A Created Lease for Hypothecation

Editor’s Note: This article first appeared in the December 1971 issue of the Real Estate News Observer.

Two Realtors owned a commercial lot on a busy street, encumbered by two private loans of $20,000 and $14,000. The lot adjoined an older motel that handled the payments and taxes.

However, the geographical management and continued deferred maintenance soon created a problem. The lot was offered for sale or exchange. There were no buyers ready, willing and able to tackle the “motel” headache.

Research proved the lot was in an ideal location for a “garage-warehouse” — the type of buildings which would rent for $25 to $35 per month.

The two Realtors exacted a 55-year “subordinated” ground lease to their own corporation, and then hypothecated the “subordinated” lease for $27,500 cash. They used $25,000 to buy the existing first and second loans at a discount. In escrow (at dosing), they borrowed enough to build the “garage-warehouse.”

Now, the Realtor-Developers were in the position of owning a completed, 15,000-square-foot warehouse (nice storage areas) that was subject to a loan of approximately $85,000 and a ground lease junior to the first loan. True, the ground lease was hypothecated, but it was owned by the Realtors’ corporation.

The last I heard, the Realtors were selling the ground lease for a profit (to retire the hypothecation) and were keeping the improvements for depreciation and long-term cash flow.

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