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If you own realty in an up-and-coming area or own residential or commercial property that might be redeveloped into a "greater and better use", then you've concerned the ideal place! This short article will assist you summarize and ideally demystify these two techniques 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, normally ranging from 49 years to 150 years, where the owner transfers all the advantages and problems of ownership (expensive legalese for future earnings and expenses!) to a designer in exchange for a month-to-month or quarterly ground rent payment that will range from 5%-6% of the fair market price of the residential or commercial property. It allows the owner to delight in a great return on the worth of its residential or commercial property without needing to sell it and doesn't require the owner itself to take on the significant risk and issue of constructing a new building and finding renters to occupy the brand-new structure, skills which lots of real estate owners simply don't have or want to learn. You may have also heard that ground lease rents are "triple net" which means that the owner sustains no charges of operating of the residential or commercial property (aside from earnings tax on the received lease) and gets to keep the full "net" return of the negotiated lease payments. All true! Put another way, during the regard to the ground lease, the developer/ground lease occupant, takes on all duty for real estate taxes, construction costs, obtaining costs, repairs and maintenance, and all operating costs of the dirt and the new building to be developed on it. Sounds pretty good right. There's more!

This ground lease structure also permits the owner to enjoy a sensible return on the present worth of its residential or commercial property WITHOUT having to offer it, WITHOUT paying capital gains tax and, under present law, WITH a tax basis step-up (which minimizes the amount of gain the owner would ultimately pay tax on) when the owner passes away and ownership of the residential or commercial property is transferred to its heirs. All you give up is control of the residential or commercial property for the regard to the lease and a greater participation in the profits stemmed from the brand-new building, but without the majority of the risk that goes with building and operating a new structure. More on threats later on.

To make the offer sweeter, the majority of ground leases are structured with periodic increases in the ground lease to safeguard versus inflation and also have fair market value ground lease "resets" every 20 or so years, so that the owner gets to take pleasure in that 5%-6% return on the future, ideally increased value of the residential or commercial property.

Another favorable characteristic of an advancement ground lease is that once the new structure has been built and rented 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 property. At the exact same time, the stream from operating the residential or commercial property is likewise sellable and financeable, and if the lease is drafted properly, either can be sold or financed without threat to the other party's interest in their residential or commercial property. That is, the owner can borrow money against the worth of the ground rents paid by the designer without affecting the designer's ability to fund the building, and vice versa.

So, what are the drawbacks, you may ask. Well initially, the owner quits all control and all possible earnings to be obtained from building and running a new building for in between 49 and 150 years in exchange for the security of minimal ground lease. Second, there is risk. It is mainly front-loaded in the lease term, but the danger is genuine. The minute you move your residential or commercial property to the designer and the old structure gets destroyed, the residential or commercial property no longer is leasable and will not be creating any revenue. That will last for 2-3 years up until the brand-new structure is constructed and fully tenanted. If the developer stops working to develop the structure or stops halfway, the owner can get the residential or commercial property back by cancelling the lease, however with a partly constructed building on it that produces no revenue and worse, will cost millions to end up and lease up. That's why you should make absolutely sure that whoever you lease the residential or commercial property to is a skilled and skilled contractor who has the monetary wherewithal to both pay the ground lease and complete the construction of the structure. Complicated legal and organization options to provide protection against these dangers are beyond the scope of this short article, but they exist and require that you find the ideal organization advisors and legal counsel.

The Development Joint Venture

Not satisfied with a boring, coupon-clipping, long-term ground lease with minimal participation and restricted advantage? Do you want to leverage your ownership of an undeveloped or underdeveloped piece of residential or commercial property into an amazing, new, bigger and better financial investment? Then perhaps an advancement joint venture is for you. In an advancement joint venture, the owner contributes ownership of the residential or commercial property to a limited liability business whose owners (members) are the owner and the designer. The owner trades its ownership of the land in exchange for a portion ownership in the joint endeavor, which portion is identified by dividing the reasonable market worth of the land by the total job cost of the brand-new building. So, for instance, if the value of the land is $ 3million and it will cost $21 million to construct the brand-new structure and lease it up, the owner will be credited with a 12.5% ($3mm divided by $24mm) interest in the entity that owns the new structure and will take part in 12.5% of the operating profits, 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 in the meantime, a basis step up to reasonable market price is still offered to the owner of the 12.5% joint endeavor interest upon death. Putting the joint venture together raises many questions that need to be negotiated and dealt with. For instance: 1) if more cash is needed to end up the structure than was originally budgeted, who is accountable to come up with the additional funds? 2) does the owner get its $3mm dollars returned initially (a top priority 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 day-to-day organization choices? or major decisions like when to refinance or sell the new building? 5) can either of the members transfer their interests when wanted? or 6) if we build condominiums, can the members take their profit out by getting ownership of particular apartments or retail spaces rather of cash? There is a lot to unload in putting a strong and fair joint venture arrangement together.

And then there is a threat analysis to be done here too. In the development 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 job than in the past. The risk of a failure of the project does not simply result in the termination of the ground lease, it could result in a foreclosure and possibly total loss of the residential or commercial property. And after that there is the possibility that the marketplace for the brand-new structure isn't as strong as originally forecasted and the new building doesn't create the level of rental income that was anticipated. Conversely, the structure gets constructed on time, on or under budget plan, into a robust leasing market and it's a home run where the worth of the 12.5% joint endeavor interest far surpasses 100% of the value of the undeveloped parcel. The taking of these threats can be significantly lowered by choosing the exact same competent, experience and economically strong designer partner and if the expected benefits are large enough, a well-prepared residential or commercial property owner would be more than justified to take on those risks.

What's an Owner to Do?

My very first piece of guidance to anybody thinking about the redevelopment of their residential or commercial property is to surround themselves with skilled professionals. Brokers who understand advancement, accountants and other financial consultants, development consultants who will deal with behalf of an owner and obviously, great skilled legal counsel. My 2nd piece of recommendations is to utilize those professionals to figure out the financial, market and legal characteristics of the prospective deal. The dollars and the offer capacity will drive the decision to develop or not, and the structure. My third piece of recommendations to my customers is to be real to themselves and attempt to come to an honest awareness about the level of risk they will be prepared to take, their capability to find the best developer partner and then trust that designer to manage this process for both party's shared economic benefit. More quickly stated than done, I can ensure you.

Final Thought

Both of these structures work and have for years. They are especially popular now due to the fact that the cost of land and the cost of construction materials are so expensive. The magic is that these advancement ground leases, and joint ventures provide a more economical way for a designer to manage and redevelop a piece of residential or commercial property. More economical in that the ground lease a developer pays the owner, or the earnings the designer show a joint venture partner is either less, less risky or both, than if the designer had purchased the land outright, which's an advantage. These are advanced transactions that require sophisticated experts working on your behalf to keep you safe from the risks fundamental in any redevelopment of realty and guide you to the increased worth in your residential or commercial property that you seek.