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If you own real estate in an up-and-coming location or own residential or commercial property that could be redeveloped into a "greater and better use", then you've concerned the right place! This article will help you summarize and hopefully demystify these two methods of enhancing a piece of real estate while participating handsomely in the advantage.

The Development Ground Lease

The Development Ground Lease is a contract, typically ranging from 49 years to 150 years, where the owner transfers all the advantages and concerns of ownership (elegant legalese for future profits and costs!) to a developer in exchange for a month-to-month or quarterly ground rent payment that will range from 5%-6% of the fair market price of the residential or commercial property. It enables the owner to take pleasure in a good return on the value of its residential or commercial property without having to sell it and doesn't require the owner itself to take on the incredible danger and complication of constructing a new building and finding renters to inhabit the brand-new structure, skills which many realty owners merely don't have or wish to learn. You might have also heard that ground lease rents are "triple net" which means that the owner sustains no charges of operating of the residential or commercial property (aside from income tax on the gotten rent) and gets to keep the complete "net" return of the worked out rent payments. All real! Put another method, during the regard to the ground lease, the developer/ground lease renter, takes on all obligation for genuine estate taxes, construction costs, borrowing costs, repairs and maintenance, and all running costs of the dirt and the new structure to be built on it. Sounds respectable right. There's more!

This ground lease structure also enables the owner to delight in an affordable return on the existing value of its residential or commercial property WITHOUT needing to offer it, WITHOUT paying capital gains tax and, under present 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 term of the lease and a greater participation in the profits stemmed from the brand-new building, however without the majority of the threat that chooses structure and operating a brand-new building. More on risks later.

To make the deal sweeter, the majority of ground leases are structured with routine boosts in the ground lease to protect versus inflation and also have reasonable market price ground lease "resets" every 20 or so years, so that the owner gets to enjoy that 5%-6% return on the future, hopefully increased worth of the residential or commercial property.

Another favorable quality of an advancement ground lease is that as soon as the brand-new building has been constructed and leased up, the landlord's ownership of the residential or commercial property including the rental stream from the ground lease is a sellable and financeable interest in property. At the same time, the developer's rental stream from operating the residential or commercial property is likewise sellable and financeable, and if the lease is prepared correctly, either can be sold or financed without risk to the other celebration's interest in their residential or commercial property. That is, the owner can obtain cash versus the worth of the ground rents paid by the designer without impacting the designer's capability to finance the structure, and vice versa.

So, what are the disadvantages, you may ask. Well first, the owner provides up all control and all possible earnings to be derived from building and operating a brand-new structure for between 49 and 150 years in exchange for the security of limited ground lease. Second, there is danger. It is mainly front-loaded in the lease term, but the danger is real. The minute you move your residential or commercial property to the designer and the old structure gets demolished, the residential or commercial property no longer is leasable and will not be creating any income. That will last for 2-3 years until the brand-new structure is built and completely tenanted. If the developer fails to develop the structure or stops midway, the owner can get the residential or commercial property back by cancelling the lease, however with a partially constructed structure on it that produces no revenue and even worse, will cost millions to complete and rent up. That's why you need to make definitely sure that whoever you rent the residential or commercial property to is a competent and knowledgeable contractor who has the financial wherewithal to both pay the ground lease and finish the construction of the building. Complicated legal and company solutions to offer protection against these risks are beyond the scope of this short article, however they exist and require that you find the right business consultants and legal counsel.
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The Development Joint Venture

Not pleased with a boring, coupon-clipping, long-term ground lease with restricted participation and minimal advantage? Do you desire to leverage your ownership of an undeveloped or underdeveloped piece of residential or commercial property into an exciting, brand-new, larger and much better investment? Then possibly an advancement joint venture is for you. In an advancement joint endeavor, the owner contributes ownership of the residential or commercial property to a minimal liability business whose owners (members) are the owner and the developer. The owner trades its ownership of the land in exchange for a portion ownership in the joint venture, which portion is figured out by dividing the fair market worth of the land by the total project expense of the new structure. So, for example, if the value of the land is $ 3million and it will cost $21 million to develop the new building 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 building and will take part in 12.5% of the operating revenues, any refinancing earnings, and the revenue on sale.

There is no earnings 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 fair market worth is still to the owner of the 12.5% joint endeavor interest upon death. Putting the joint endeavor together raises numerous questions that should be negotiated and dealt with. For example: 1) if more money is needed to complete the building than was initially allocated, who is responsible to come up with the extra funds? 2) does the owner get its $3mm dollars returned initially (a concern distribution) or do all dollars come out 12.5%:87.5% (pro rata)? 3) does the owner get an ensured return on its $3mm financial investment (a preference payment)? 4) who gets to manage the everyday company decisions? or major decisions like when to refinance or sell the new structure? 5) can either of the members transfer their interests when wanted? or 6) if we develop condos, can the members take their revenue out by getting ownership of certain houses or retail spaces rather of cash? There is a lot to unload in putting a strong and fair joint venture arrangement together.

And after that there is a risk analysis to be done here too. In the development joint venture, the now-former residential or commercial property owner no longer owns or manages the dirt. The owner has acquired a 12.5% MINORITY interest in the operation, albeit a bigger task than in the past. The threat of a failure of the project doesn't just lead to the termination of the ground lease, it could lead to a foreclosure and maybe overall loss of the residential or commercial property. And after that there is the possibility that the market for the new building isn't as strong as originally predicted and the new structure does not create the level of rental income that was expected. Conversely, the structure gets constructed 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 goes beyond 100% of the value of the undeveloped parcel. The taking of these dangers can be substantially decreased by choosing the same competent, experience and financially strong designer partner and if the expected benefits are big enough, a well-prepared residential or commercial property owner would be more than warranted to take on those threats.

What's an Owner to Do?

My first piece of advice to anyone considering the redevelopment of their residential or commercial property is to surround themselves with skilled specialists. Brokers who understand development, accountants and other monetary consultants, advancement experts who will work on behalf of an owner and naturally, excellent skilled legal counsel. My 2nd piece of suggestions is to use those specialists to figure out the financial, market and legal dynamics of the possible transaction. The dollars and the deal capacity will drive the decision to establish or not, and the structure. My 3rd piece of guidance to my clients is to be real to themselves and attempt to come to a truthful realization about the level of threat they will want to take, their capability to find the ideal developer partner and after that trust that designer to control this procedure for both celebration's shared economic benefit. More easily said than done, I can guarantee you.

Final Thought

Both of these structures work and have for years. They are especially popular now because the expense of land and the expense of construction products are so costly. The magic is that these advancement ground leases, and joint ventures provide a more economical way for a developer to manage and redevelop a piece of residential or commercial property. Less costly in that the ground rent a designer pays the owner, or the earnings the designer show a joint endeavor partner is either less, less dangerous or both, than if the designer had purchased the land outright, and that's an excellent thing. These are sophisticated transactions that demand advanced experts working on your behalf to keep you safe from the threats intrinsic in any redevelopment of realty and guide you to the increased value in your residential or commercial property that you look for.