Recently I was hired by the executors of an estate to sell an apartment in a ground lease building on the Upper East Side. We’ve cleaned and staged the property, but as of this writing, we’ve chosen to wait before putting the unit on the market because there is too much uncertainty surrounding the renewal of the lease which expires June 30, 2010. I’ve been in this business since 1980, have sold in several landlease buildings in the past, but I’ve never heard of an instance where the co-op board and landlord waited until the 11th hour before coming to terms on a leasehold extension.
“That’s a reckless tactic,” says attorney Dennis Greenstein who specializes in co-op and condo law. “I’d have to read the actual landlease document to see what options are available to the co-op, but in theory, upon the expiration of the lease, it’s very likely that the shareholders’ tenancy will end, and their equity could cease to exist.” Greenstein characterizes ownership in a leasehold as “a diminishing asset.” As you move up in the years of the lease term and if no provisions have been made to extend the lease, then the property’s value actually depreciates. If the lease is allowed to expire, the landlord can take the property back, and the condo or co-op would no longer exist. The shareholders would revert to being renters and would lose their equity. Could a landlord force tenants out of their homes? That’s a very thorny question according to the attorneys I’ve surveyed.
A ground lease co-op or condop[1]is one where the underlying land is owned by a landlord and is leased to the cooperative or condop which pays rent to the landowner. Each leasehold situation is different, and each is governed by the lease agreement which spells out how much rent is to be paid and for how long—usually 50-99 years. The document also contains conditions for extending the lease and for increasing the rent at specified intervals and may also include a provision to purchase the land. Usually, the rent is calculated as a percentage of the property’s appraised value. If land values go up, increases will follow when the rent is readjusted along with corresponding increases in each unit’s maintenance fees.
There’s more uncertainty for apartment owners in ground lease buildings and also fewer tax advantages than for unit owners in fee simple co-ops. When the corporation owns the land, shareholders can deduct that portion of their maintenance that represents the taxes paid on the building as well as the interest paid on the building’s underlying mortgage. In a landlease building, the portion of the maintenance used to pay the ground rent is not tax deductible.
It’s also more complicated to obtain financing in ground lease buildings because of the associated risk that a landowner might decide to sell the land or not renew the lease. My bank sources say lenders generally want to see about 40 years left on the lease term. Similarly, it’s more difficult for a ground lease building to borrow money itself for any capital improvements, because lenders usually want the mortgage secured by both the structure and the land.
In the case of the co-op apartment owned by the estate that has hired me, there’s a dispute between the landlord and the shareholders about the value of the land and the term for the lease renewal—which is not a big surprise. The landlord says the land is worth more than the shareholders’ estimate, and the landlord will offer a 30 year extension, while the shareholders want a 99 year renewal. In all probability, this particular case will go to arbitration, and whatever the outcome, the shareholders will have to pay additional fees to attorneys, consultants and perhaps even bankers.
Ground lease apartments are not for everyone. However because of the uncertainties and limited tax benefits, apartments in landlease buildings cost considerably less than similar units in fee simple properties. Taxes are also less because the landowner pays these.
My colleague Susan Abrams, a shareholder herself at the ground lease co-op Tower East on 72nd Street who has sold 13 apartments in the building over the years, says, “You get substantially more for considerably less in a landlease building. You get to live in a grander apartment than you could otherwise afford, but you have to be comfortable paying higher monthly maintenance.” In Abrams’ estimation, prices for comparable apartments in fee simple buildings are at least 30% higher. For the apartment that she is currently listing at Tower East, she’s looking for a buyer with a high income who will be comfortable paying more in maintenance while giving up less liquid assets because of a significantly discounted price.
In the end, it’s really all about making informed decisions. It’s critical to understand the terms and conditions of a ground lease document. What are the provisions for extensions? How are rent increases to be calculated over the term of the lease? Are increases tied to market appraisals or to regular escalation? How stable are the building’s financials? How healthy is the reserve fund?
Hopefully the co-op board and landlord mentioned above will work past their current stalemate without going into costly and lengthy arbitration, and we’ll come to market and identify a ready, willing and able buyer who will pay a fair but discounted price.
[1] Relatively new on the scene are leasehold condops like 215 East 95th, 110 Central Park South, 995 Fifth, 445 Lafayette among others.