Need some guidance on setting price for a ground lease

[Ryan Morlino]

I need some advice on pricing rent for a ground lease with a 99 year term.  Let me give a little background info first.

My wife and I recently built and rented two houses on land belonging to my in-laws.  The agreement has been that we would lease the land from them for a percentage of gross income.  We plan on building more houses on this property over the years, so the lease payment would go up as we expand (but fixed percentage).  The houses were rented out on the first of this month, so we are late in getting this ground lease done, but it has all been done in good faith and we have their full support.

Neither party really has a great feeling for what our rent should be and no one is trying to make money off of the other, however, we are all trying to be fair with each other.  The best method I can come up with for pricing a ground lease is estimating the market value of the land, coming up with a reasonable number of years to return 100% of property value (ie. when the cumulative rent payments equal market value), and dividing that out into a monthly payment (which would then be turned into a percentage of gross income).

For example, if the property we are leasing is valued at $50k, using a 10 year break even term, monthly payments would be $417 ($50k / 10 years / 12 months per year).

Does that seem like a reasonable strategy to price a ground lease?  If so, what would a good return period be for the lessor?  7 years, 10 years, 15 years?

Also, I've read about some ground leases having terms where rent is paid up front in a 99 year term (full market value) with the right to purchase the land at a future date for a nominal amount.  Would it be unreasonable to ask for a mix of this and a typical ground lease, where we would pay monthly rent until market value has been reached, at which point rent would go away?  Sort of like a rent-to-own, but ownership would never change, only rent would go away.

Thanks for any insight you can offer!

[Deanna McCormick]

I would suggest your wife's parents put the property in a trust, similar to what my parents did,, the land ownership is transferred into the name of the trust,, the parents have the right to manage how the trust is divided upon their deaths, your wife's share ( if other siblings are involved) would be stated as a percentage.. all operating costs are paid by the trust,, all income is paid into the trust the trust is a tool for them to use to as a financial plan for the future. Honestly if you don't think this is possible talk to a trust lawyer. 

So the rent you are thinking of paying to them for income isn't important.. why pay them land rent if they have to then claim that income for rent as a taxable income.. 

My parents bought a property for my sister,, the cost of the house, lot rent, taxes, she never paid,, but an accounting was done where those amounts were kept track of and were deducted from her inheritance, they had other properties also but this was one way they could provide for her, have control of that asset for taxes, and still designate it for her after they died. so you could set up something similar maybe if your in-laws knew the benefits of this estate planning. 

You say you own the houses built on their property,, What if you leased those houses to the Family Trust,, the trust would rent the houses out,, and from that income they would pay you for property management of those properties. The trust can take off expenses for your management fees. You can lease the properties to the trust at a break even cost so your not showing a gain, or maybe even better lease to them at a loss so you have a loss for a few years.. 

Otherwise I would have the entire property appraised for land value,, and write up a contract for deed for purchase of the land, make it long term, small payments and balloon due after death of last parent, so the inheritance would cover that cost. So doing that way the value of the property at the time  you took control was already set, you would not have a adjustment either up or down so nobody can contest if property would jump high in value at a later date..

LOTS to consider.. why you built before you had this taken care of is a mystery.. but their is a way to figure it out.. make it tax and estate wise.  Also a trust does not have to go thru probate. which makes things nice.