Ground Leases: A Vintage Structure Bridging Modern Gaps

In recent years, developers have turned to the centuries-old concept of ground leases as a powerful tool in the contemporary struggle to pencil deals and close increasingly wide funding gaps.

Ground leases have roots going back to at least 11th century England when feudal landholding structures necessitated long-term land leases. Though the concept has certainly transformed over time, the basic structure is still the same: an owner will lease land to a tenant for a long term; the tenant then—depending on the lease terms—can construct, own and benefit from improvements, such as buildings. This is, of course, an alternative to a typical fee simple ownership, where one single entity owns both the land and the improvements upon it.

In general, there are two types of ground leases: subordinated, and unsubordinated. In the former, a tenant’s bank receives security interest in the property during a loan period, so that if a tenant defaults, the bank may be able to repossess both the land and the improvements upon it. In the latter, the landlord retains ownership rights, so that the bank may only repossess the improvements in the event of a default.

Ground leases are not a new concept in the affordable housing industry. Historically, they have been used in the United States when municipalities, housing authorities or private landowners that wish to both maintain land ownership and stimulate affordable housing production enter into leases with housing developers. Though ground lease terms are varied, in the affordable housing world, they are generally set to 99-year terms with fixed annual increases.

In this way, the lessor benefits by both generating long-term revenue from their land, and by securing a mission-oriented use of their land for long-term affordable housing, and the developer can benefit from ground leases by enjoying a negligible upfront land cost, freeing up dearly needed space on the debt side for construction, management and maintenance. Additionally, ground leases can provide tax incentives for developers, whose rental payments for a ground lease might be fully deductible for federal income tax purposes depending on the particularities of the lease agreement (unlike the principal payments under a loan or mortgage, which are not fully deductible).

In recent years, changes in the industry have spurred innovative uses of this centuries-old real estate structure as developers continue to seek deals amidst increasingly wide funding gaps.

Safehold’s Third-Party Investor Solution
Whereas historically, developers had to wait for external owners to approach them with ground lease opportunities, or seek opportunities with owners of underused land, a relatively new player in the ground lease field, Safehold, seeks to allow developers to take ground leases into their own hands, selling land they already own while maintaining property rights, unlocking the benefits of ground leases for developers looking to construct or preserve new affordable housing.

By allowing a broader range of developers to enter into ground leases, Safehold provides a “low-cost gap filler” that can energize projects, says Steve Wylder, Safehold’s executive vice president and head of investments. This gap filler provides increasingly necessary supplemental funding, he says, “helping to optimize capital structures and move projects forward.”

Though still a relatively young company, having been founded in 2017, Safehold has already done big business and has funded over $6.5 billion of ground leases around the country, according to Wylder, which includes over 80 multifamily deals. This growth can in part be attributed to Safehold’s main strategy of making ground leases consistent, simple and accessible to a broad range of affordable housing developers. “We fund proceeds at a premium to the underlying land value, with ground rent at an attractive cost of capital well inside of the cost of permanent financing,” Wylder explains. Safehold offers a standard lease term of 99 years with 2.0 percent annual increases, capped CPI resets and no fair market resets or percentage rent provisions.

Entering into a ground lease with Safehold allows developers to access “more permanent proceeds and at a significantly lower blended cost of capital,” says Wylder. For example, one estimate says that replacing $1 million of a permanent loan that would have otherwise been used to purchase land with a ground lease at an initial cost of capital of 50 basis points lower could result in an additional $150,000 of upfront proceeds to the project.

Additionally, this lease structure can help developers to “secure competitive awards of bond capital and stretch the impact of government resources,” Wylder says.

The types of ground leases offered by Safehold work for most markets, says Wylder, and can be particularly impactful in areas where development costs are particularly high. “Overall, we’ve now closed transactions in a range of locations with a mix of operators, tax credit investors, construction lenders and permanent lenders,” he explains. “Every deal is unique, but we feel great about our ability to navigate challenges as they arise and get these transactions closed.”

Community Land Trusts: A Win-Win-Win for Mission-Oriented Developers
One other innovative contemporary use of the ground lease structure is through a Community Land Trust (CLT). With roots in the civil rights era, CLTs have emerged as a powerful tool for communities across the country to guarantee high-quality attainable housing for generations to come, by leveraging ground leasing to collectively own land and selling homes on that land to income-qualified individual families who pay a ground lease fee back to the Trust.

The impetus for the CLT model comes down to one concept, says Jason Webb, community and technical assistance principal at Grounded Solutions Network. “How can we de-commodify land and continue to change the paradigm around how land can collectively be owned and controlled,” he asks. The answer, he says, lies in the power of ground leases, which allow motivated collectives to organize and own land within their neighborhoods and protect their communities’ long-term vitality.

According to Webb, there are currently 334 CLTs across the country, and though they are all unique in their operations, they adhere to the same model. “They all use this methodology of using public or private subsidy dollars to write down the cost of the home for the new homeowner,” says Webb. After the home is built, the CLT will “secure that subsidy by retaining ownership of the land, and creating a leasehold estate with the homeowner so that they can mortgage and finance the structure that’s on top of that land.”

One of the largest federal programs that supports CLTs across the country is the Federal HOME program. Webb points out that under the HOME program, oftentimes the federal government will allow the Participating Jurisdictions to set their own terms for the homes’ affordability restrictions. For various reasons and interests, these municipalities will range anywhere from five to 50 years. In a CLT, that automatically defaults to 99 years, and resets to 99 years for every individual that takes title to the property. “The moment that somebody either passes down or sells the unit, the new owner goes ahead and gets a new 99-year ground lease.”

In this manner, CLTs essentially hold land in perpetuity, since an individual would have to acquire property ownership at the age of one to reach the end of the lease period by 100.

Though CLTs are still primarily aimed at the low- and moderate-income homeownership market, Webb says that CLTs are increasingly utilizing ground leases to partner with affordable multifamily developers. “The Low Income Housing Tax Credit program itself actually favors the idea of separation of land and structure from a debt perspective,” says Webb, making this partnership more and more attractive as capital becomes increasingly costly for issues of inflation, interest rates, insurance and otherwise.

Webb points to West Side Community Land Trust in Charlotte, NC as an example of this innovative partnership. There, the West Side CLT set up a ground lease with The Paces Foundation, a Georgia-based developer, to construct a 120-unit senior housing complex, with rents restricted to those earning between 30 and 80 percent area median income.

The development was made possible after the West Side CLT was able to seek out and purchase land and partner with The Paces Foundation to work together and leverage the LIHTC program. Critically, as Webb notes, because of the ground lease structure, “it’s extending that 15-year period of affordability that LIHTC usually brings and extends that out to 99 years. It also allowed CLT to charge a monthly ground lease fee to that developer that worked within the pro forma in their operating budget to create a source of revenue for the CLT.”

This unique structure created a win-win-win arrangement in which the developer was able to benefit from the debt advantages leveraged by a ground lease, the CLT was able to set up long-term revenue, and the community at large benefitted from a significant boost to dearly needed affordable housing for seniors.

Another interface that multifamily affordable has with CLTs, Webb says, is when CLTs partner with other local entities to combine land holdings on one larger ground lease deal that they then work with a developer to build out affordable housing units. For example, Dudley Neighbors Incorporated, a CLT in Boston that Webb formerly directed, teamed up with a local CDC to combine their land “to get this deal done.” The resulting 50-unit complex served residents earning less than 60 percent AMI and sits on a major thoroughfare with rich access to transit.

“CLTs have been able to leverage the idea of purchasing or getting land donated and then being put into positions where they don’t necessarily need to do the development. Most CLTs don’t do development; instead, they partner with developers and bring land and sometimes financial subsidy to the table to make them permanently affordable, whether it’s through home ownership or rental.”

Webb notes that CLTs tend to go the furthest in communities undergoing wider revitalization efforts, particularly “when they’re brought in early enough to be able to purchase land at that naturally discounted price as things are being revitalized.” In this way, the CLT can “carve out that affordability for the long term.” This is not just true for urban areas; Webb points to rural areas, where large farmland is now being taken over for housing. “The community land trust is one of those mechanisms where folks feel like they also have control of their community’s destiny.”

However, Webb says that CLTs can work to carve out equitable and affordable housing “across the board,” so long as there is enough motivation and subsidy to meet high costs in certain markets. Webb encourages prospective developers interested in working with CLTs to visit Grounded Solutions’ recently launched CLT census map to identify local organizations to engage with the opportunities afforded by this unique structure. “We do feel like this model is a win-win. Even from a public policy standpoint of taxpayer dollars, it is a matter of using our taxpayer dollars to go and secure housing for five, ten, 15 years, or do we want to leverage those dollars for the longest possible term?”