Crack Open The SAFE

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Summary

  • Most every property sector has certain risks and it’s the investors job to pay close attention to the underlying fundamentals to determine whether or not he or she is comfortable.
  • For the landowner, a ground lease provides a stable income stream typically from a creditworthy tenant, while still allowing the landlord to retain ownership of land.
  • Another benefit to land owners is that ground leases normally have a reversionary clause, which transfers ownership of the improvements to the landlord at the end of the lease.

As many of you know, I am the epitome of a “sleep well at night” investor and I actually created a portfolio geared specifically for REIT investors with a low tolerance for risk. Arguably, risk comes in many shapes and sizes, so it’s up to the individual investor to determine his or her own definition of risk, and how it fits within their portfolio.

One of the ways that we analyze REIT risk is by comparing various fundamental tools such as dividend safety, balance sheet discipline, earnings growth, etc… We also developed our own scoring system for evaluating the competitive advantages for REITs, and we will soon be automating the “Rhino Rating” system that will serve as a valuable tool for dedicated REIT investors.

As you know, each reach REIT property sector has its own risks to consider, and investors must recognize that certain sectors have elevated risk. For example, malls and shopping centers are subject to higher tenant turnover today because of retail store closures and bankruptcies. Similarly, certain healthcare REITs (namely skilled nursing-focused REITs) are considered higher risk because of operator margins and macroeconomic pressures.

In fact, almost every property sector has certain risks and it’s the investors’ job to pay close attention to the underlying fundamentals to determine whether or not he or she is comfortable with the risk they are taking.

As a developer for over twenty years, I encountered a number of interesting deals that intrigued me, and one of the most interesting (and rewarding) were ground leases. As a developer, especially in the south, ground leases are rare and more common in places like New York City or Hawaii.

Although it might seem odd at first for a developer or tenant to construct a building on land that is owned by someone else, there are good reasons why a ground lease is advantageous to all parties involved.

Perhaps the biggest advantage for tenants is that a ground lease provides access to well-located land that otherwise could not be bought. This is why ground leases are widely used by many big retail tenants such as McDonald’s, Chick-fil-a, and Starbucks.

Another advantage of a ground lease is that the tenant does not have to come up with the upfront cash required to purchase the land in a deal. This lowers the upfront equity required in an investment, freeing up cash for other uses, and also improving the yield.

For the landowner, a ground lease provides a stable income stream typically from a creditworthy tenant, while still allowing the landlord to retain ownership of land. Usually, ground leases have built-in escalation clauses and eviction rights, which give the landowner adequate rent increases over the term of the lease as well as further downside protection in the event of a default.

Another benefit to landowners is that ground leases normally have a reversionary clause, which transfers ownership of the improvements to the landlord at the end of the lease.

Key points of ground lease structure:

  • Tenant leases the land on a triple net lease basis and operates the building for the duration of the lease.
  • Landlord collects ground rent payments, typically including contractual escalations and/or percentage rent payments during the lease term.
  • At lease expiration, or upon a tenant default, landlord continues to own the land, and the title to all improvements thereon reverts to the landlord. Ground leases are often extended throughout the duration of the lease term.

Source: SAFE website

The Ultimate Sleep Well At Night REIT

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