Andrew Fallon, assistant vice president at Calkain Cos.
Market values of land alone logically come in
somewhat below what ownership of both land and improvements would fetch. And
buyers just as logically expect a return premium for full ownership relative to
ground leases.
Hence the historic differential in cap rates between
ground leases and outright trades of land and net leased structures is
typically in the range of 50 to 100 basis points depending on location, tenant
credit, lease term and structure and related factors, notes active net lease
investment broker Andrew Fallon, assistant vice president with specialty
advisor Calkain Cos.
Well-positioned ground leases in major markets tend
to trade at cap rates in the vicinity of 6 percent or a bit below these days,
compared to roughly 6.5 to 7 for land and improvements subject to net leases.
One potentially exploitable factor likely to generate outsize returns for the
savvy small-cap investor is that full ownership of both land and improvements
reverts to the landowner when the lease terminates.
Hence a forward-looking investor able to track down
and land a replacement tenant (ideally with minimal retrofitting expenses)
might be able to essentially secure ownership of a functional structure sooner
rather than later – without really paying for it. Another strategic approach
here is to actively trade in ground leases, insightfully buying and selling
based on timing of built-in rental-rate escalations.
And when an existing tenant does opt to exercise
renewal options again and again, the more typical passive high-net-worth
individual playing this space today still owns land that should retain value
throughout economic cycles, Fallon relates. Given that small-cap ground leases
are mostly in high-traffic locations – and tend to trade in all-cash
transactions – cap rates are generally less volatile than with leveraged real
estate investments as interest rates rise and fall, he elaborates.
“The marketplace views ground leases as a very
secure type of investment – even more than ownership of both land and (net
leased) structures,” continues Fallon, who has brokered deals for ground leases
of properties occupied by the likes of 7-Eleven, KFC/Taco Bell, McDonald’s,
Chick-fil-A, Wells Fargo, Bank of America and others.
“The thinking is that if the tenant is willing to
spend the capital on the improvements (knowing they’ll eventually revert to the
landowner), then it’s a location worth committing to.”
Long-term ground leases these days have exceptional
appeal for high-net-worth individual investors tired of dealing with “tenants,
toilets and trash” – and who also seek better fixed-income returns than today’s
dismal bond rates, and far less wealth-preservation risk than the stock market
entails.
But again, given how NNN leases are structured,
ground lease investing can also offer savvy small-cap real estate entrepreneurs
opportunities to generate even better returns through active trading strategies
– or embracing re-tenanting risk under the right circumstances.
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