land lease buildings to be untenable.
It often takes a buyer a lot of time to get comfortable with purchasing a land lease. When selling a unit on a land lease, that same discomfort can result in a longer sales process.
What Happens When a Land Lease Expires?
If a land lease expires without being successfully renewed, then the land and everything built return to the landowner.
This means the condo or co-op building and everything attached to the land belongs to the landowner if a land lease expires. This is even true if the tenant paid for the construction of the building.
As you would expect, land lease buildings in NYC typically trade at a discount because of the uncertainty associated with lease renewals. This presents an excellent opportunity for savvy buyers to understand what happens when a land lease expires.
Ground leases on government-owned land
Except in Battery Park City, you can’t typically find ground leases in residential co-ops and condominiums. Among other things, they add a layer of costs on top of each unit owner’s maintenance.
This can become rather considerable with each rent reset. This makes the apartments less marketable. In turn, they generally sell at a significant discount to comparable units in buildings unencumbered by ground leases.
For example, most people do not know that all of Battery Park City is on a land lease or that New York built the neighborhood on new land excavated from landfill material from the construction of the World Trade Center. As a result, the land in Battery Park City is owned and managed by the Battery Park City Authority, a local government agency.
Ground leases are the reason Battery Park City apartments have such high monthly charges. The Battery Park City Authority does not need to pay property taxes because of its status as a government agency. Instead of covering the land owner’s property taxes, as is common in many ground lease agreements, buildings in Battery Park City are charged “pilot payments,” which the Battery Park City Authority uses to build out and improve the neighborhood.
Therefore, an experienced buyer’s agent will be able to advise you that you have little to worry about buildings having land leases in Battery Park City.
The Battery Park City Authority is a not-for-profit, a government agency whose sole mission is to maintain and improve the neighborhood. There is minimal risk that they won’t agree to renew land leases with reasonable terms.
The normal co-op structure
The typical co-op structure is that each apartment “owner” is a shareholder in a corporation that owns the real estate in the apartments. The corporation does not own the real estate but leases it from a real estate investor under a ground lease with a ground lease.
At the end of the lease, the equity of all shareholders in the co-op can be wiped out if the property owner does not renew the lease. This essentially reduces its shareholders to the status of renters. This diminishes the leverage held by the co-op to negotiate favorable rental terms in a new lease.
Very often, the co-op buys the land at an exorbitant price. If they cannot muster the funds, they agree to painful one-sided terms favorable to the ground lessor. This separation of interests also creates the terrifying prospect of a ground lessor selling the land.
Opportunistic investors are looking to capitalize on the rent resets during periods of rising land values. This generates a great income stream. This is a common situation in the news today as land prices break new records every day.
Land lease buildings in NYC with private landlords
Land lease buildings in NYC built on privately owned land can present a significant challenge in valuation and marketability, especially if a lease is close to expiring. Those buildings in NYC typically have a 99-year lease agreement with two 20 year extension options.
Therefore, you might not have much to worry about if you are only 20 years into the lease. However, if you only have 20 years left on the lease, you face some serious risks!
So what happens when a ground lease expires without renewal?
This is a nightmare scenario for condo and co-op buildings built on ground that they do not own. The ground lease agreement states that all structures on and capital improvements of the land, including anything added by the tenant, are forfeited upon the ground lease’s expiration.
So the building that the co-op corporation paid for gets handed over to the landlord if they cannot renew the lease. For a co-op shareholder, that means the value of their shares will plummet to zero. Remember that they held equity ownership in a co-op corporation, not a real property of any sort.
Furthermore, this co-op corporation, unfortunately, did not even own the land, in which case shareholders effectively owned a portion of “lease equity.”
As you can imagine, the co-op or condo board will be in a pretty tough negotiating position regarding lease renewal with a private, for-profit landlord.
Because of the uncertainty involved with ground lease buildings in NYC declines in value over time, especially as a lease expiration date becomes imminent.
Examples of Ground Lease Co-ops in Trouble
The land underneath the Carnegie House co-op, located at 100 West 57th Street, sold to a group of investors for $285MM, and the land underneath the Trump Plaza co-op on East 61st Street is currently on the market. This situation is terrifying for co-op unit owners. The only reason investors would purchase a co-op ground lease is to make money on it – that is, generating the ground rent increase as high as possible based on the then-existing market price of the land.
According to an analysis by The Real Deal, the Carnegie House co-op’s annual rent owed under the ground lease at current market prices could increase from $4.4MM/year to $27MM/year! Imagine what that would do to your maintenance payments!
So, if you’re ever searching Streeteasy and become enamored with a 2br/2ba co-op with a beautiful terrace that is priced comparably to a studio, but has unusually high maintenance costs, turn away fast and continue your search. A ground lease probably encumbers it. Do not try to convince yourself that it’s worth it because of the low price tag. You do not want to mess with a ground lease co-op!
