Why Owning A Land Lease Building Does Not Have To Be Scary
Property developers and landlords are furious about the land owners jacking up their lease payments.
In a move straight out of the Tony Soprano business handbook, owners of some of Manhattan’s prime commercial real estate are finding their secure investments are not quite as secure as they imagined. The reason is that they do not own the land on which their multi-billion dollar properties stand. And their landlord is milking them for all they can.
As land prices surge in Manhattan, commercial landlords are finding that the fine print in their contracts are causing them to rack up millions of dollars in additional payments while their lawyers hang their heads in shame. The issue is that some of the biggest landlords—such as SL Green who are in the process of building a 3 billion dollar tower next to Grand Central Terminal—are themselves renters. The vague language that they signed off on, in order to charge the tenants in their buildings rent, now allows the land owner to increase SL Green’s rent according to soaring land prices in the Big Apple.
Part of the reason for the increase is that Manhattan’s commercial hubs, such as Midtown, have also evolved into lucrative residential development areas, as reported by Crain’s. The land can now command much higher rents than both the landlord and developer imagined. Only the landlord safeguarded themselves in writing—whereas the developer did not.
“The land under 625 Madison Avenue—a tower owned and operated by SL Green—is absolutely one of the best development sites in Manhattan,” says Michael Alpert, president and vice chairman of Ashkenazy Acquisition Corp. “In addition, the ground lease has a very clear valuation clause.”
Unsurprisingly, SL Green opposes this view. “625 Madison has been a great investment for this company since the day it was acquired, and we have every expectation it will continue to perform for the company well into the future,” says Andrew Mathias, SL Green’s president. “Expectations of astronomical prices and rents in the future are pure speculation and not representative of the current market.”
Such disagreements are common place. The recourse for the building owner is to pass their additional costs on to their tenants, which, depending on their lease agreements, could be difficult.
In some cases, such as in Trump Plaza, a co-op at 167 East 61st Street, the co-op owners, depending on their means and influence, can structure their own buyout of the land. That would leave them in the odd position of being both partial co-owners of their co-op building and owners of the land on which it resides.
Case in point—Marc Cooper, a vice chairman of the Peter J. Solomon Company, and his building. The rent for the land was scheduled to balloon in 2023 tripling maintenance fees and affecting the co-op’s value. Cooper, became the board’s president and realized his objective in helping cobble together $190 million in cash to buy the land underneath the building.
“We took a storied building from what could have been the depths of despair and restored it to where it is now, on par with some of the best buildings on the Upper East Side,” Mr. Cooper told the New York Times. An easier solution, of course, would have been to sell the co-op and pay cash for a condo in a building with no ground lease. But then again—when money is no object, why take the easy route?
The New York Times report that approximately 100 buildings in Manhattan have land or ground leases. The residential buildings are mostly co-ops, although the list includes some condominiums. These buildings tend to have high monthly carrying charges because of the rental payments for the land. And as the co-ops do not pay real estate taxes, shareholders cannot deduct as much from income taxes as shareholders in typical co-ops do.
Choosing to buy a land-lease co-op is ultimately a trade-off. There are no tax deductions for land payments but the the purchase price is considerably lower than those not on a land lease. However, the maintenance is high and liable to rise based on the whims of the land owner. Depending on the terms of the rental lease for the land, a land-lease property may not be a bad move. In an appreciating market, a buyer can get in for a lower price than elsewhere and sell well before the rents for land go up. In London, the concept of land leases are nothing new. In particular, in Central London—Westminster and Knightsbridge—most of the land is owned by the monarchy, with no option for individuals to buy it out.
It’s a complex process. Who would want to purchase a property not knowing how much their maintenance will increase, which bank would want to finance a mortgage for a co-op or condo, and unaware if the mortgagor would be able to afford it?
“Banks are a little bit wary of land-lease buildings,” Ace Watanasuparp, the regional manager for Citizens Bank told the Times. “If a buyer takes a 30-year mortgage, but the land lease only has 17 years left, who knows what will happen.”
One strategy for co-op owners in a land lease building where the maintenance fees are being jacked up to pay for the land is to rent it out. Some co-ops frown on subletting, whereas others allow it—but for a only a certain period of time.
Land lease buildings are normally more lenient towards renters. If the owner has a favorable mortgage with a decent rate—or has already paid much of it off and has a lot of equity—refinancing as an owner occupant, pulling out some cash and then renting it out so the tenant absorbs all the mortgage and maintenance costs, could be one option. The owner could then put a down payment on another primary residence which may wind up being less expensive than the first. When the land lease of the former building is paid off, the co-op will own it and maintenance rates should drop. Two properties for the price of one. Sort of.
Another favorable scenario would be to buy a land lease apartment before the renegotiation of the land contract. Once the contract is renegotiated and extended, the value of the property will increase. This was the scenario laid out in a Brick Underground article, where an owner’s property value instantly increased by $90,000 when his lease was extended by additional 66 years.
If you’re a worrier with an aversion to risk, an apartment that sits on a land lease may not be for you. If, on the other hand, you have an inside track on the landowner’s willingness to negotiate, it could be the easiest equity you ever made.
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