Real Estate Tip – Ground Leasing Part 2: By-Agreement & Percentage-Rent Options

In our last real estate tip, we discussed the importance of good rent adjustment methods in long-term ground leases. Today, we look at the pros and cons of two rent-adjustment options:

The By-Agreement Method

In a 2012 Hawaii case, a landlord sued a tenant claiming that a by–agreement rent adjustment was not working. The real story, though, is that for 50 years a Hilo shopping plaza manager and his ground landlord had been able to agree on their rent adjustments. The by-agreement method provides that every five years (or other agreed-upon period) the landlord and tenant set a new rent amount. The parties may use an appraisal to help them reach an agreement, but if they do not agree, the rent is set by arbitration. Landlords benefit because they are not tied to a fixed percentage increase or an economic indicator, both of which often reflect market conditions poorly. The primary risk is the difficulty of matching subtenants’ rent adjustments to the ground lease adjustment.

Percentage Rent Method

In a 2009 ME ground lease with a 200-year term, the only rent the tenant paid is a percentage of gross sales of the businesses on the land. The primary benefit of the percentage-rent method (to both the landlord and the tenant) is the inherent fairness of rent that constantly adjusts to reflect market conditions. Possible risks for the landlord include below-market performance by the businesses, tenant records that make gross sales hard to verify, and the need for unusual remedies, such as the use of a receiver (if the business flounders).

Today’s real estate tip is brought to you by Rick Smith, a LEED Accredited Professional and member of Bernstein Shur’s Real Estate Practice Group and Green Building Team. Stay tuned for more useful tips for real estate professionals.

For more information on ground leasing, contact Rick at rsmith@bernsteinshur.com or 603 623-8700 ext. 8829 or 207 774-1200.