Long-Term Ground Leases, the Redevelopment Option and Contract Incentives

Ground leased property trades at a discount relative to the fee interest. We explore contractual alternatives that would be Pareto preferred by owners of the leased fee estate and the leasehold interest. The sharing of the value of the residual claim between the owner of the leased fee and the leasehold and a lease extension clause triggered by redevelopment can enhance the value of the asset to both parties. The results suggest that employing such contractual terms in ground leases in the United States would lead to outcomes more consistent with the fee simple case. Escalation clauses also have a potential impact on the timing and intensity of redevelopment.