Ground leases – The case for and against

What is a Ground Lease

When governments recognise they are not property developers there is a structure to achieve development of some significant public sector property assets without development risk for government whilst retaining control of the properties.

The structure involves a sale of the air-space by governments to a developer with strict controls imposed for the permitted development whilst the government retains ownership of the land.  The developer’s “purchase price” of the air-space often reflects an annual rent of the land (ie. ground rent) with the rent amount attached to the performance of the property allowing the government to share in some of the “upside” in developing the asset with minimal risk and without losing control/ownership of the land.

The developer’s airspace rights are secured by a long term lease, sufficiently long to become an asset or “bankable security”.

Ground leases have been typically used by governments to encourage development of land for specific land uses whether heritage restoration of office buildings or hotel development where required with a ground lease structure that grants the developer a form of ownership (ie. leasehold interest) and allows the government to retain ownership of the land (ie. freehold interest).

Consequently, the government retains a significant asset (land) with a long term, low risk cashflow (ground rent) generated, gains a property for public benefit with a compliant land use (ie. gains a defined building in the ground lease) and carries little default risk given the value of the developer’s asset in the air-space.

The Need and Formulation of Ground Leases (The Rocks Case Study)

The NSW State Government has utilised ground leases to encourage defined development that includes heritage preservation throughout The Rocks district and development in Darling Harbour.

In the early 1970’s a union organised Green Ban assisted to prevent extensive demolition of heritage buildings throughout The Rocks.  The outcome preserved a significant number of heritage buildings in government ownership in varying states of deterioration requiring substantial capital and property development risk to restore with heritage sensitivity and commercial reality sufficient to attract tenants.

The solution that avoided any government capital outlay and transferred development risk to developers was found in the ground lease structure where developers obtained “ownership” for a price significantly less than the property (land and buildings) value in recognition of the commitment to outlay significant capital and subsequently lease the restored asset.

Ground Leases – “The Case Against”

Although property development via a ground lease structure has been well established for many years, there are still higher costs associated.  Typically banks will impose higher lending costs for their perception of the risk premium (compared to freehold title) and purchasers of the resulting leasehold will typically outlay a lower price.

Sub-division of the building (ie. strata title leasehold) results in lower sale prices for office suites and residential units than the freehold equivalent.

Ground Leases – “The Case For”

The success of the ground lease structure is evident today in The Rocks with a high office occupancy rate within heritage listed buildings with impressive restorations completed by developers where government retains land ownership and control.

The NSW State Government receives an ongoing cashflow from the ground rents linked to a combination of (statutory) land value and gross rents received for 50 to 70 years (balance of 99 years) and developers have created buildings (offices and hotels typically) that have been traded as (leasehold) investments by sale to subsequent owners since initial works completion.

Any Future Use for Ground Leases?

The original purpose for ground leases was to allow the government to encourage property development (including heritage restoration) within strictly controlled guidelines without capital outlay whist retaining a significant asset.  This has operated effectively in The Rocks as explained above.

The NSW State Government now faces a strategy decision for their significant passive assets (ie. portfolio of ground leases) in The Rocks and Darling Harbour generating a significant cumulative cashflow from long term (building) leases.

The government’s original purpose of establishing a ground lease has been achieved by the defined buildings now completed and (mostly) operating with commercial success evident in the changing ownership of the buildings from time to time.

Facing every government are conflicting demands upon capital for public services.  Also evident at the present time is a buoyant property market that indicates an opportune time to re-assess property asset strategies and possibly dispose of some holdings.

It could prove opportune for the State Government to dispose of certain ground leases as the initial objectives will continue to be met by a compliant building based on a ground lease and the sale will allow the government to recycle capital into matters of greater public priority.

The property market cycle may be described as a current peak with an extended plateau phase that could result in a maximised price being achieved for the Lessor’s ground lease interest being a series of passive rent payments for the remaining term.

Recycling Capital for Higher Public Priorities

The NSW State Government has identified the upgrade of the Circular Quay wharves as a high property development priority with a budget cost estimated to be around $200million.

Part of this budget challenge could be funded by the sale of some ground leases where the market cycle and sentiment is likely to result in a maximised price from passive investors such as superannuation funds or high wealth investors seeking a long term, low risk asset with little default risk.  A ground lease provides a form of securitised property being an income stream based on the property asset without the direct operating risks.


Creation of ground leases in The Rocks solved significant problems for the State Government decades ago and forms an ideal long term passive property holding.  In contrast, disposal of some may again solve significant issues being the (public services) demand for capital whilst preserving the original purpose of establishing the ground leases.

Article written by Chris Smith, Principal, Valuations and Advisory, HillPDA