Rates are higher, banks are tighter, and construction costs haven’t come down nearly enough. Senior loans that once stretched to 70–75% of cost now size off tougher DSCR and debt-yield hurdles, while mezz and pref come with double-digit coupons and hairy refi risk. The result: developers are being asked for equity checks that are larger, scarcer, and more expensive. There is, however, a contrarian way to manufacture safer leverage: a well-structured ground lease. Done right, it can finance ~80–85% of project cost at a blended single-digit rate, without setting up a painful refinance later.
1) Why the Traditional Stack Is Strained
- Rate shock meets cost inflation. Construction spreads remain wide and all-in coupons bite. Banks and debt funds are leaning on higher debt-yield and DSCR thresholds and trimming LTC.
- Equity scarcity. LPs are selective, hurdle rates are higher, and capital is competing with risk-free alternatives.
- Junior capital is expensive. Mezz/pref fills gaps but often pushes total cost of capital into the teens and increases take-out risk.
Bottom line: certain projects pencil operationally but fail under today’s capital stack, unless sponsors find cheaper, durable leverage.
2) Ground Lease 2.0: Low-Cost, Perpetual Capital Hidden in the Land
What it is. The developer leases (rather than buys) the land, typically on a 99-year term, from an institutional land investor. The ground lessor’s purchase price is based on rent coverage and an implied cap rate, not just appraised land value.
Why it matters. The lessor’s upfront payment frequently represents ~25–35% of total development cost and functions like non-recourse, non-maturing capital. There’s no principal to refinance; the obligation is relatively fixed ground rent with a modest per annum escalator.
How it unlocks leverage. Pair ~30% ground lease proceeds with a 50–55% leasehold construction loan and ~15–20% equity. The annual rent, often mid-to-high 4%s to ~5% in recent institutional quotes, reduces NOI modestly at stabilization (commonly ~20–25% hit versus fee-simple), but the gain in cheap, permanent “land capital” more than offsets it.
Why lenders can like it. Leasehold lenders underwrite a smaller loan against NOI net of ground rent. That can produce stronger DSCR / debt yield and a lower effective LTV on the loan than an equivalently high-leverage fee-simple structure. Agencies and select banks/life companies have become increasingly comfortable, if the lease is financeable (long term, clear cure rights, predictable escalations).
3) The Upside: Where Ground Leases Shine
A. Safer leverage at scale Consider a $100MM development:
- Stretch-senior model: 85% LTC one-stop = $85MM loan to refinance at take-out.
- Ground lease model: $30MM ground lease + $55MM leasehold loan + $15MM equity. At stabilization, only $55MM needs refinancing; the ground lease stays in place. This cushions cap-rate drift and value volatility.
B. Better loan metrics With NOI already net of ground rent, the leasehold loan typically benefits from higher DSCR and lower effective LTV than a comparable 85% fee-simple loan, improving execution and refi durability.
C. Lower weighted average cost of capital Blend ~4.75% (ground lease) on ~30% of the stack with ~SOFR+300 bps-type construction debt on ~55%. For ~85% of the capital structure, the WACC often lands in the high single digits, materially cheaper than senior+mezz or stretch-senior alternatives, and with less take-out risk.
D. Equity efficiency Less common equity per deal means higher ROE and the ability to do more projects. Sponsors frequently see step-ups in equity IRR and multiples when the lease is sized and priced correctly.
4) The Trade-Offs: What Can Go Wrong (and How to Mitigate)
1) Financing complexity & lender selectivity Not every lender will touch a leasehold. Expect a narrower lender universe and occasional spread premiums. Mitigation: keep ground rent ≤ ~20% of stabilized NOI (multifamily rule of thumb), negotiate lender-friendly provisions (non-disturbance, cure rights, transfer consents), and target experienced ground-lease counterparties with a track record.
2) Recap flexibility If a deal stumbles, adding rescue capital can be harder because the ground lessor is a senior stakeholder. Mitigation: where feasible, negotiate buyout/option mechanics (e.g., around initial loan maturity) and reasonable consent standards to facilitate future capital solutions. A buyout provision at year 20 or 30 could still could create similar recap friction if a development project has issues.
3) Exit valuation & buyer pool Leasehold interests can trade at a cap-rate premium versus fee simple, often modest in core markets with long terms and institutionally accepted forms, wider in secondary markets. Mitigation: use ground leases on core-quality, high-demand locations, ensure very long remaining term, predictable escalations, and extension/buyout options if possible. Underwrite a conservative 25–50 bps exit spread if market acceptance is uncertain. Note: There are examples of leaseholds on ground leases with no buyout options that traded at par to freehold cap rates of comparable assets so one could debate their are other value drivers then this mechanism.
4) Permanent, inflexible expense Ground rent is due in good times and bad. In a downturn, it can consume a larger share of revenue. Mitigation: prioritize resilient asset classes (multifamily, necessity retail, mission-critical industrial), push for CPI-linked or thoughtfully stepped escalations, consider limited lease-up deferral features, and size conservatively.
5) Practical Structuring Guide: A Short Checklist
- Purpose fit: Use for durable cash-flow assets in supply-constrained, institutionally deep markets.
- Sizing discipline: Target ground rent under ~25% of stabilized NOI; avoid oversizing the lease.
- Term & economics: 99 years (or equivalent with unilateral extensions), fixed/CPI-based escalations without surprise resets.
- Financeability: Explicit leasehold mortgagee protections, cure/notice rights, assignability/transfer standards, and non-disturbance.
- Flexibility valves: If obtainable, negotiate buyout/repurchase options or extension mechanics aligned with likely refi windows.
- Stakeholder education: Socialize the thesis early with LPs, lenders, and future buyers to avoid execution friction.
6) Who Benefits: Sponsors, Lenders, and LPs
- Sponsors: Can stretch equity further, improve returns, and de-risk take-outs. The trade-off is complexity and discipline, the lease must be sized and drafted to be lender-friendly and exit-ready.
- Lenders: Get a smaller, better-covered loan against NOI net of rent. Institutions that build leasehold expertise can capture high-quality flow with strong basis.
- LPs/Buyers: Enjoy higher ROE from cheaper leverage but should underwrite illiquidity and exit spread. In core markets with modern forms, the cap-rate penalty can be minimal; elsewhere, price the complexity.
Conclusion: Leverage Without the Hangover
Modern ground leases are not a silver bullet. They are a precision tool. Used in the right markets, on resilient assets, with financeable terms and disciplined sizing, they convert “dead” land equity and more into patient, low-cost capital. The payoff is a single-digit blended cost of capital across most of the stack and a more forgiving refinance, exactly what today’s constrained environment demands. For developers and investors willing to do the upfront work, ground leases are potentially becoming a mainstay of modern real estate finance: leverage that behaves more like ballast than a burden.
