Are Apartment Buildings on Ground Leased Land Bad Investments?

Around the Palm Springs area, there are a number of multifamily properties sitting on land that is owned by someone else.  In my conversations with investors, many of them immediately lose interest when they find out about the ground lease.

Are they jumping to conclusions? Maybe.

The worst-case scenario, a real possibility, is that the owner of the ground lease refuses to extend the lease and takes the property away from the investor. And, to be fair, they could.

However, I've never heard of it. (If you have, I'd like to hear about it.) Really, not once have I ever met, or heard a story about, a hostile acquisition..

Instead, the ground leasor usually wants cash-flow, not the management. There's a formula (in the cases I've seen) based on a percentage of the assessed value, a number which is calculated into the net operating income and cash flow of the property. At the end of the lease, or well before the end, the lease is extended.

So, when the property is sold, there's actually an opportunity for the buyer, the new investor, to get a deal by playing the hostile acquisition card.

Every investment, whether it's an apartment property or baseball cards, can be represented by a simple cash flow estimate. Every investment requires an investment (a negative, or an arrow pointing down). Then, hopefully, each year afterward, there's positive return (an arrow pointing up). At the end, when the investor sells the property for more money (that's how it's supposed to work), there's a big arrow pointing up.

In a ground lease, there may not be a big arrow pointing up at the end, if the ground leasor assumes the ownership of the property.

However, the investment may still have been a good deal for the investor; it depends on the acquisition price.

The buyer can justify a low offer by, properly, claiming that the ground leasor may not extend the ground lease, and the future value will be zero. The seller cannot promise, on behalf of the ground leasor, that all future leases will be extended. He doesn't have that authority. In any case, the value of the property is only that of the improvements, not the land, so the price should be less than comparable fee-simple properties.

A smart buyer can make low bids, and get excellent properties, with some faith that ground leases are generally extended by ground leasors. It's a gamble; but so is all of investment. It's a good bet.

Mayor of Palm Springs decides not to run again

Real estate and public officials -- the guys with the money and the guys with the approval power. Born buddies.

The mayor of Palm Springs decided to not run again after a story leaked out about his taking consulting money from a developer and not mentioning it to the council before he voted for the developer's projects.

http://www.desertsun.com/story/news/local/palm-springs/2015/05/08/palm-springs-mayor-steve-pougnet-re-election/26994771/

The developer is the Nexus Companies, the owner of the Hard Rock Hotel in Palm Springs.

http://www.prnewswire.com/news-releases/hard-rock-international-and-the-nexus-companies-announce-palm-springs-hotel-development-55959457.html

So, how did this happen? They thought no one would notice? Or care?

I'm not on my high horse about this, because I'd like Palm Springs to develop. I'm sorry that the mayor didn't use better judgment -- like, declaring it and getting general approval in advance.

136 units in Palm Springs available

I like this deal, and I like the property.


It's located two blocks from Indian Canyon, and the downtown Palm Springs tourism and entertainment scene.  Built in 1980, the structures look good, and surrounding properties are up-scale condominiums and good hospitality.


The numbers look good to me:

• Positive leverage: this is what we call it when the cap rate is greater than the loan interest rate. In other words, the investor is making money on the loan. 
• Rents are increasing: the market is very strong for apartment properties, with low vacancy and increasing rents.
• Location, location... oh, you know: not only is the property close to the Indian Canyon corridor, it's adjacent to The Courtyard, the site of the International Film Festival and the Tahquitz Road business community. I walk this area for enjoyment and exercise regularly.
• Cash on cash: a buyer may well buy the property for less than the asking price, and raise rents, and end up with a, say, 17% cash on cash return (this measures the net annual cash flow divided by the down payment, a good rule of thumb comparing investments). This could be the best deal around in a large apartment property.

It'll take a couple of million to get the property, but it may be the best two million an investor can place. Call me for more information.