At Metropolitan Capital Advisors (“MCA”), a commercial real estate capital intermediary, we are continually tasked with assisting our clients in financing challenging projects. Financing a ground lease, in which the lender’s mortgage is typically not secured by a fee interest in the real estate but rather by the borrower’s leasehold interest in the real estate, certainly qualifies as a challenging assignment as ground leases are notoriously difficult to finance.
A ground lease can be an effective way for a developer or end-user to gain long-term control of land (a “leasehold interest”) that a fee owner may otherwise not sell. Such is the case when private property is being developed on public land that is not available for sale or when a private interest wants to retain long-term fee ownership in the land to eventually sell or, perhaps, to create an annuitized income stream to pass down a generation. In fact, many holiday shoppers may be surprised to know that Northpark mall in Dallas was originally developed on a ground lease, as is the World Trade Center in New York (owned by the Port Authority).
While one could conceivably write a book (or a least a chapter or two) on the ins and outs of financing ground leases, we will just touch on the most salient points in this blog post.
First and foremost, as previously stated, the leasehold mortgage is secured not by the fee interest in the real estate but by the borrower’s leasehold interest in the real estate. Therefore, in order for the ground lease to be financeable, it must have certain attributes that give a prospective lender adequate protection of its collateral. In fact, the lender’s biggest risk is not a default by the borrowerbut a premature termination of the ground lease. Such an occurrence would completely wipe out the lender’s collateral, giving it little recourse to recover the loss of principal. It is, therefore, crucial that the ground lease give the leasehold mortgagee (the lender) rights and remedies similar to those afforded to real estate-secured lenders in the event of a borrower loan default. The rights and remedies will typically include the right, without the landlord’s consent, to:
- foreclose and sell the tenant’s leasehold estate and interests
- assume the borrower’s lease
- assign or sublease the assumed lease to a third party
- cure the tenant’s default – ideally, the ground lease cannot be terminated by a default by the tenant that is curable by the leasehold mortgagee
- enter into a new lease under the same terms and conditions as the original lease, if the ground lease is terminated by the landlord, so long as the leasehold mortgagee pays all back rent due
Additionally, in order for a ground lease to be financeable, it must have significant remaining term. Lenders may require that the ground lease extend anywhere from 10 to 20 years beyond final maturity date of the loan so that the borrower will be able to refinance the loan at maturity. In fact, in some states certain regulations will put requirements on the loan term as it relates to the remaining lease term (i.e. ten years beyond the lease term or less than 4/5 of the remaining lease term).
Finally, in some instances it may be necessary for the landowner to agree to a subordinated ground lease in order for the prospective ground lessor to obtain the necessary financing, as opposed to an unsubordinated ground lease in which the leasehold estate is the primary security for the loan. In a subordinated ground lease, the landowner allows the lender to place a lien against its fee simple interest in the land to secure the payment of the loan. The lender will have a lien against both the fee simple interest in the real estate and the leasehold estate of the tenant. In some cases, such as when the land is owned by a public entity (i.e. the Port Authority), this may not be feasible.
Although there are typically more hurdles associated with financing ground leases, so long as the lender is given rights and remedies similar to that of a real estate-secured loan, those hurdles can certainly be cleared. If you have a ground lease in need of financing or refinancing, contact one of MCA’s Senior Directors to assist you in locating the best financing source. Or, if you would like, please fill out the form below, and we will contact you shortly regarding your financing needs of a ground lease or if you are needed a commercial real estate deal funded: