The future for ground rents is positive

Posted by Knight Frank Newcastle on 17th December 2019 -

As a result of legislative change, investment into residential ground rents has become less attractive and commercial buildings now offer a more interesting and flexible proposition. Hotel ground rent deals have been hitting the headlines in recent times but in fact, the entire commercial sector is opening up with offices, leisure, student accommodation, healthcare, retirement living, care homes, garden centres and even activity camps all offering ground rent investment opportunities.

Investment in commercial ground rents, whilst previously limited to astute investors who were ahead of the curve, has become more commonplace. Knight Frank research estimates that the ground rent market totalled £865 million in 2018. 

Initially commercial ground rent investment was limited to specialist long-income investors looking for alternatives to commercial bonds and index linked gilts due to the negative returns they have offered in recent years. Shrewd investors have adapted their strategy and invested in commercial ground rents which provide the same long-term inflation linked cashflows but at a significant premium. A 30-year index linked guilt today yields minus 1.46% vs commercial ground rents yields of c2.5%.   

Commercial ground rents have now become a mainstream investment, with a much wider pool of buyers recognising this lucrative and long-term income stream, which is low risk and less sensitive to the property cycle than traditional property investment. The scale of demand is pushing buyers into European markets, as seen by the recent launch by Long Harbour of its first European Ground Lease Fund.

Ground rent investment has traditionally been held back by lack of available stock but with increased portfolio transactions from private equity firms in the last few years there are more opportunities available.

We are now starting to see more examples of long-leasehold sales. We recently completed the sale of a Travelodge in Harlow, which was on a 983-year-long lease with 5-yearly uncapped RPI reviews. This received lots of interest from a wide-range of buyers and sold at a minimal discount to freehold value.

One of the recent innovations that we have seen in the ground rents arena is that investors are offering their tenants more flexibility in the structure. Whereas previously the only option would be an incredibly long lease, with 125 years as the average length, we are now seeing more options. This includes opportunities for buybacks - either at a £1 or at a price which shows the investor a targeted return; and we’ve also seen buybacks at 50 years, as well as differing rental levels and forward fundings. This not only helps the tenants but helps with bank financing. With more flexibility and awareness of the appeal of commercial ground rents, I predict that there will be even more options and flexibility in the structure of future deals.

Operational businesses are particularly well-matched to ground rents deals as they have an underlying income which tracks inflation, making them ideally suited to keeping pace with inflation-linked rent reviews. The property is critical to the operation of these businesses and therefore they are unlikely to become functionally obsolete in the short-to-medium term.

At Knight Frank we have already seen a substantial demand for commercial ground rents, in the last three years we’ve been involved in over £512 million worth of deals.

There is no doubt that the commercial real estate ground rents conversation has evolved and there will be significant opportunities for investors to take advantage of the strength of the investment market and the new flexibility being offered. The future of ground rents looks positive.