Is Europe ready for a ground lease revolution?
William Astor, Chief Executive, Long Harbour , 02 November 2020
Is Europe ready for a ground lease revolution?
William Astor, Chief Executive, Long Harbour
The concept of ground leases, a structure of property ownership that separates the value and title of land from the assets that sit on it, has long been a fundamental part of the UK’s real estate system.
In large European markets such as Germany (now the largest real estate market in Europe), however, the concept of ground leases has been around for a long time but is less developed. Europe therefore has a large pool of untapped freehold, owner-operated, high quality, income generating assets that are well suited to ground leases and attractive to investors.
But can the UK model work in Europe?
We believe it can, in part through better structured deals. Extending lease terms that remove refinancing risk and rebalance asset reversion terms can reduce the cost of capital and provide a simpler structure that is more attractive to landowners. Along with the commercial advantages, we believe this approach will help to open the market for ground leases and significantly increase the number of transactions in 2021.
In an era of record low or negative interest rates, investors are increasingly seeking alternative sources of long income which offer the qualities traditionally associated with corporate or government bonds.
In real estate, the significant weight of pension fund capital seeking such investments is rapidly opening up a relatively new market for ground leases in continental Europe.
The structure is also attractive to landlords and real estate asset managers looking to unlock capital. By selling the freehold and taking on a ground lease, a landlord is able to free up the capital tied in the land, and invest it in other parts of their portfolio or further acquisitions. This provides a unique financing structure to landlords, reducing the need for refinancing and the interest rate risk, and can also lower their weighted average cost of capital (WAAC).
In the current climate, with bank liquidity making finance more difficult to secure, the ground lease structure offers an alternative way of raising capital and long-term fixed funding for the real estate market. Unlike debt, ground leases are also a form of capital that do not have to be amortised.
The principle of ground leases as a structure for landlords and asset managers applies across almost all real estate sectors, including residential, hotels, leisure, office and retail. One of its main advantages is its flexibility.
Through the Long Harbour Euro Secured Income 1 Fund (“LHESIF 1”), an open-ended fund with a target of €400m of acquisitions in European ground leases, we are actively targeting European markets where we see the potential for high demand from landlords including Germany, The Netherlands and Ireland.
There remain a number of challenges to the growth of ground leases in Europe. While there is a strong commercial case in support of the ground lease concept, there remains a lack of understanding of the product in many parts of Europe.
However we believe the practical limitations in Europe, particularly the complexity of agreements and restrictive covenants, can be overcome and the UK experience can be transferred to European markets. At Long Harbour we are doing this by offering modern ground leases in a way that will make it easier for landowners and investors to make the switch to a ground lease structure.
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