The bulk of the projects involve tax-exempt lessor structures. Since government entities and not-for-profit organizations are exempt from genuine residential or commercial property taxes in many jurisdictions, a ground lease between such entities and a borrower-sponsor provides a task the opportunity to either be exempt from residential or commercial property taxes or subject to a payment-in-lieu of taxes arrangement, both of which can offer significant cost savings over the life of a project.

In greater education, universities generally utilize channel financed ground lease structures to build trainee housing jobs. These jobs consist of a ground lease between a university, as landlord, and the borrower-sponsor, as occupant. The university concurs to the ground lease due to the fact that, since the borrower-sponsor is accountable for repayment of the bonds and the mortgage is on the leasehold, the university can build a job on school without incurring financial obligation and keep the project totally free once the ground lease is ended. During the term of the ground lease, the arrangements of the ground lease supplies a method for the university to control or monitor the task and get an annual ground lease rent.

In other markets, the provider frequently owns the land and ground leases the arrive at which the project is to be developed to the borrower-sponsor, who constructs the project and subleases it back to the company. Such a job gets approved for a real residential or commercial property tax exemption since it is owned by a government entity, and since the federal government entity is likewise tenant under the sublease, the task receives sales tax exemptions on products during building and construction. The issuer, as renter under the sublease, is responsible for payment of the bonds, while the borrower-sponsor develops and operates the project pursuant to conditions of contracts with the issuer. The borrower-sponsor typically has a chance to purchase the land and task once the bonds are paid.

These structures present unique risks to bond buyers. The bonds are generally protected by mortgages on the leasehold and/or subleasehold estates. Bondholders must bear in mind the rights of celebrations to end the ground lease or interfere with their capability to work out remedies. If the ground lease is ended or the trustee can not take belongings of the project, the corresponding lien on the physical job is snuffed out and the security plan has no value.

With that in mind, shareholders ought to look for the following protections in any ground lease that becomes part of a local bond funding:

Term - the term of the ground lease ought to be at least 5 years beyond the maturity date of the bonds, and bondholders ought to press for more if at all possible. The extra five or more years permits an exercise and extension of the term of the bonds in the occasion it is needed to enable the task to capital to cover operating costs and debt service. If the bonds on a task have a bullet maturity, the term of the ground lease need to be at least double the regard to the bonds to enable a refunding of the maturing bonds.

Authorization - the ground lease need to clearly license the borrower-sponsor to sustain a mortgage on the ground lease or else a court would consider the lien on the leasehold estate void.

Transfer and Assignment - the ground lease ought to be assignable by the trustee without restrictions. Failure to consist of such arrangements could avoid a mortgagee from offering or moving the leasehold estate (by sale or otherwise) upon foreclosure or the execution of an assignment-in-lieu of foreclosure. It is necessary for the arrangements to enable the trustee to designate another entity to take position in lieu of the trustee since the funding structure might depend on the status of borrower-sponsor to maintain the tax-exempt status of the bonds and/or provide other tax advantages. Additionally, such designee should be entitled to a new lease to aid in the restructuring of the job upon foreclosure or assignment-in-lieu of foreclosure.

Notice and Opportunity to Cure - any notification of default by the occupant under the ground lease must be supplied to the trustee, and the trustee must have a chance to cure of a minimum of thirty days. An uncured occasion of default of tenant under the ground lease generally gives the lessor the right to terminate the ground lease, which would get rid of the trustee's collateral. A notice and opportunity to cure permits the trustee to maintain its security and later on seek repayment for such costs of borrower under the leasehold mortgage, trust indenture or other bond files.

New Lease - if the ground lease is ended for any factor, like termination upon default, or is declined in insolvency, the trustee must have the opportunity to enter into a new lease on the same terms.

No Modification - the ground lease need to not be permitted to be customized without the consent of mortgagee, or else the proprietor and debtor could customize mortgagee rights and remedies without mortgagee's understanding or permission.

In our experience representing shareholders, the majority of the ground rents we have examined have included the foregoing provisions. As we have actually encountered more intricate fundings, we have seen the following serious issues:

Cross-Default - the ground lease and sublease need to not cross-default with the trust indenture, loan contract or any other bond document (Example: "A default under the Trust Indenture is a default under this Lease ..."). Any occasion of default under the bond files should offer the trustee the chance to work out solutions, not give the landlord the opportunity to eliminate the leasehold estate and, as an outcome, the security, unless the trustee cures borrower-sponsor's default.

Third Party Beneficiary - the ground lease and sublease need to recognize the trustee and any follower trustee as third-party recipients. This can be done by including an arrangement that designates any leasehold mortgagee as a third-party recipient that can impose the contract versus the property manager and the renter. Leasehold mortgagees are not parties to the ground lease, so a third-party recipient classification is required to implement mortgagee defenses in the ground lease and sublease versus the landlord and occupant in court. Additionally, if success of the project is reliant on the property owner and borrower-sponsor meeting specific requirements or providing certain services under the ground lease or sublease, the third-party beneficiary classification is required for the leasehold mortgagee to enforce those arrangements versus the celebrations if they fail to satisfy expectations.

Borrower Notices and Consents - if the job is a lease-sublease structure where the borrower-sponsor is the renter under the ground lease and the landlord under the sublease, the borrower-sponsor must have no authorization rights on any mortgagee matters under the ground lease or the sublease. The borrower-sponsor as ground lease occupant and sublease property manager is more of a passthrough entity for the job up until the bonds are paid, while the borrower-sponsor as developer and manager is a real party-in-interest to the job. Just as developers and supervisors typically do not have consent rights to adjustments of the security, the borrower-sponsor should not have those approval rights to the mortgage in the task. It gives the borrower-sponsor serious take advantage of in a workout versus shareholders. If the borrower-sponsor has consent rights over mortgages in the sublease, for example, it could avoid the execution of a mortgage on the subleasehold estate over unsettled management and designer charges that are secondary to debt service.

Shared Parcels - the ground lease and sublease need to be on their own subdivided plot, not part of a bigger fee estate parcel. When ground lease tasks become part of a bigger cost estate parcel, the project is at threat of unassociated actions and charges on the cost estate. For example, if a property manager that has actually ground leased part of the cost residential or commercial property to a project, moneyed by bonds and protected by a leasehold mortgage, chooses to develop the rest of the residential or commercial property on the cost estate and protect it by a fee mortgage, a foreclosure of that fee mortgage would snuff out the leasehold and subleasehold estates. Similarly, if the landlord's cost job sustains taxes, energy charges, property owners association fees or other expenses that have the possible to end up being "very liens" exceptional to the leasehold estate, a foreclosure of those liens would terminate the ground lease and sublease. If the ground lease and sublease need to be part of a larger charge parcel, the ground lease and sublease must (a) need that any mortgage or lien placed on the fee interest is subordinate to the ground lease, (b) require that the property manager without delay pays any charges or fees that risks the leaseholds, and (c) enable the borrower-sponsor and the leasehold mortgagee to cure charges on the charge estate and seek compensation from the property manager.

Multiple Mortgagees - The ground lease must recognize the capacity for several mortgagees and focus on the most senior mortgagee. We have actually encountered projects with several mortgagees where the mortgagees do not have an intercreditor agreement. In those cases, either the subordinate mortgagees are subordinate to the senior mortgagees based on time of recording and the other bond documents, or the secondary mortgagees have a springing security interest that connects as soon as the senior bonds are settled. Because there is no intercreditor arrangement, the offer is silent as to negotiation treatments upon an occasion of default. Subordinate mortgagees, who generally have a closer relationship with the borrower-sponsor and misaligned interest with the senior mortgagees, frequently take the reins negotiating with proprietors in a workout without notifying or consulting the senior mortgagees. Either the ground lease should clarify that the property owner will prioritize the most senior protected mortgagee in negotiation and dispute resolution, and/or an intercreditor agreement with clear standards should be taped on the project.

Before buying a ground lease job, bondholders must totally comprehend the project and its risks. While reviewing the main declaration and engaging with the underwriter, this customer alert must serve as a detailed checklist of issues that ought to be dealt with. In the context of a restricted offering, point of view buyers of the bonds have utilize to request our suggested modifications to the ground lease. In those deals, most property managers are related parties that straight gain from the channel funded task. It would normally benefit property owners for the tasks to succeed, and a failure to work out in great faith or a termination of the ground lease with a leasehold mortgage would negatively affect their reputation and ranking in the bond market. If any of these protections are not consisted of when the bonds are provided, it is important to acquire them in a workout as a condition for forbearance or refinancing.