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Ground rent capitalization is calculated as the annual income stream divided by the land capitalization rate, which represents a combination of an investor's required return and the capitalization rate for sales of similar properties in the same market.
As mentioned earlier, ground rent is paid by the long leaseholder to the freeholder for the use and development of the land. It is usually calculated as a percentage (5-10%) of the income from the land and any buildings.
Most freehold ground rent investments return yields of 5% ? 10%, some freeholders also earn income by arranging insurance and management of the properties that occupy their land. In some cases the freeholder may also be able to develop land that isn't used or leased by the lessees.
The capitalization rate is calculated by dividing a property's net operating income by the current market value. This ratio, expressed as a percentage, is an estimation of an investor's potential return on a real estate investment.
For example, let's say that you sign a ground lease on a parcel of land, and then borrow $500,000 to build a restaurant on it. If you default on the loan while under a subordinated ground lease, your lender can go after the property (including the land) as collateral.