Friday Thoughts: Getting in at the ground floor

Pramerica bought the Park Plaza Riverbank Hotel ground lease in 2010. Photo credit: Pramerica

[Editor's Note: The following is commentary]: Ground rent or ground lease deals have been moving into the mainstream with great effect at companies such as PPHE Hotel Group, putting them into a strong position in the London market, which they and their shareholders are appreciative of. And we can thank those institutional investors who have no interest at all in changing the sheets or dropping another mint on the pillow, but would just love to enjoy the success story that is hotels.

And so the love would seem to continue, skipping toward a sunset which, at 200 years, is very far away indeed. A sunset into which even the shadow of a flying car is likely to be hopelessly retro, great-grandpa.

But for all the sober deals at PPHE and Grange, there will be those who put the party at risk for everyone, deals that have been done when development costs hit an unexpected Indian burial ground, deals where the idea of selling out the ground beneath you becomes the only option.

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It is these deals where there are concerns. We have heard tell of deals where the horizon is closer than 200 years away and nearer to 50 or 30 years. This is no longer a quiet piece of cheap borrowing in the background. This is close enough to feel the heat of the looming debt and close enough for those who would provide them to have a significant say in what happens on property, what happens on sale—and how appealing a hotel is— and also have an influence on the value.

At the moment, in a low-interest-rate environment, interest rates are, well, low. Great. Better if, as in ground-rent deals, your rent increase is linked to inflation. Less good if it suddenly goes all Weimar Republic and you’re pushing money around in wheelbarrows to pay for bread.

One hopes to avoid this, of course, but, as CBRE’s Tom King told our IHIF newsletter, a ground rent is a known quantity. In an unstable environment, other costs are wont to rise. Rent could be the straw that breaks the camel’s back, particularly for those already on hairy margins. And then buyers may be thin on the ground.

This was underlined at a DLA Piper event last year that saw Robert Stapleton, director in the hotel agency at Savills, comment that one of his clients had described them as, “The biggest cancer in the hotel industry.” Stapleton said, “They acquire the asset, get the most secure slice of the action, and then trade the ticking time bomb on to someone else”.

There is also an IFRS 16 factor to continue and we can all appreciate how thrilled you are to hear that. If the agreement includes a collar—ensuring that rent uplifts do not exceed a maximum (protecting the tenant) or fall below a minimum (protecting the investor)— it has to go into the books as a long-term liability. Not so simple, but also no more complex than it has to be. 

Investors’ motivation in getting into ground-rent deals is a desire for a quiet life, a life with regular hot meals, sitting by a warm fire, with maybe an aged gun dog at their feet. They have no appetite for drama, just a reasonable rate of return. They want to avoid the highs and lows of hotel performance and enjoy the steady increase in property values. Expect a focus on established players in established markets and raise a querulous eyebrow to the rest.