Many co-ops in New York lease, rather than own, the land beneath their apartment building. For the board of a leasehold co-op, navigating a contested land valuation, in which the amount of the co-op’s ground rent is determined through arbitration, can be a daunting process. Much of the action plays out seemingly beyond the board’s control, in an extended battle among appraisers, arbitrators and lawyers, with the outcome dictating the co-op’s financial position for years to come. During the process, the prospect of higher maintenance fees to cover the new ground rent will generate shareholder anxiety and adversely affect the marketability of co-op apartments. As a result, the board will feel pressure to reassure shareholders, while remaining candid about the potential for an unfavorable outcome.
To manage these challenges, the board must have a solid understanding of the valuation process and its context. This article outlines the contested land valuation process and some of the broader considerations the board should have in mind as it navigates the process.
Approaching a Ground-Rent Reset Date
Most ground leases run for an initial term of about 30 years, followed by a series of optional extension or renewal terms that can be exercised by the co-op. The renewal terms in most ground leases are 15 to 25 years, and the total duration of the lease if all extension terms are exercised is typically 99 years. To account for changes in economic and market conditions over this long time frame, the ground lease may contain a rent-escalation clause. Alternatively, as discussed here, the ground lease may provide that the amount of the rent can be reset based on the fair market value of the land, as determined through arbitration, usually at intervals of 10 or 15 years. The ground rent will be a straight percentage – normally about 6 percent – of the land’s market value.
As a ground-rent reset date approaches, the co-op board will consult with its counsel and will normally retain an appraiser who is experienced in valuing commercial real estate. The appraiser will provide the board with a preliminary valuation of the land (likely a range of potential values), which should enable the board or its managing agent to estimate the potential increase in the co-op’s ground rent and its effect on shareholder maintenance.