Ground leases are becoming common in commercial real estate. From office towers in major cities to industrial projects in fast-growing markets, many deals today separate ownership of the land from ownership of improvements. While this structure can create opportunities, it also adds underwriting complexities that many investors underestimate or ignore. If you are analysing a leasehold property, a standard real estate pro forma may not suffice.

This article explains how ground lease underwriting is different from traditional non- groundlease underwriting, why common assumptions can become unreliable, and what lenders, borrowers, and investors should evaluate before closing a deal.

What Is a Ground Lease?

In a ground lease, the landowner keeps ownership of the land and leases it to a tenant, usually for 50 to 99 years. The tenant then develops and operates the property built on that land. In this setup, the tenant owns the leasehold interest, while the landowner owns the fee interest, also called the leased fee interest.

When the lease expires, ownership of the building and improvements usually transfers back to the landowner unless the lease is extended. This creates reversion risk, which is one of the biggest factors affecting ground lease underwriting.

Ground leases are commonly found in:

• Retail and fast-food properties where the land is owned by municipalities or universities
• Office and mixed-use developments built on institution-owned land
• Industrial and logistics facilities on government or port authority land
• Hotel and resort properties in expensive coastal markets
• Public-private partnership and affordable housing projects

Why Standard Underwriting Assumptions Do Not Work for Leasehold Properties?

When underwriting a non-ground lease property, investors assume the owner controls both the land and the building forever. With a leasehold property, that assumption changes completely. Since the land is leased for a fixed period, many traditional underwriting methods become irrelevant.

The Cap Rate: In a non-ground lease property, the cap rate reflects the long-term income potential of both the land and the building. But in a leasehold structure, the tenant’s ownership rights are temporary. Once the ground lease expires, the income stream may end or change significantly.

This creates these important differences:

• A leasehold property is usually worth less than a similar non-ground lease property
• Using standard market cap rates can overvalue a leasehold asset because most comparable sales are non-ground lease deals
• Leasehold cap rates are often higher than non-ground lease cap rates to reflect the additional risk

The difference between leasehold and non-ground lease cap rates can vary based on: remaining lease term, ground rent escalation structure, renewal options, reversion terms at lease expiration. One common mistake is treating a leasehold property like a premium asset and applying an aggressive cap rate. In reality, investors usually require a higher return because of the limited ownership term. For this reason, many appraisers use discounted cash flow (DCF) analysis instead of direct capitalization when valuing leasehold properties.

LTV and Leasehold Financing Challenges: Lenders face additional risks when financing leasehold properties because the collateral has a limited life. In a non-ground lease deal, the land keeps its value indefinitely. In a leasehold deal, the lender’s collateral can disappear when the lease expires or if the lease is terminated due to default. This creates the following complications:

Important Lender Protections

To make a leasehold property financeable, lenders usually require strong protections within the ground lease agreement, in the absence of which lenders may reduce loan proceeds or decline the deal entirely. These include:

• Notice and cure rights so lenders can fix tenant defaults before the lease is terminated
• New lease rights allowing the lender to enter into a replacement lease if needed
• Non-disturbance agreements that protect the tenant and lender if the landowner changes
• Lender approval rights for major lease modifications

Ground Rent Escalation Can Negatively Impact Future NOI: Ground rent is usually fixed at the beginning of a lease, but it increases over time based on terms written into the agreement. These escalation structures can vary significantly from one ground lease to another, and this is where many underwriting mistakes could potentially happen. The most common escalation structures are:

• Fixed percentage increases, such as a 10% rent increase every five or ten years
• CPI-linked increases tied to inflation
• Percentage rent structures tied to tenant revenue or property NOI
• Fair market value resets, where rent is recalculated based on current land value

Among these, FMV resets create the highest risk. The impact goes beyond simply paying higher rent. Since ground rent is treated as an operating expense, any increase directly reduces net operating income. Unlike repair costs or vacancy losses, ground rent cannot be delayed or controlled because it is a contractual obligation. As a result, a property that initially appeared to generate a strong yield may see returns compress significantly after a rent reset, even if occupancy and rental income remain stable. This decline in NOI can affect multiple underwriting metrics at once:

• Debt service coverage ratio (DSCR) may weaken and potentially violate loan requirements
• Property valuation may decline because the income approach reflects lower stabilized NOI
• Refinancing proceeds may shrink, creating additional equity requirements at maturity

For this reason, ground rent should never be modeled as a flat expense throughout the hold period. A strong leasehold underwriting model should project multiple escalation scenarios, including stressed FMV reset assumptions, and test how each scenario affects NOI, DSCR, refinancing ability, and investor returns before capital is committed.

Exit Assumptions Become Quite Complicated: This is one of the areas where leasehold underwriting mistakes happen most often. Many investors model the future sale of a leasehold property the same way they would model a non-ground lease asset. But as the ground lease term gets shorter over time, the property becomes less attractive to buyers and lenders, which can reduce the exit value significantly. Several factors affect leasehold terminal value:

• The remaining lease term declines during the hold period
• Reversion risk increases as lease expiration gets closer
• Financing options become more limited for future buyers
• Buyers usually demand higher cap rates to compensate for added risk

As the remaining term declines further, buyers start factoring in these factors that can reduce the exit price:

• The future cost of extending the lease
• The possibility of renegotiating terms with the landowner
• The cost of purchasing the land outright
• Increased refinancing risk

A strong leasehold exit model should account for the remaining lease term at sale, the availability and economics of renewal options, the potential cost of extending the lease or buying the fee interest, and the likely lender and buyer demand at exit. These assumptions can materially change projected returns and should be analyzed carefully during underwriting.

Some investors underwrite a future purchase of the land as part of their exit strategy. In this scenario, they plan to buy the fee interest during the hold period and eventually sell the property as a non-ground lease asset. While this strategy can improve value, it also requires careful analysis of acquisition cost, negotiations with the landowner, tax considerations, and additional capital requirements.

Subordinated vs. Unsubordinated Ground Leases

Ground leases are generally structured in one of two ways: subordinated or unsubordinated.

Subordinated Ground Lease: In a subordinated ground lease, the landowner agrees that the lender’s mortgage will have priority over the landowner’s fee interest. Because of the additional risk to landowners, subordinated ground leases are relatively uncommon today. This structure:

• Makes financing easier for the borrower
• Gives lenders stronger collateral protection
• Transfers more risk to the landowner

Unsubordinated Ground Lease: In an unsubordinated structure, the landowner’s fee interest remains senior to the leasehold mortgage. This structure is much more common in institutional ground lease transactions. Because lender protections are weaker in unsubordinated leases, mortgageability provisions become extremely important. This means:

• The lender only has rights to the tenant’s leasehold interest
• The lender does not gain ownership of the land in a foreclosure
• The lender effectively steps into the tenant’s position under the lease

The Growth of Institutional Ground Lease Capital

Over the past decade, institutional investors have become much more active in the ground lease market. Dedicated ground lease investment platforms now provide specialized capital solutions that function as an alternative to mezzanine debt or preferred equity. These platforms usually:

• Purchase the land beneath an existing property
• Create a long-term ground lease with the property owner
• Structure leases with long durations, often around 99 years
• Include CPI-linked rent escalations and renewal options

For sponsors, this can lower upfront capital requirements and unlock additional financing flexibility. However, it also creates a permanent ground rent obligation that affects cash flow, valuation, financing, and exit assumptions throughout the investment period.

Key Underwriting Checklist for Ground Lease Deals

Before investing in a leasehold property, underwriters should carefully review the following areas.

Lease Structure

• Total lease term and remaining lease term
• Renewal options and extension conditions
• Ground rent escalation structure
• Rent reset provisions
• Reversion terms at lease expiration
  
  

Financing Feasibility

• Mortgageability provisions within the lease
• Remaining lease term compared to lender requirements
• Expected LTV adjustments for leasehold collateral
• DSCR and debt yield under stressed rent scenarios
  
  

Valuation Analysis

• Comparable leasehold transactions instead of non-ground lease comps
• DCF modeling tied to remaining lease term
• Separate valuation of leasehold and fee interests
• FMV rent reset stress testing
  
  

Exit Planning

• Remaining term at projected sale date
• Future lender and buyer demand
• Probability and cost of buying the fee interest
• Exit cap rate premium compared to non-ground lease assets

Common Leasehold Underwriting Mistakes

1. Using Non-Groundlease Comparables: Leasehold properties trade differently from non-ground lease assets because of their limited ownership structure. Using non-ground lease comparables can inflate value assumptions and create refinancing problems later.
   
   
2. Ignoring FMV Reset Risk: A single fair market value reset clause can dramatically increase ground rent and reduce property cash flow. These provisions should always be modeled carefully.
   
   
3. Assuming a Large Buyer Pool at Exit: Leasehold assets typically attract fewer buyers and lenders, especially as the remaining lease term shortens. Exit assumptions should reflect this reduced market depth.
   
   
4. Miscalculating Remaining Lease Term: Many investors underestimate how quickly lease terms decline over time. A lease signed decades ago may already be approaching levels where financing becomes difficult.
   
   
5. Treating Ground Rent as Fixed: Ground rent often changes over time and should be modeled dynamically. Assuming flat rent throughout the hold period can significantly distort returns.

Ground lease underwriting requires a very different approach from traditional non-ground lease underwriting. The limited nature of the leasehold interest, changing ground rent obligations, financing complexity, and terminal value risk all make these deals more sensitive to underwriting assumptions. Applying standard non-ground lease underwriting methods to leasehold assets can lead to overly optimistic projections and unexpected losses later in the investment cycle. At RealVal, we help investors and lenders navigate complex leasehold transactions with detailed underwriting, cash flow stress testing, and valuation analysis tailored to ground lease structures. Our team can help you identify risks early and underwrite with greater confidence, write to us at info@therealval.com to schedule a consultation.