There Is Hidden Value Where Many Won’t Look

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Now that 100% bonus depreciation is back, everyone’s sprinting toward the same finish line. Fee simple deals with depreciable improvements are now all the rage. These assets will start to see increased transaction velocity in the latter part of Q3, all of Q4, and most likely throughout 2026. The deals are going to get competitive, there will be upward pricing pressure, and buyers will be asking the same question: “How much can I write off this year?”

The masses will all be looking in one distinct direction like lemmings racing off a cliff. The after-tax benefits of accelerated depreciation are real. If buyers look past the flavor of the day, there are other amazing investment opportunities. Even seasoned professionals will abandon core investment fundamentals in search of short-term economic benefit. This will leave a large pocket of opportunity sitting untouched: NNN ground leases.

Why Ground Leases Deserve a Closer Look

Ground leases get passed over for one simple reason - they don’t come with a building so there is no after-tax depreciation benefit. But when you strip away the tax perks and just look at the fundamentals, ground leases check all the right boxes:

• Half the Price: You’re buying the land, not the land and the building. Your cost basis is about half of what it would be for the same asset as a fee simple purchase. Same land, same tenant, same lease term - for about half the price.

• True Absolute NNN Leases: Ground leases are the most bondable net leased assets. There is zero ambiguity as to who is responsible for the utility services to the building, the foundation, building & roof structure, etc. Most ground leases won’t even provide rent abatement upon damage or destruction to the premises. Your tenant calls you to tell you the utility service to the building has been damaged? Tell them to read their lease. You can even help them out by telling them which section of the lease will help them realize they don’t ever need to call you. Very few fee simple single-tenant leases have the necessary provisions to truly be considered absolute bondable NNN leases. Ground leases are the most pure form of NNN leases out there.
• Built-In Downside Protection: The rent is lower because you’re only collecting rent based upon land value, not land value plus the costs of constructing improvements. That means there's little risk of rent ever being lower than current rent at time of purchase. Ground leases almost never revert to the land owner at irreplaceable levels. In fact, they are usually significantly below market when they expire - like ½ to ¼ of market rent (just for ground rent as compared to actual land value at the time of reversion).

• Lease Term Remaining Isn’t Nearly As Critical: Buying a ground lease with a short lease term remaining does not carry the same risk as buying a fee simple asset with a short remaining lease term. If the lease term remaining is short, that means the lease was signed a long time ago. Not only are you buying a legacy lease with rent set at land values from 10-20 years ago, you are closer to getting to the upside. It’s a double whammy: bringing ground rent to current land values AND converting to fee simple rent.
  
• Major Skin in the Game: The tenant has often poured millions into building improvements out of their own pocket. If they walk away, they lose their investment. That kind of commitment means they’re far more likely to keep that rent check coming, even when times get tough. Things get even better for the landlord if the tenant has financed their construction and you have an unsubordinated ground lease (Note: NEVER subordinate your land to your tenant’s debt). Now you have the tenant’s lender as a de facto guarantor on your lease. If the tenant defaults, the lender will step in to make the rent payments while they try to find a buyer to take over the tenant’s position so they can obtain payoff to be made whole. If they don’t keep the ground lease in good standing, they lose their lien position on the improvements.

• The Tenant Doesn’t Matter: Tenant strength and quality is not nearly as important with ground leases. Buying a single-location Arby’s franchisee? Not a big deal. The real estate fundamentals are there. Rent and location are all that matter.
• If They Leave, You Win: Let’s say the tenant does default. Guess what? You just inherited a fully built, improved property for the price of the land. Rent potential? Doubled. Exit value? Way higher. Buying an asset where a tenant default becomes a near best case scenario is about as safe an investment decision as one can make.

• No Need to Worry About Improvement Value: The land owner has zero concern about reuse of the improvements because he/she did not pay for the improvements in the first place. The new tenant wants to scrape the existing improvements and build new? Who cares? The new ground rent is going to be way higher than previous. The new tenant wants to use the existing improvements? Even better. Pay me.

Don’t Be Afraid to Swim Against the Current

While everyone’s making depreciation their top priority, there are some great ground lease deals getting overlooked. Assets in “A” locations with strong tenants and long-term leases are going to be passed over just because they don’t check the bonus depreciation box. That kind of herd mentality may push cap rates up slightly for an asset class that has traditionally traded at a premium (ground leases have always traded at more aggressive cap rates than their fee simple counterparts for the reasons outlined above, regardless of the lack of depreciation). For the savvy and patient investor, this creates a rare window to acquire premium real estate at a discount, with built-in downside protection, and passive long-term value creation.

The Bottom Line

Look, depreciation is great - we all want it. But if you’re only chasing write-offs, you’re going to miss some of the best long-term plays in the market right now. Ground leases aren’t sexy on paper, but they’re asymmetric in all the right ways: limited downside, real passive upside, and a tenant that’s way too invested to just walk away.

There is no one right way to invest. My takeaway from nearly 30 years in the business is that replaceability of rent is the most important indicator of investment security. Of course you always want to buy the best location. Buying the best location with replaceable rent is harder to accomplish. Buying the best location with rent that will double or triple if you lose your tenant will guarantee a walk off home run - sometimes Aaron Boone ALCS game 7 walk off home run against the Red Sox kind of home runs.

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