Commercial building owners turning to ground leases in the COVID era
After commercial real estate transaction volume came to a halt in Q2 and Q3 due to the COVID-19 pandemic, there are signs the industry is beginning to thaw. Within the last 30 days, building owners in Denver, Seattle, Philadelphia and San Jose have turned to Safehold’s modern ground lease to navigate an unprecedented economic climate.
In a recent Commercial Observer interview, Safehold Chairman & CEO Jay Sugarman explained why modern ground leases are especially attractive in the current market.
Minimizing maturity risk in uncertain times
“If we’ve learned anything in the last 30 years about real estate and finance, it’s that most of the problems come about when you have a loan maturing into a very weak fundamental market,” Sugarman explained. “So, if you could move the maturity on a big part of your capital structure from five or ten years out to 99 years, you would materially reduce your risk as an owner or operator of that building.
“We think ground leases can help generate up to 300 to 500 basis points better IRRs on many owner’s five- and 10-year holds,” Sugarman elaborated. “When you think about that in the context of a world where the 10-year was recently below 60 basis points, can you really afford to not generate an extra 300 to 500 basis points return on your investor capital?”
The cost efficiency of modern ground leases
“We went into COVID-19 thinking [ground leases] are a solution that should have been available to owners for decades,” Sugarman said. “They can lower risk, increase returns, and as an added benefit, help reduce the friction costs every real estate transaction incurs. Remember, you generally pay transfer taxes and other frictional costs on the full value of the property every time it trades or gets refinanced, but in reality, the land sits quietly off to itself for 100 years. It shouldn’t really be part of the frictional cost of transactions, and is an inefficiency that should’ve gone away a long time ago.”
A logical solution for building owners
If you put these together, you look at COVID-19 and you say, “Can people afford to be inefficient with capital?” No, they can’t. “Can they afford to be inefficient with costs?” No, they can’t. “Do they want to take on more or less risk?” They want less. It seems like more and more people should at least be looking at ground leases to achieve their goals.”
Locking in the lowest rates in history
“We have the lowest interest rates in history and you can lock them in for 100 years, and that’s why everybody should be thinking about this,” Sugarman said in reference to the ultra-long duration nature of ground leases. “We think it’s well worth people’s time to understand the potential advantages just on that basis.”