Better than corporate bonds?

Buying an investment grade corporate bond certainly sounds like a sound investment, but is it really in light of the financial crisis we just endured? Many companies didn’t survive and when that happens your corporate bond is as worthless as the paper its printed on. The only guarantee that you have that you will have the return of your principal is the PROMISE of repayment by the issuing company. So why not get a return on your investment, typically at a higher rate of return (plus a return that can increase in nominal terms over time), not backed by a promise, but by something that will be around forever: LAND.

Real estate Land Leases are very similar to their cousin, the Triple Net Lease investment, but in my opinion with some great advantages. They are probably one of the safest investments outside of United States Government Bonds (some day perhaps even safer, but let’s not hope for that!). With a conventional Triple Net Lease property, you have invested in not only the land, but also have incurred the cost to build (or buy) the building sitting on the land. The tenant then leases the land and the building from you, which in turn provides you with a return on your investment for both the land and building.

Alternatively with a Land Lease, you own, and have invested in the land, but someone else (the tenant) has built a building on your land. You would not have out-layed the money to build (or invest in) the building…someone else did. That tenant would have spent a lot of money doing site improvements (utilities, parking lot, etc) plus would have built a building, all on your land and you wouldn’t have spent one dollar for all of those great improvements being placed on your property. The investment in such an investment property alternatively is just a fraction of what it would be for a Triple Net Lease property. The tenant would typically have a very long lease on your property allowing them to use and enjoy those improvements, improvements that they spent the bucks for, and pay you a lease payment for the use of your land. At the end of the lease all those improvements are still going to be still sitting on your property and become yours. So at the end of the lease term you get the improved site plus the building, neither of which you paid for! Accordingly you get all of those improvements without having had spent one dollar for them. You’ve got to like that proposition! Sounds better than a mere promise from some corporation who may not even be around in twenty years.

In my view, there are three distinct advantages for Land Lease deals over the typical Triple Net investment. With the Triple Net investment you would have invested in a building, which after the lease runs out, may have a lesser value than when you first bought it. The building would have depreciated and may additionally require some monies to renovate it for the next possible tenant. Accordingly your cost basis is certainly going to rise.  In the case of the Land Lease you never spent a dime to buy or build that building in the first place. At the end of the lease it just would become yours, so your cost basis in that building (assuming the same amount of renovation monies have to be spent as in the Triple Net case) is going to be far less. When it comes to time to lease the property again to another tenant that tenant is going to pay the same amount of rent whether the property was originally a Triple Net investment or a Land Lease investment. Your return on investment would be ‘through the roof’  better in the case of the Land Lease. The rent is the same but the investment would have been far less. Sure there are some distinct tax advantages that the Triple Net investor hopefully would have benefited from by virtue of taking some depreciation on the building, but still eventually some of those tax benefits may reverse themselves when dear Uncle Sam asks that you recapture the depreciation.

The second distinct advantage is really an extension of the first advantage and it deals with the risks of re letting the property. In the Triple Net investment case, you would have invested in the both the land and the building and our original tenant was provided you with a rate of return on that invested dollar. The next tenant is only going to pay rent on what the market conditions are now at. Sure it could be higher than they now are, but in many cases the market rate is going to be less. With the Land Lease investment (where you don’t have any cost basis in the building and site improvements) the odds are quite high that you will at least get a lease payment  equal to what the land lease payments were and probably a lot more (because here again you have a tenant paying for the use of the building-which you didn’t have spend a dime to build!). This rollover risk accordingly is much lower for the Land Lease investor.

The third advantage is that I believe there is a greater vested interest for the original tenant to continue to lease the property or find a replacement tenant for you, for they are the ones that invested all of their monies on your land.

There is of course an economic cost for having all of these benefits. It would be a typical expectation that the Land Lease investor to have about a 80-100 basis point lower return on investment than a comparable Triple Net deal. Lower risk, lower return, or as I see it: a lot lower risk for a somewhat lower return.

Regardless, it would also be typical to see a higher yield being paid on a Land Lease deal than a bond investor receives for the same corporation with the same maturity. It is also typical to see bumps in your land lease payments every five years, usually by 10%, something you don’t find in normal corporate bond offerings. In today’s market, you will find Land Lease yields in the 5-7% range. It’s like getting junk bond yields without the junk!

For even greater diversification and risk reduction, consider a portfolio of different Land Lease investments.

These are the reasons why I think Land Lease investments, with strong investment grade tenants, is one of the best real estate investments out there. To learn more and to structure an acquisition strategy to boost your yields please feel free to contact me.

Dougall McCorkle, MBA
Sales Associate and Commercial Specialist
Premier Commercial, Inc., Licensed Real Estate Brokers
Direct: 239.213.7234
Cell: 239.860.3368
dougall@premiermail.net