July 3, 2011

When You Rent *and* Own


Is leased land under a building a reason to
get cold feet? Or a bargain opportunity?

The invitation for the cocktail party at the Azure, a new Upper East Side condop building, called for a celebration — “Una Gran Fiesta!” — but it was really more of an entreaty. Prudential Douglas Elliman’s Jacky Teplitzky, who’s marketing apartments in the building, had learned that only a quarter of the calls inquiring about the project were coming from brokers and their clients. (Usually, it’s more like three-quarters.) Soon she discovered that a major issue wasn’t the project so much as its underpinnings. The building has a land lease, meaning that residents pay rent for the ground on which it stands instead of owning it outright, as most co-ops and condos do.

Land-lease buildings are getting the stink-eye these days, mostly because of their maintenance fees — “Not only are you paying the mortgage on the building, but you’re also paying rent for the land,” typically adding 20 percent or so, explains StreetEasy’s Sofia Song — and complicated ownership structure. “A lot of attorneys have a visceral reaction: Stay away, there’s too much liability here,” says real-estate lawyer Sandor Krauss. Banks have followed suit, and it has become difficult lately to get a mortgage in some land-lease buildings. “There are a lot of question marks, a lot of hesitation,” admits Teplitzky. “Even if buyers get comfortable, sometimes they’re talked out of it.” Hence her little fiesta, which was meant not just to serve margaritas but also to educate prospective buyers and their reps.

The obvious fear, for buyers, is that the owner of the land will hold the building hostage when it comes time to re-up the lease. In the worst-case scenario, he or she would simply refuse to renew the lease, presumably (though not realistically) causing the building to be demolished. A more likely scenario: You own an apartment in the building, and when you’re trying to sell, buyers hesitate because they fear a spike in the ground rent a few years down the road. Or they are concerned about their prospects of selling to the next buyer, who will have the same concern.

It’s not just an academic point, either. Prices in land-lease buildings are showing a noticeable and steady attrition of value. According to StreetEasy, one East 72nd Street co-op—whose ground lease has 96 years to run!—has seen its median price per square foot tumble from $1,066 (based on seven sales) in 2006 to $500 (based on three sales) in 2011. Same story for another on East 63rd Street ($665 in 2006; $242 in 2011). Appraiser Jonathan Miller says that in a weaker market like we have now, “if you have other options, and they make sense, you see more of a hit in land-lease buildings.”

Of course, if you read the numbers differently, they reveal buying opportunities. Land-lease apartments run anywhere from 15 to 30 percent cheaper than their counterparts. Krauss, who himself decided to buy a land-lease apartment after much research, says it depends on the terms and length of the lease. Some have clauses calling for automatic renewals, and those are less risky, especially if the increase is specified. (Ideally, there’d be a clear schedule of how rents will rise and by how much.) Buildings with an option for the co-op to buy the land are also preferable, especially if there’s cash in the reserve fund. Attorney Lior Aldad says that some offer tax benefits, too, mitigating the higher maintenance fees. And, of course, you have to ask how far off the expiration date is. Sixty, 70, 99 years away: Chances are you, and even your potential buyers, will be long gone.