The subject of ground leases has shown up a number of times in the previous few weeks. Numerous A.CRE readers have emailed to request for a purpose-built Ground Lease Valuation Model. And I remain in the procedure of producing an Advanced Concepts Module for our property financial modeling Accelerator program covering the mechanics of modeling ground leases. So I thought now would be an excellent time to share my Ground Lease Valuation Model in Excel.

This design can be used standalone, or added to your existing property-level model. In any case, it is valuable for both landowners aiming to size a ground lease payment or leasehold owners aiming to comprehend the worth of the (i.e. enhancements) relative to the cost simple interest (i.e. land).
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Excel design for assessing a ground lease

What is a Ground Lease and Leasehold Interest?

If you not familiar with the principles of Ground Lease and Leasehold Interest, I'll refer you to the definitions in our Glossary of CRE Terms:

Ground lease - "A lease structure where a real estate investor leases the land (i.e. ground) only. When it comes to a ground lease, generally one party owns the land (i.e. charge basic interest) while a different party owns the improvements (i.e. leasehold interest). In a lot of cases, the owner of the land leases the land to the owner of the improvements for a prolonged duration of time (20 - 100 years)."

Leasehold Interest - "In real estate, a leasehold interest refers to a structure where a specific or entity (lessee) leases the land (i.e. ground lease) from the fee simple owner (lessor) of the land for a prolonged time period. The lessee of a leasehold estate will generally own the improvements on the land and utilize the land and enhancements as if the lessee were the owner of the land. During the term of the ground lease, the lessee will pay rent to the lessor for use of the land. At the end of the ground lease term, the lessee needs to return use of the land, and any improvements thereon, to the land owner.

Ground leases prevail to prime areas, where landowners do not always wish to offer but where they might not have the expertise (or desire) to operate. Thus, they rent the land to somebody who owns and runs the improvements on the land, and get a ground lease payment in return. You see this rather often with office complex in the downtown core of major cities.

Another case where you'll encounter ground leases are in retail shopping centers. Oftentimes, popular retail renters choose to develop and own their area but the developer doesn't necessarily want to offer the land. So, the retail renter will accept rent the ground for 40+ years and build their own building on the rented land. Banks, national dining establishments in outparcels, and big outlet store are examples of renters that often consent to this structure.

Quick Note: Not interested in DIY analysis? Consider working with A.CRE Consulting to manage your bespoke modeling job.

How to Use the Ground Lease Valuation Model

All areas of the Ground Lease Valuation Model are contained on one worksheet. This is deliberate to enable you to place this design into your own property-level model to make it simpler to add a ground lease component to your analysis.

All analysis is carried out on the tab entitled 'Ground Lease'. A 'Version' tab is also consisted of where you can see a modification log for the model, as well as find important links associated with the model.

The Ground Lease worksheet is separated into seven areas as laid out and explained listed below:

The Residential or commercial property Description area includes 5 inputs related to the financial investment. These inputs are:

SF/M2 - In cell I3 enter whether the procedure of size is in square feet (SF) or square meters (M2). Residential or commercial property Name - Name of the investment. It prevails in realty to add the name of the investment with (Ground Lease) to represent that the investment is for the charge basic interest in land with a ground lease. Address - Address, city, state/province, zip/postal code, and nation. Land Size - Total SF or M2 of land. The number of acres or hectares will than instantly be calculated in cell E6. Leasehold Net Rentable Area - Total net rentable area in SF or M2 of the physical enhancements (i.e. the leasehold). The land is presumed to be owned by one individual or entity, and the leasehold interest (i.e. improvements) to be owned by a separate person or entity. So for example, you might be thinking about obtaining the land on which a Target Superstore is built. Target owns the building and is renting the land for some extended time period. The overall rentable area of the building is the 'Leasehold Net Rentable Area'.

Section 1 - Residential Or Commercial Property Description

The Investment Timing section consists of four needed inputs and one optional inputs. These inputs relate to the chronology of the ground lease and investment.

Ground Lease Start Date - The month and year when the ground lease started. This should also be the month and year of the first payment. Next Ground Lease Payment - The month and year when the next ground lease payment is due. Ground Lease Length (Years) - The length of the ground lease in years from ground lease beginning through ground lease maturity. This is the total length of the ground lease, not the number of years remaining. The maximum length is 100 years. Based upon the ground lease length, the model then calculates the Ground Lease End Date (i.e. maturity date). Analysis Start Date - The month and year that the analysis is to begin. This normally is equivalent to the Next Ground Lease Payment date, although the design was developed to enable for analysis to start prior to the Next Ground Lease Payment date. Analysis End Date - An optional input, this is by default the Ground Lease End Date. In the event you're examining a much shorter hold duration, just change the orange font cell I17 to the preferred analysis end date.

Section 2 - Investment Timing

The Ground Lease Terms section includes business terms of the ground lease, including payment quantity, frequency, and lease boosts. This section includes 5 inputs plus the option to by hand model the lease payment quantities.

Initial Payment Amount - The quantity of the first lease payment. Depending upon the payment frequency input (see listed below), this amount might be for a yearly or monthly payment. Lease Increase Method - The technique utilized to design lease boosts. This can either be: None - No rent boosts. % Inc. - A percentage increase over the previous rent quantity. $ Inc. - An amount increase over the previous lease amount. Custom - Manually design the rent payment amounts by year. If Custom is chosen, the annual rent payment quantities in row 26 end up being inputs for you to manually alter (i.e. font style turns blue). Important Note: If you select Custom and begin to change the yearly lease payment amounts in row 26, there is no chance to revert back to another Lease Increase Method.

Section 3 - Ground Lease Terms

It is within the Valuation (Fee and Leasehold) area where you determine the reversion worth of the land (i.e. ground lease), the present worth of the land (i.e. ground lease), and the imputed worth of the leasehold interest. This area is broken up into three subsections, with five inputs and one optional input throughout the three subsections.

Ground Lease Reversion Value - Within this subsection you model the value of the residential or commercial property as if there was no ground lease. Or simply put, a normal direct cap appraisal of a property investment. Inputs consist of: Current Net Operating Income (Annual Before Ground Lease Payment) - Enter the yearly net operating earnings derived from leasing the enhancements, exclusive of any ground lease payment. Market Cap Rate - The cap rate for the residential or commercial property, as if no ground lease was included. The concept being to get to a worth of the residential or commercial property before representing the ground lease. Retenanting Costs (Nominal) - At the end of the ground lease term, the ground lessor will get back the land plus any improvements on the land. What will it cost (i.e. Retenanting) to retenant the residential or commercial property in today's expense (i.e. before inflation). Retenanting may consist of basic leasing expenses, it may consist of remodelling and leasing, or it may consist of taking down the structure and rebuilding something new. The idea is to arrive at a 'Net Reversion Value (Nominal)' after representing the expense to retenant. Reversion Growth Rate (Annually) - All of the above computations are done before accounting for inflation (i.e. growth). Enter a development rate here, and the 'Net Reversion Value (Nominal)' will be grown to get to a 'Reversion Value (Adjusted for Growth)' utilized as the reversion worth in the ground lease present worth estimation. Reversion Value (Adjusted for Growth) - Optional Input. The reversion value utilized in the ground lease present worth calculation. It is calculated by taking the residential or commercial property worth net of any retenanting expenses, and then growing it by a growth rate. The worth is an optional input in the event you wish to customize the reversion value.

Discount Rate - The discount rate at which to compute today value of the ground lease money circulations. Consider this discount rate as an obstacle rate (i.e. necessary rate of return) for a ground lease financial investment.

Section 4 - Valuation (Fee and Leasehold)

The Ground Lease Returns (Unlevered) section permits you to calculate the unlevered (i.e. before financial obligation) returns of a ground lease investment. If you are thinking about purchasing a ground lease, it is within this section where you can enter your acquisition/investment expense, and see the matching returns from that financial investment. The section includes just one input.

Ground Lease Investment Cost - This is the cost to acquire land with a ground lease. It needs to consist of the acquisition expense, together with any other due diligence, closing, and pursuit costs associated with the financial investment.

After going into the Ground Lease Investment Cost, the section computes 5 return metrics:

- Unlevered Internal Rate of Return

• Unlevered Equity Multiple
• Net Profit Average Rate of Return
• Average Free-and-Clear Return
  
  Note that the resulting returns are highly reliant on the analysis period, payment schedule, and reversion worth.
  
  Section 5 - Ground Lease Returns (Unlevered)
  
  The Ground Lease Returns (Levered) area enables you to calculate the levered (i.e. with debt) returns of a ground lease investment. If you are considering purchasing a ground lease and plan to fund the purchase, it is within this area where you can enter the financial obligation assumptions, and see the matching return from that levered investment. The area includes 3 inputs.
  
  Ground Lease Permanent Loan Amount LTV- Enter the loan-to-value of the ground lease mortgage, and the model will calculate the loan amount.
• Annual Rate Of Interest - The annual rate to be paid on the mortgage. Note that the design currently just permits an interest-only loan.
• Interest-Only Payment (Annual vs. Monthly) - Enter whether the mortgage payment will be due regular monthly or every year.
  
  After getting in the debt presumptions for the ground lease investment, the section calculates five return metrics:
  
  - - Levered Internal Rate of Return
• Levered Equity Multiple
• Net Profit
• Average Rate of Return
• Average Cash-on-Cash Return
  
  Similar to the unlevered analysis, the resulting returns are highly based on the analysis duration, payment schedule, and reversion value. The amount and rate of the financial obligation will likewise greatly drive the levered return. And as a tip, for now the design only permits financial obligation with interest-only payments and a balloon at the end of the analysis period.
  
  Section 6 - Ground Lease Returns (Levered)
  
  The last section is where backend inputs utilized in the different information validation lists are found. Unless you plan to customize the model, there is no factor to change the values in this section.
  
  Section 7 - Data Validation
  
  Video Walkthrough - Using the Ground Lease Valuation Model
  
  In addition to the written guidance above, I have actually created a short video that walks you through the various sections of the design. Note that this video is based on v1.0 of the design.
  
  Download the Ground Lease Valuation Model
  
  To make this design available to everyone, it is used on a "Pay What You're Able" basis with no minimum (go into $0 if you 'd like) or optimum (your support helps keep the content coming - normal real estate appraisal designs cost $100 - $300+ per license). Just get in a rate together with an e-mail address to send out the download link to, and after that click 'Continue'. If you have any concerns about our "Pay What You're Able" program or why we use our models on this basis, please reach out to either Mike or Spencer.
  
  We regularly update the design (see version notes). Paid contributors to the design get a new download link through e-mail each time the design is upgraded.
  
  Version Notes
  
  Version 2.33
  
  - Rewrote 'Flying Start Guide' with updates and for enhanced readability
• Updates to placeholder values
• Fix to misspelled word on Version tab
  
  Version 2.32
  
  - Removed redundant details in E17: G17.
• Updated I22 to show more precise years of term remaining.
• Updates to placeholder worths
  
  Version 2.31
  
  - Further revisions to reasoning in I59
  
  Version 2.3
  
  - Fixed issue where the OFFSET() range in the optional formula for 'Reversion Value' (I59) was missing the last cell
  
  Version 2.2
  
  - Revised formula in M26: DG26 to resolve for issue when payment is Monthly and not % Inc (thanks to Accelerator member JS for the fix!).
• Updates to placeholder worths
  
  Version 2.1
  
  - Updates to placeholder values.
• Added additional notes under 'Quick Start Guide' to clarify typical confusion around start dates for different sections.
• Misc. formatting updates
  
  Version 2.0
  
  - Moved 'Analysis Start', 'Analysis Period', and 'Analysis End' inputs above Ground Lease dates for enhanced user experience.
• Added a 'Quick Start Guide' to supply a tutorial for utilizing the model.
• Renamed 'Lease Increase Method' to 'Lease Payment Increase Method' for clarification purposes.
• Renamed 'Ground Lease Reversion Value' to 'Current Fee Simple Value and Ground Lease Reversion Value'.
• Added 'Investment Term' assumption to enable financier to analyze returns on an Analysis Period shorter than the Ground Lease term - Renamed 'Investment Timing' to 'Valuation Timing' to separate in between evaluation and investment returns.
• Renamed 'Analysis Start Date' to 'Valuation Start Date', 'Analysis Period' to 'Valuation Period', and 'Analysis End' to 'Valuation End'.
• Updated heading formatting to better distinguish between Valuations areas and Investment Returns sections.
• Adjusted return formulas to make vibrant to Investment Hold Period
  
  Version 1.0
  ozarkia.net
  - Initial release
  
  About the Author: Spencer Burton is Co-Founder and CEO of CRE Agents, an AI-powered platform training digital colleagues for commercial real estate. He has 20+ years of CRE experience and has actually underwritten over $30 billion in property across leading institutional firms.