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If you own real estate in an up-and-coming location or own residential or commercial property that might be redeveloped into a "higher and better use", then you have actually pertained to the ideal place! This article will help you summarize and ideally demystify these 2 approaches of improving a piece of real estate while participating handsomely in the benefit.

The Development Ground Lease
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The Development Ground Lease is a contract, typically ranging from 49 years to 150 years, where the owner transfers all the benefits and burdens of ownership (fancy legalese for future profits and expenses!) to a developer in exchange for a monthly or quarterly ground rent payment that will range from 5%-6% of the reasonable market value of the residential or commercial property. It allows the owner to enjoy an excellent return on the worth of its residential or commercial property without having to offer it and does not require the owner itself to handle the incredible risk and complication of constructing a new structure and finding renters to inhabit the new structure, skills which numerous property owners merely do not have or desire to find out. You may have also heard that ground lease rents are "triple web" which means that the owner sustains no expenses of operating of the residential or commercial property (other than earnings tax on the gotten rent) and gets to keep the full "net" return of the negotiated lease payments. All real! Put another way, during the term of the ground lease, the developer/ground lease renter, handles all obligation genuine estate taxes, building and construction expenses, obtaining expenses, repair work and maintenance, and all running costs of the dirt and the new structure to be developed on it. Sounds respectable right. There's more!

This ground lease structure also allows the owner to take pleasure in a reasonable return on the current value of its residential or commercial property WITHOUT having to sell it, WITHOUT paying capital gains tax and, under present law, WITH a step-up (which decreases the quantity of gain the owner would ultimately pay tax on) when the owner passes away and ownership of the residential or commercial property is moved to its beneficiaries. All you provide up is control of the residential or commercial property for the regard to the lease and a greater participation in the profits originated from the new structure, but without the majority of the danger that chooses building and running a new structure. More on threats later on.

To make the offer sweeter, most ground leases are structured with regular boosts in the ground lease to secure against inflation and likewise have fair market price ground rent "resets" every 20 approximately years, so that the owner gets to take pleasure in that 5%-6% return on the future, hopefully increased value of the residential or commercial property.

Another positive quality of an advancement ground lease is that as soon as the new building has actually been built and leased up, the property manager's ownership of the residential or commercial property including the rental stream from the ground lease is a sellable and financeable interest in genuine estate. At the same time, the designer's rental stream from running the residential or commercial property is also sellable and financeable, and if the lease is prepared appropriately, either can be sold or funded without threat to the other celebration's interest in their residential or commercial property. That is, the owner can borrow money versus the worth of the ground rents paid by the developer without affecting the developer's capability to finance the building, and vice versa.

So, what are the downsides, you might ask. Well initially, the owner provides up all control and all prospective profits to be originated from building and running a brand-new structure for in between 49 and 150 years in exchange for the security of limited ground rent. Second, there is danger. It is primarily front-loaded in the lease term, but the danger is genuine. The minute you move your residential or commercial property to the developer and the old building gets demolished, the residential or commercial property no longer is leasable and will not be producing any income. That will last for 2-3 years till the brand-new building is developed and fully tenanted. If the developer stops working to develop the building or stops midway, the owner can get the residential or commercial property back by cancelling the lease, however with a partially developed structure on it that generates no income and worse, will cost millions to complete and rent up. That's why you must make absolutely sure that whoever you rent the residential or commercial property to is an experienced and skilled contractor who has the financial wherewithal to both pay the ground rent and complete the building and construction of the structure. Complicated legal and business options to offer defense against these threats are beyond the scope of this article, but they exist and need that you find the ideal business consultants and legal counsel.

The Development Joint Venture

Not satisfied with a boring, coupon-clipping, long-term ground lease with restricted participation and limited upside? Do you desire to leverage your ownership of an undeveloped or underdeveloped piece of residential or commercial property into an interesting, brand-new, larger and much better investment? Then maybe a development joint endeavor is for you. In an advancement joint endeavor, the owner contributes ownership of the residential or commercial property to a restricted liability company whose owners (members) are the owner and the designer. The owner trades its ownership of the land in exchange for a percentage ownership in the joint endeavor, which portion is determined by dividing the fair market price of the land by the total project cost of the brand-new structure. So, for instance, if the worth of the land is $ 3million and it will cost $21 million to construct the brand-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 brand-new building and will take part in 12.5% of the operating revenues, any refinancing profits, 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 value is still readily available to the owner of the 12.5% joint endeavor interest upon death. Putting the joint endeavor together raises various concerns that need to be worked out and dealt with. For instance: 1) if more money is required to finish the structure than was initially budgeted, who is responsible to come up with the additional funds? 2) does the owner get its $3mm dollars returned first (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 choice payment)? 4) who gets to control the daily service decisions? or significant choices like when to refinance or sell the brand-new building? 5) can either of the members move their interests when preferred? or 6) if we build condominiums, can the members take their profit out by getting ownership of particular apartment or condos or retail areas rather of cash? There is a lot to unload in putting a strong and fair joint venture arrangement together.

And then there is a danger analysis to be done here too. In the advancement joint endeavor, the now-former residential or commercial property owner no longer owns or controls the dirt. The owner has actually gotten a 12.5% MINORITY interest in the operation, albeit a larger project than in the past. The danger of a failure of the task does not simply result in the termination of the ground lease, it could lead to a foreclosure and possibly overall loss of the residential or commercial property. And after that there is the possibility that the market for the brand-new building isn't as strong as originally forecasted and the new building does not generate the level of rental income that was anticipated. Conversely, the building gets developed on time, on or under budget, into a robust leasing market and it's a home run where the value of the 12.5% joint venture interest far goes beyond 100% of the worth of the undeveloped parcel. The taking of these risks can be significantly decreased by picking the exact same qualified, experience and economically strong developer partner and if the expected advantages are large enough, a well-prepared residential or commercial property owner would be more than warranted to take on those dangers.

What's an Owner to Do?

My very first piece of recommendations to anyone considering the redevelopment of their residential or commercial property is to surround themselves with knowledgeable experts. Brokers who understand development, accounting professionals and other monetary consultants, advancement experts who will deal with behalf of an owner and of course, great skilled legal counsel. My second piece of advice is to use those specialists to figure out the financial, market and legal dynamics of the potential transaction. The dollars and the offer potential will drive the decision to develop or not, and the structure. My third piece of guidance to my clients is to be true to themselves and attempt to come to an honest awareness about the level of threat they will want to take, their capability to discover the ideal designer partner and then trust that developer to manage this procedure for both party's mutual economic advantage. More quickly said than done, I can ensure you.

Final Thought

Both of these structures work and have for years. They are especially popular now since the cost of land and the expense of construction products are so costly. The magic is that these advancement ground leases, and joint endeavors supply a less costly way for a designer to control and redevelop a piece of residential or commercial property. Less costly in that the ground rent a designer pays the owner, or the revenue the designer shares with a joint venture partner is either less, less dangerous or both, than if the designer had actually purchased the land outright, and that's a good idea. These are sophisticated deals that require sophisticated experts working on your behalf to keep you safe from the dangers inherent in any redevelopment of real estate and guide you to the increased worth in your residential or commercial property that you look for.