What is a Ground Lease?

Subordinated vs. Unsubordinated

What Is a Ground Lease? How It Works, Advantages, and Example

Investopedia/ Tara Anand

A ground lease is an arrangement in which a tenant is permitted to establish a piece of residential or commercial property throughout the lease period, after which the land and all enhancements are committed the residential or commercial property owner.

- A ground lease is an arrangement in which a renter can establish residential or commercial property during the lease period, after which it is committed the residential or commercial property owner.

- Ground leases are typically made by commercial proprietors, who normally rent land for 50 to 99 years to renters who construct structures on the residential or commercial property.

- Tenants who otherwise can't pay for to purchase land can develop residential or commercial property with a ground lease, while proprietors get a stable earnings and maintain control over the use and development of their residential or commercial property.

How a Ground Lease Works

A ground lease suggests that improvements will be owned by the residential or commercial property owner unless an exception is created and stipulates that all relevant taxes sustained during the lease duration will be paid by the tenant. Because a ground lease permits the proprietor to assume all enhancements once the lease term ends, the property owner might sell the residential or commercial property at a greater rate. Ground leases are likewise typically called land leases, as landlords lease out the land only.

Although they are used mainly in industrial space, ground leases differ greatly from other kinds of commercial leases, like those found in mall and office complex. These other leases usually do not assign the lessee to handle responsibility for the unit. Instead, these occupants are charged rent in order to run their companies. A ground lease involves renting land for a long-term period-typically for 50 to 99 years-to a tenant who constructs a structure on the residential or commercial property.

Tenants usually presume duty for all monetary elements of a ground lease, including lease, taxes, construction, insurance, and funding.

A 99-year lease is usually the longest possible lease term for a piece of property residential or commercial property. Historically, it was the longest possible under typical law. Nowadays, it depends on the jurisdiction whether leases longer than 99 years are allowed. Most U.S. states still have a 99-year optimum.

The ground lease defines who owns the land and who owns the building and improvements on the residential or commercial property. Many landlords utilize ground leases as a way to retain ownership of their residential or commercial property for preparing reasons, to avoid any capital gains, and to produce earnings and profits. Tenants generally assume obligation for any and all expenditures. This includes construction, repair work, restorations, enhancements, taxes, insurance coverage, and any funding costs associated with the residential or commercial property.

Example of a Ground Lease

Ground leases are frequently utilized by franchises and huge box stores, along with other industrial entities. The home office will typically purchase the land, and permit the tenant/developer to construct and use the center. There's a good chance that a McDonald's, Starbucks, or Dunkin Donuts near you are bound by a ground lease

Many of Macy's shops are ground leased. Macy's owns the structures however still pays lease on the ground the structure is on. As of February 3, 2024, Macy's reported long-lasting lease liabilities of simply under $3 billion. This rented real estate includes small-format stores, warehouse, office, and full-line stores.

A few of the basics of any ground lease must consist of:

- Terms of the lease.

- Rights of both the proprietor and renter

- Conditions on financing

- Use arrangements

- Fees

- Title insurance coverage

- Default

Subordinated vs. Unsubordinated Ground Leases

Ground lease occupants often finance improvements by handling financial obligation. In a subordinated ground lease, the proprietor agrees to a lower concern of claims on the residential or commercial property in case the occupant defaults on the loan for enhancements. To put it simply, a subordinated ground lease-landlord basically enables the residential or commercial property deed to act as collateral when it comes to occupant default on any improvement-related loan.

For this kind of ground lease, the landlord might work out higher lease payments in return for the threat handled in case of occupant default. This might likewise benefit the property manager because constructing a building on their land increases the value of their residential or commercial property.

In contrast, an unsubordinated ground lease lets the landlord retain the top concern of claims on the residential or commercial property in case the renter defaults on the loan for enhancements. Because the lender might not take ownership of the land if the loan goes unpaid, loan specialists may be reluctant to extend a mortgage for enhancements. Although the landlord maintains ownership of the residential or commercial property, they normally have to charge the tenant a lower quantity of lease.

Advantages and Disadvantages of a Ground Lease

A ground lease can benefit both the renter and the property manager.

Tenant Benefits

The ground lease lets a renter construct on residential or commercial property in a prime area they could not themselves acquire. For this reason, large store such as Whole Foods and Starbucks frequently use ground leases in their business expansion strategies.

A ground lease also does not need the renter to have a down payment for securing the land, as buying the residential or commercial property would need. Therefore, less equity is included in obtaining a ground lease, which maximizes money for other functions and improves the yield on making use of the land.

Any lease paid on a ground lease may be deductible for state and federal income taxes, meaning a decrease in the renter's total tax problem.

Landlord Benefits

The landowner gains a stable stream of earnings from the renter while keeping ownership of the residential or commercial property. A ground lease generally consists of an escalation provision that guarantees increases in lease and eviction rights that supply defense in case of default on lease or other costs.

There are likewise tax savings for a proprietor who uses ground leases. If they offer a residential or commercial property to a renter outright, they will recognize a gain on the sale. By executing this type of lease, they avoid needing to report any gains. But there may be some tax implications on the rent they get.

Depending on the provisions put into the ground lease, a property manager may also have the ability to keep some control over the residential or commercial property including its use and how it is established. This suggests the property owner can approve or reject any modifications to the land.

Tenant Disadvantages

Because proprietors might require approval before any changes are made, the tenant might come across roadblocks in the use or advancement of the residential or commercial property. As a result, there might be more constraints and less versatility for the renter.

Costs associated with the ground lease procedure may be higher than if the renter were to purchase a residential or commercial property outright. Rents, taxes, enhancements, allowing, along with any wait times for property manager approval, can all be pricey.

Landlord Disadvantages

Landlords who do not put in the appropriate arrangements and stipulations in their leases stand to lose control of occupants whose residential or commercial properties go through advancement. This is why it's constantly essential for both celebrations to have their leases examined before signing.

Depending upon where the residential or commercial property lies, utilizing a ground lease might have greater tax ramifications for a landlord. Although they may not understand a gain from a sale, lease is considered earnings. So rent is taxed at the normal rate, which may increase the tax problem.

What Are the Disadvantages of a Ground Lease?

Some of the drawbacks of ground leases consist of the possibility of residential or commercial property loss, loss of higher income due to market modifications if lease increases aren't constructed into the contract, and tax downsides, such as devaluation and other expenditures that can't offset earnings.

Is a Ground Lease a Great Investment?

It can be. A ground lease lets an occupant develop on residential or commercial property in a prime area they could not themselves purchase. They can invest their money in enhancing the residential or commercial property. On the other hand, a renter might deal with constraints on what they can do with the residential or commercial property.

What Happens When a Ground Lease Expires?

Ground leases typically last years so it will not expire anytime soon. When it does, you'll need to leave the residential or commercial property, and all structures and enhancements go back to the property manager. However, a lease can be extended. Prior to the expiration date, unless you or your property manager take particular steps to end the agreement, it will simply continue on precisely the same terms till its end. You do not need to do anything unless you receive a notification from your landlord.

A ground lease is a contract in which a renter can develop residential or commercial property during the lease duration, after which it is turned over to the residential or commercial property owner. Ground leases are frequently made by commercial landlords, who normally rent land for 50 years to 99 years to renters who build buildings on the residential or commercial property.

Tenants who can't manage to purchase land can build on the residential or commercial property and use the land, while property owners get a consistent earnings and maintain control of their residential or commercial property.

Schorr Law. "Lease Over 99 Years Is Void, Not Voidable."