Insights Mar 9, 2021

Taking Advantage of Adding Ground Lease to your CRE Capital Stack

We are excited to announce the launch of our new series of podcasts interviewing leading industry experts whom we are privileged to have as clients and advisors. All of them have been in real estate lending and real estate finance for a long time and definitely have amazing stories and experiences to share with us. 

Today, I am pleased to introduce to you Andrew Weiss, the founder of Sapphire Capital Group, a boutique real estate capital advisory firm based in Bethesda, MD. 

We will hear about Andy’s fascinating career in the industry and about the niche business in CRE financing that Andy’s team are experts in Ground Lease Financing. I recommend reading till the end to learn how incorporating Ground Least in your capital stack will help sponsors save millions of dollars.

Who is Andrew Weiss

Andrew started his career back in the late 1980s after graduating from MIT business school. He started his career as a lender with Prudential, where he handled acquisitions and refinancing debt. Also, Andy was the analyst when the company went public. So he sat in the seat between the CEO and the investment bank, running the model to take the company public, which was an interesting experience to have at a young age.

In between, he worked for a private equity firm, CIM Group, a national private equity firm that invests in all sorts of real estate and development deals. He was with them during the recession. So spent a lot of time acquiring distressed debt, and then, he ended up refinancing most of CIM’s portfolio. After CIM, Andy worked for a large national mortgage banking firm, Meridian Capital, where he ran a DC office and worked on raising debt and equity on deals all over the country. Uh, that was in the early two thousand and he did lots of JV equity development deals for large projects in DC. He also ran a group that did multi-family loans, which is something that Meridian Capital is well-known for.

Ended his employed career working for Cantor Fitzgerald as a lender. And that was the timeframe which Cantor Fitzgerald ended up acquiring Berkeley Point, which was a big multifamily Fannie/Freddie lender. At Berkeley Point, Andy was originating CMBS loans for CCRE, which was the Cantor Fitzgerald subsidiary. 

Andy’s sat on all sides of the table. He understands what it means to be a borrower, mortgage broker, or lender, all of which he’s done. Yet, his real strength is that he is a relationship person and he has developed some very powerful relationships, ranging from high net worth individuals, family offices, and then larger institutional owners and equity sources. So by the time he left to start his own capital advisory business, he had a pretty powerful Rolodex, which he used to help his relationships and clients acquire and recapitalize properties.

Let’s hear about Sapphire Capital Group…

Let’s hear in Andy’s words: Sapphire Capital Group is a real estate finance company. All really seasoned professionals. And we take on assignments to raise debt and equity for owners and developers, who acquire and own real estate or do ground-up development. We typically take on assignments to raise debt and equity, and that ranges from multi-family situations with Fannie and Freddie or bank debt and JV equity. We work on larger deals with really institutional equity sources and smaller deals might be family offices or high net worth individuals.

We work on deals across the country, some in primary markets like DC, New York, San Francisco, but we also do secondary market deals. We’ve done a deal in Fort Myers. We look at deals in Richmond. I have deals in Philadelphia and in Jacksonville. Not every deal is going to be a $90 million ground lease. We’ve done $20 million ground leases. 

Andy is talking about some of the most interesting recent deals they’ve closed…

Deal #1: First deal that comes to mind is a $90 million acquisition in North Carolina of three separate multifamily projects. The sponsor was acquiring three projects that were all in the same sub-market. We took on the assignment to raise literally all of the capital. So we went to Fannie and Freddie and got quotes and ended up doing Fannie Mae’s debt on the three properties. Then we found a joint venture equity source that put up 90% of the equity. We hand-hold the sponsor on how to do a deal that was that large. We ended up bringing a high net worth individual who became a co-GP with the sponsor. So that person both signed on the debt and contributed more than half of the GP capital. Good properties, the good market in a relatively large deal, the sponsor needed help raising capital and we played a very active role. We put the numbers into our models and helped present the deal to all the different audiences. So that’s one deal where we raised probably 98% of the capital.

Deal #2: A client calls me one day and has a chance to acquire about 20 acres of land needed to close quickly. So, I got a high net worth individual to put up the bulk of the capital. The property had to get entitled and planned to develop a 400 unit, probably an $80 million multi-family project. Then we went out and did a JV equity deal. But the HNW investor stayed in the deal, going from the land acquisition to the entitlements, to the construction. 

So those are two recent deals that were stressful, interesting, but very successful.

Deal #3: The other deal was a pre-COVID, $95 million CMBS loan that I had in the process when COVID hit, unfortunately, the CMBS market shut down during COVID. I had picked a good CMBS lender. We kept in touch, kept doing weekly calls. Once the market opened up again, other than a couple of tweaks to the structure, we were able to close that in July 2020. So I had two large deals close, and we’ve been very busy. I have a private equity deal on closing for a sponsor on a property in Florida and have a portfolio of apartments in Texas that I have a term sheet for JV equity. Not everything we do is ground lease capital, but ground lease capital is definitely my niche and the thing that I’m very focused on.

So again, a lot of my theme is just because I’ve been in the business so long and I’ve gone to conferences and I’m a social guy and keep in touch with people, I’ve got pretty powerful Rolodex of both owners and developers, and then on the capital side of starting with lenders to high net worth individuals, family offices, and growing to the big institutional equity sources.

What is the deal with guitars:)…

Now the guitars. The guitars are my crowd-pleaser for my zoom call. The PRS is the Porsche and the Robin on the other side is probably the BMW:)

 I’ve played guitar since growing up in New Jersey in high school, and this one is a PRS, my favorite one, and have a bunch of guitars and still play in a band. And unfortunately in COVID playing at home is a lot more than playing out, but, hopefully, that’ll end in 2021 and I’ll be playing at my favorite spot Old Angler’s inn where we’re, we’re sort of the pseudo house band.

FINALLY!!! WE ARE TALKING GROUND LEASES… 

I’m excited to talk about this. First of all, ground leases have been around forever. So it’s not the ground leases are new, but sort of the way CMBS changed and people call it CMBS 2.0 when all the rules changed and the underwriting became more onerous and more structured. Same thing with ground leases. Ground leases now have become more popular. There’s one public company called Safehold, that has done a lot to educate the industry. We’ve done a couple of deals with them. In 2017 we took on an assignment on a hundred million dollar multi-family acquisition in DC. The sponsor had a $67 million loan application from Fannie Mae. So he needed $33 million of equity. DC is very competitive and it was a very expensive purchase. And although it was a good sponsor and it was a good property, it was hard for him to raise equity.  The sponsor asked me to help him with the project. What we did, which was different, as we broke the investment into two pieces. We brought in a $40 million ground lease investor, so that left $60 million to raise. We went back to Fannie Mae and they agreed to lend $42MM. All of a sudden, it went from a $33 million equity needed down to an $18 million equity raise. A big difference for the client! And because of the math and the way the numbers work, which I’ll explain, the returns went up from roughly a five cap on buying it as a fee simple property to roughly a 5.6 cap of buying it as at least sold with the ground lease investor. That made it all fall in place. We helped them raise the equity and we closed. And that was sort of the first large ground lease deal I did.

The idea of using Ground lease in the capital stack to reduce the amount of equity that the sponsor needs is a huge game-changer. If structured properly, you can reduce the amount of equity that the sponsor needs and you can increase his returns

Andrew Weiss, Sapphire Capital Group

A couple of things I learned from that process, just simply the idea of reducing the amount of equity that the sponsor needs are a huge game-changer. So if structured properly, what we know how to do, and with our powerful Rolodex of investors, you can reduce the amount of equity that the sponsor needs and you can increase his returns. Back to the first deal, the $40 million ground lease investor came in properly structured. We were still able to get a Fannie Mae loan.  The combination of the ground lease investor and the Fannie Mae loan got the sponsor up to roughly 82% leverage and made the returns go from a five cap to a 5.6 cap. That allowed him to raise the equity where otherwise, without this ground lease investment, he probably would have had a hard time raising the equity.

How does the ground lease capital actually work?…

Typically, in a transaction where the ground lease investor is brought in, they acquire the land and enter into a 99-year ground lease with the sponsor. A couple of factors that go into that is they negotiate the amount of the ground lease investment, and that’s typically based on two stats. One is the coverage. So the NOI from the property divided by the ground rent, you want that to be at least 3:1. In the case above, remember the numbers, the NOI was roughly $5 million and the ground rent was about $1.4 million. So you had a very safe, comfortable relationship between the NOI and the ground rent. The ground lease investor is viewing it as a AAA bond. So they know that things would have to get pretty bad for the sponsor to be defaulting on the ground rent. It’s a passive investment, and it’s going to be paying interest like a bond. The other couple of facts. You typically want the NOI to ground rent to be at least 3-to-1. And in this case, the ground lease investment was just under $40 million. The total property was worth a hundred (million), so less than 40% of the loan to value of the ground lease investment divided by the fee simple value of the property. 

Who should use the Ground Lease strategy…

Types of Deals

It really applies across the board. Ground leases work great for acquisition because it reduces the amount of equity that the sponsor needs to bring to the table. It also works really well for recapitalization. So if a sponsor owns a property and they’re thinking of raising money for another deal, the recapitalization of a property with the ground lease capital and the leasehold debt can all come out tax-free. Wealthy owners should also consider Ground Lease if they’re going to go do a development deal. It’s harder to raise money for development deals. If they own existing properties that they can recapitalize, it can work great to recapitalize the existing property. 

Ground lease capital works great for acquisition because it reduces the amount of equity that the sponsor needs to bring to the table. It also works really well for recapitalization. If a sponsor owns a property and they’re thinking of raising money for another deal, the recapitalization of a property with the ground lease capital and the leasehold debt can all come out tax-free.

Andrew Weiss, Sapphire Capital Group

Development deals are harder, but we’ve also done it on many development deals. We did a large development deal in DC where the sponsor was developing a $125 million budget. They were putting together the different players and it made sense for them. It was a $30 million ground lease investment as part of the whole $125 million budget. That worked out great.

Pre COVID, there were a lot of ground lease investors that loved hotels because hotels typically the daily rate, and the hotel occupancy is going to go up. The hotel rate is going to go up with CPI, so they love the idea that the ground rent increases are going to be offset by the increase in the NOI from the hotel, which is typically going up with CPI. I am sure they will come back post-Covid.

Tax benefits

Ground lease in your capital stack also has good tax benefits because the ground lease capital plus the new leasehold loan can all come out tax-free and not trigger capital gains tax. So there’s also a whole tax side of this, which is advantageous for the sponsor. 

Ground Lease during downtime…

Raising money during COVID has been hard. My Ground Lease niche, actually, has been very helpful for lots of people, that we’ve closed deals with. The lending community, which I’m very, very close with, shut down in March and it was very hard to get a loan on anything. Across the board, Fannie Freddie and everyone else was having problems. 

We worked with sellers to get intros to potential buyers of their properties because the ground lease structure could allow those buyers to pay more. Given, the ground lease capital worked for their particular deal. It doesn’t work for every deal, but when it works, it can be very powerful. 

So we were at the right place at the right time. When COVID hit, a large DC Metro project was under contract and the buyer, although unbelievably successful and well known, was having issues with financing. Two zoom calls later, I was able to help a large multifamily owner in the DC region close on a $280 million multi-family acquisition by bringing in $90 million of ground lease capital. So it could be financed with a Freddie Mac loan. We closed a $90 million ground lease capital, a $125 million Freddie Mac loan on this 500 plus unit project in DC that closed into the second quarter in 2020. 

And again, the ground lease capital deals are complicated because the ground lease has gotta be tweaked and modified in this case, really to accommodate and to work with the issues that Freddie Mac had with it. Myself and my team are experienced and we were able to do what we needed to do so that the ground lease capital could be used in this case to significantly reduce the amount of equity he needed to close. 

Importance of working with expert-advisors when incorporating ground lease in your capital stack… 

Ground leases are a little harder to structure. It’s complicated. 

Ground leases 1.0 did get a bad rep and had some problems. Lots of wealthy owners in New York, for example, would say to the acquirer, I’m not a seller. I’m not a seller. And eventually would say, okay, I’ll ground lease you my land, and you can build something on it. And many of those, not everyone, but many of those ground leases had things like ground rent, resets, and land appraisals. So the ground lease would include a provision that would say, after year 30, we’re going to appraise the land. And the ground rent is going to be the blank percent of the new appraised value of the land. 

We do things differently. First, our ground leases are structured. When you agree on a year one ground rent, it’s typically going to have an annual escalation, 2-3%, and the ground rent is going to go up each year. The important bottom line is if ground leases are not structured properly, they can create problems. A lot of the people that in the industry remember the problem that happened as a result of ground leases. 

Another thing that we bring to the ground lease deal is a negotiation of, what I call, a repurchase option. A lot of people get scared: “if I’m going to sell my land and my ground rent is going to go up every year, eventually it could become a problem when the ground rent has escalated to an amount that makes it hard to finance the property”. We’ve been successful at negotiating a repurchase option for a sponsor. Meaning they close on a 99-year ground lease, but they’re going to have a one-time right in year 25 to buy back their land at a pre-negotiated formulaic price. This is a game-changer for our clients. 

There are many large institutional funds that raise billions of dollars and don’t necessarily want to reduce the amount of equity. They may prefer to do with the old-fashioned way of just putting in 40% equity and go get a 60% loan. And if that works perfectly why change it? And there’s something to be said for that, if you’re sitting on $5 billion of equity and you’re the equity investor, you can be selective and decide what you want to do. I respect that. 

But I do think for the sponsor if structured properly, ground lease reducing the amount of equity is probably the biggest factor to help the sponsor make more money. In most of my sponsor relationships, borrowers and owners care about making money, and they want to figure out how to put in less equity and get to the promote or get to their returns quicker.

Every deal is different and every deal has its own nuances to it. So it’s not one size fits all. Each deal is sort of unique, but a couple of things I’ve mentioned on this call, allow us to be very confident that on a real estate deal that makes sense, we can figure out how to use the ground lease capital to reduce the equity and improve the sponsor’s returns and, make it good for both sides. At Sapphire Capital, we have the expertise and a pretty powerful Rolodex of ground lease investors that will do retail deals, office deals, multi-family deals, even hotels.

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