The next big thing: The ground lease, reinvented

The next big thing: The ground lease, reinvented

5 min read

Not long ago, it was impossible to have a conversation related to ground leases without invariably hearing a horror story about a ground lease gone wrong. Traditional ground leases have long been stigmatized as the real estate industry’s ugly stepchild, a direct result of the value-destroying elements commonly found in archaic ground lease structures. Look no further than the Chrysler Building for a prime example of an outdated structure coming back to haunt real estate investors.

However, taking an objective look at the real estate capital structure, there is no question that a commercial real estate building and the land underneath it represent two very different investments. On one side, there’s the building, which is a management-intensive, higher-return asset, and on the other side, there’s the land, which is in effect a very long-term, lower-return passive bond. It seems obvious that property owners and investors would want to unbundle these investments to improve capital efficiency and maximize their returns. Unfortunately, antiquated ground lease structures, many of which were originally drafted decades ago, have prevented this type of separation from taking place in a mutually beneficial way.

Over the last 30 years, the real estate markets have evolved considerably. The modern net lease sector has allowed operating businesses to monetize their passive real estate holdings by selling them to professional real estate investors in order to recycle capital into their core skillsets and generate higher returns. The modern real estate finance markets have demonstrated the value of tranching stratas of risk since the introduction of the CMBS industry in the early 90s. Throughout this time of immense change, however, ground leases have remained largely stagnant. The absence of progress is largely a result of the fact that the owners of most of the ground leases in the country, such as municipalities, universities and churches, are not set up to help real estate owners create value — their chief concern is maximizing the value of their own land. As a result, ground leases have suffered from a lack of innovation that has left them out of sync with the modern marketplace and contributed to the product’s negative reputation.


That negative reputation was driven mainly by provisions that were crafted to solely benefit land owners and ignored the impact on the building owner’s ability to finance and sell in the future. Chief among them are much-maligned “fair market value resets,” which allow landlords to raise rents based on theoretical land values. Moreover, vague terms like “highest and best use” all but ensure building owners will end up in some sort of legal dispute with the land owners. These and other poorly crafted provisions create uncertainty and ambiguity — two variables the modern capital markets loathe — which in turn has meant that building owners have not been able to access the most efficient financing terms or achieve the lowest cap rates when they sell their properties. A modernized ground lease eliminates these issues and is designed to create the most efficient capital structure in today’s modern capital markets.

The good news is, when properly structured, a modernized ground lease makes perfect sense and creates benefits too valuable not to be widely utilized. When designed in a way that works seamlessly with the modern real estate capital markets, ground leases can enable building owners to earn higher cash-on-cash returns and overall IRRs than fee-simple ownership. A properly structured ground lease can also eliminate a substantial amount of future transaction costs when the property is sold or refinanced, and lower an owner’s debt maturity risk by as much as half. It’s a powerfully compelling value proposition, and the reason we have seen an increasing number of real estate investors and developers winning competitive bids with modern ground leases as their technological advantage.

While it’s historically difficult to change perceptions, it’s become clear in the early days of the ground lease renaissance that a product with the power to reduce the cost of capital, eliminate unnecessary costs and minimize maturity risk while providing a low, predictable cost of funds over an ultra-long term, cannot be ignored any longer. At Safehold, we’ve built a $2 billion ground lease portfolio in just over two years, working with a wide range of building owners, from the largest core funds and institutional sponsors to sharpshooting specialists focusing on a single product type or market. With a steady stream of repeat business, we see an increasing receptivity to modern ground leases that should continue to grow as these benefits become more widely understood.

As with any new product or service, it takes time for innovative ideas to become mainstream. But as long as we’re providing a superior solution to a building owner’s other capital alternatives, we’re confident the best solution will ultimately win out. Awareness will build as this new class of ground leases continues to gain traction, driving increased adoption and ultimately changing the way people think about real estate ownership.

Unpredictable economic headwinds are creating challenging conditions for owners, lenders and buyers to have conviction in their valuations.

This is leading to a lack of liquidity in the capital markets, where owners are hesitant to sell at higher cap rates. Meanwhile, buyers and lenders are reluctant to execute transactions without a clearer sense of the cost of capital in the near term.

Consequently, the commercial real estate industry is at a crossroads, and building owners that have historically focused on traditional fee simple ownership are becoming increasingly open to more efficient capitalization strategies.

As a leader in the modern ground lease industry, Safehold helps asset owners maximize the efficiency of their capital stacks by providing low-cost capital — all while mitigating development and debt maturity risks and generating a strong return profile, said Tim Doherty, Safehold’s recently appointed Chief Investment Officer.

“Existing owners are facing refinancing at higher costs and potentially lower proceeds,” Doherty told Bisnow’s Studio B. “Developers are also seeing lower debt proceeds and higher pricing, and buyers are struggling to meet the bid-ask spread.”

Bisnow spoke with Doherty to learn more about what he is seeing in the market and the advantages of modern ground leases in all economic conditions.

Bisnow: How would you characterize the mindset of building owners and developers in this market?

Doherty: The volatile market has definitely made it difficult for owners, lenders and buyers to have confidence in their valuations, leading to a standstill in the capital markets. Owners don’t want to sell at higher cap rates, and buyers and lenders are not confident where the cost of capital will be in the near term to execute deals.

But we are seeing market transaction volume increase. People are picking their spots and executing where there is liquidity. They’re going after markets where the valuations have changed, but the fundamentals haven’t. Multifamily and industrial are great examples of product types that continue to have strong fundamentals.

Bisnow: Safehold pioneered the modern ground lease. How has the perception of ground leases changed since then?

Doherty: Pretty dramatically. When we started, the market’s perception was very different from what it is today. Before we created the modern ground lease, they were inconsistent, poorly conceived and overly complicated. We provided consistency and simplicity, taking into account the interests of all participants, including lenders and owners.

We’ve now executed over $6B on more than 135 deals across numerous markets and asset classes for different types of capital needs. This includes development, acquisition and recapitalization. It’s one thing to see the hypothetical concept. It’s another to actually see it working in practice and generating higher returns for owners, operators and developers.

With over seven years of track record, we have seen several round trips and refinancings of leasehold positions, which have demonstrated the liquidity of the leasehold position as well as the increased returns for our clients.

Bisnow: What are the key structural advantages of a modern ground lease relative to traditional real estate capital?

Doherty: It goes back to the cost of capital. We’re a low-cost provider, and cheaper than all other CRE capital available. Simplicity, consistency and a low cost of capital allow us to provide our customers with accretive, passive capital to drive better returns.

Leasehold owners benefit from less equity required upfront, eliminating friction costs throughout the term and significantly reducing refinancing risk.

Bisnow: What is your investment team focused on in the near term?

Doherty: In a volatile market, you’re always looking for sectors and deals that are actionable. You’re going into areas that are impacted on the value side, but not the fundamental side. Office has been hit on both, so that’s a very difficult one for people to peg down. You don’t know what your revenues are or what the valuation method is yet.

Residential, including multifamily, student housing and build-to-rent, is the biggest sector we’re focusing on right now because the fundamentals have not changed, even if certain markets might be seeing near-term deliveries.

Existing owners are facing refinancing at potentially less proceeds than they currently have outstanding. This is creating a capital need that can come in the form of fresh equity, such as cash in from the existing owner or new, high-priced preferred equity.

Alternatively, Safehold’s low-cost, highly accretive capital enables owners to create a more efficient, conservatively priced capital stack that reduces and, in some cases, eliminates the need for additional equity required while driving better returns.

Bisnow: How do Safehold ground leases impact leasehold liquidity when building owners sell their assets?

Doherty: We’ve seen 42 sales and refinancings behind our ground leases, so the proof of concept is there. In these transactions, the cap rates have been very similar to fee simple comparable transactions, both on multifamily and office assets, with a range of no spread on cap rate to about 10 to 15 basis points.

Having a track record on third-party market transactions has been a powerful part of the liquidity story for Safehold’s modern ground lease assets.

Bisnow: How should owners evaluate the option of a modern ground lease structure for their needs?

Doherty: We’re always here to help new clients understand the benefits for their assets as well as the liquidity track record we have seen produced with our existing clients.

In today’s current environment, we are seeing a lot of demand across all property types. The most active market is currently multifamily — acquisitions, development and recapitalization. The ground lease creates a lower blended cost of capital than fee simple stacks for all scenarios.

The added benefit today in the higher-rate environment is in recapitalizations. If an asset was purchased three years ago with 65% leverage, a 100-to-125-basis-point move in cap rates would make the debt now 85%, requiring a cash-in refinance on a fee simple basis of approximately 10% to 25% of the debt balance.

Alternatively, if the same property was recapitalized with a Safehold ground lease and a bank or agency first mortgage, the equity could refinance 100% of the in-place debt and, in some cases, take cash out upon recapitalization.

Overall, we’re still in the early innings of this business with tremendous growth potential for Safehold and our customers.

Connect with Safehold

East Coast

Tim Doherty

Chief Investment Officer

West Coast

Steve Wylder


Ryan Howard

Stay in the loop

Subscribe to have the latest updates, insights and more delivered straight to your inbox.