Commercial Loans and Fun Blog

Land Leases and Merger of Interests

Written by George Blackburne | Fri, Jan 7, 2011

Interesting Deal Involves Merger of Land Lessor's and Land Lessee's Interests

Our hard money mortgage company, Blackburne & Sons, is competing for a very interesting loan this month. The borrower is the owner of a land lease. He leased the land to a developer for 55 years, and the developer built a large shopping center on the property.

Although the developer is still current on the underlying land lease, the shopping center has largely failed. Most of the retail spaces are vacant. The holder of the chattel mortgage on the developer's leasehold interest, a bank, started foreclosure, so the developer declared Chapter 11. The parties could not agree on a reorganization plan, so the bankruptcy court has ordered the sale of the shopping center's leasehold interest (the shopping center on leased land).

Our borrower owns the land lease. He receives a big land lease payment every month of, say, $15,000. Now he wants to buy the shopping center that sits on his land.

I was surprised to see a deal like this because normally the holder of the land lease would simply sit back and wait for the developer to default on his land lease payments. If the developer were to default, the holder of the land lease would declare him in default and "foreclose" on his land lease (more precisely terminate the developer's interest in shopping center). The holder of the land lease would then own the entire property - both the land and the shopping center that sits on the land - in fee simple (the normal way that people hold title). The land lessor's interest and the land lessee's interest would merge because they are identical parties.

In this case, however, the holder of the land lease is afraid that someone else will buy the shopping center, and he will be stuck with a "lousy" $15,000 per month income for the next 51 years. Fifteen thousand dollars per month sounds like a lot of money until you think of the hyper-inflation suffered by Zimbabwe.

Therefore our borrower is coming to us to help him purchase the land lessee's interest. Once the land lessor's interest merges with the land lessee's interest, he will be able to easily sell the combined interests for far more money than the sum of the two parts. Few investors want to buy real estate on leased land because it brings with it the obligation to make the land lease payments during a recession. In addition, real estate on leased land is sometimes difficult to finance.

Do you need a commercial mortgage loan on real estate on leased land? Simply go to C-Loans.com and apply for a normal first mortgage. Then, in the Special Issues section, please insert the words, "The property is on leased land with 49 years remaining on the lease. The monthly land lease payments are $4,600 per month." Be sure to apply to banks. Banks are the type of commercial real estate lenders who make commercial real estate loans on leased land.