How ground leases became “ticking time bombs” for iconic properties

Rent resets can increase costs to unsustainable levels

Jan.January 22, 2019 03:00 PM

From left: Chrysler Building at 405 Lexington Avenue, 625 Madison Avenue, and Lotte New York Palace Hotel at 455 Madison Avenue (Credit: Pixabay and Google Maps)

When the Abu Dhabi Investment Council and Tishman Speyer decided to put the iconic Chrysler Building up for sale this month, the four-fold rent hike they saw last year certainly contributed to the decision.

After paying $7.75 million in 2017, the building’s owners saw their rent bill balloon to $32.5 million last year. That number will rise to $41 million in 2028 and $55 million by 2038. The owners’ current ground lease with Cooper Union, which has owned the land since 1859, expires in 2147.

The Chrysler building is far from the only ground-leased Manhattan property that is facing major rent hikes in the near future. A common scenario involves rent increases based on the land’s “fair market value” – which owners may have never expected to rise as high as they have when they signed on to these deals decades ago.

When SL Green Realty’s ground lease at 625 Madison Avenue hits a market value reset in 2022, its ground rent with Ashkenazy is expected to rise from $4.6 million to $21 million. In 2026, the Lotte New York Palace hotel will see its rent payments to the Archdiocese of New York reset to fair market values as well.

“These fair market-value resets have in essence become ticking time bombs,” Cushman & Wakefield’s Doug Harmon told the Wall Street Journal.

These looming rent hikes can cause further problems with refinancing or attracting new tenants, and are often based on the land’s potential use as a site for luxury condos, rather than their current, less lucrative use.

Aby Rosen’s RFR Realty, for example, had trouble refinancing 390 Park Avenue because he was unable to refinance the property. The ground lease was set to increase from $6 million to $20 million in 2023. Brookfield Properties and Waterman Interests took over the ground lease earlier this year. Rosen’s RFR still controls the building.

Ground leases continue to be a fixture in real estate investment, though developers have begun negotiating protections to avoid the pitfalls of traditional rent resets. This can lead to complex, “mind-bending” negotiations, and can also reduce competition for otherwise attractive sites.

These century-long deals have been particularly attractive to multigenerational land owners such as families, educational institutions and government entities. Cooper Union, for example, earned three times as much from the Chrysler Building as it did from tuition last year. The school may soon be able to restore free student tuition, which it had to cancel in 2014 due to financial difficulties. [WSJ] — Kevin Sun

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