CFOs ask three things about a ground lease: how it classifies, what discount rate applies, and what happens to the gain when the land is sold. None of the answers are exotic, but all three should be settled with your auditor before signing.
Classification. The finance-lease tests look at transfer of ownership, purchase options, term relative to economic life, present value relative to fair value, and specialised nature. A very long land lease can trip the term test depending on how economic life is assessed. This is a judgement your auditor makes, not a given, and it is worth asking early because it changes expense recognition.
Discount rate. The rate implicit in the lease if readily determinable, otherwise the incremental borrowing rate. Over ninety-nine years the rate chosen has an enormous effect on the measured liability. Small differences compound into very large balance sheet numbers.
The gain. Selling land at more than basis produces a gain. Whether and when it is recognised depends on whether the transaction qualifies as a sale under the revenue standard and on the leaseback terms — particularly any repurchase option, which can prevent sale treatment entirely.
Sponsors frequently ask for a right to buy the land back. It feels like a free option. Under sale-leaseback guidance, a repurchase right can prevent the transaction from being accounted for as a sale at all — which turns the whole thing into a financing on your books and defeats much of the point.
This is one reason our standard structure carries no repurchase option and, where a sponsor wants protection on a future transfer, uses a right of first offer instead. Raise it with your auditor before negotiating for a buyback.
A lease liability is not funded debt and most sophisticated readers of financial statements treat it accordingly. Rating agencies, lenders and institutional investors have been handling capitalised leases since the standard took effect and are comfortable distinguishing a ground rent obligation from borrowed money.
Where it matters is covenants. A leverage or fixed-charge covenant drafted before the standard, or drafted loosely, may sweep in the lease liability. Check the definitions in your existing credit documents before closing, not after.
This page is general information, not accounting advice. Valor is a principal buying land, not an accounting firm. Confirm treatment with your own auditor for your specific facts.
Yes. Under ASC 842 the tenant recognises a right-of-use asset and a lease liability. Classification affects expense recognition, not whether it appears.
It depends on the classification tests and on how economic life is assessed for a very long land lease. It is an auditor judgement. Ask before signing.
Over ninety-nine years, small rate differences produce very large differences in the measured liability.
Possibly, depending on whether it qualifies as a sale and on the leaseback terms. A repurchase option can prevent sale treatment entirely.
Check the definitions in your existing credit documents. Some older or loosely drafted leverage and fixed-charge tests can sweep in a lease liability.
We will give your accounting team the term sheet and the lease mechanics in writing so they can reach a view before anyone signs.
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