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 a contract in which an occupant is allowed to establish a piece of residential or commercial property during the lease period, after which the land and all improvements are turned over to the residential or commercial property owner.

- A ground lease is a contract in which an occupant can establish residential or commercial property throughout the lease period, after which it is committed the residential or commercial property owner.

- Ground leases are frequently made by commercial proprietors, who usually lease land for 50 to 99 years to tenants who build structures on the residential or commercial property.

- Tenants who otherwise can't pay for to buy 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 shows that improvements will be owned by the residential or commercial property owner unless an exception is developed and states that all appropriate taxes sustained throughout the lease duration will be paid by the tenant. Because a ground lease allows the property owner to presume all enhancements once the lease term ends, the property manager might offer the residential or commercial property at a higher rate. Ground leases are also often called land leases, as landlords rent out the land just.

Although they are used primarily in business space, ground leases differ considerably from other kinds of industrial leases, like those discovered in shopping center and workplace structures. These other leases typically don't assign the lessee to take on duty for the system. Instead, these renters are charged rent in order to run their companies. A ground lease includes renting land for a long-lasting period-typically for 50 to 99 years-to a tenant who constructs a building on the residential or commercial property.

Tenants generally presume obligation for all financial aspects of a ground lease, including rent, taxes, building and construction, insurance coverage, and financing.

A 99-year lease is generally the longest possible lease term for a piece of realty 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 permitted. Most U.S. states still have a 99-year maximum.

The ground lease specifies who owns the land and who owns the structure and enhancements on the residential or commercial property. Many property managers use ground leases as a method to keep ownership of their residential or commercial property for planning factors, to prevent any capital gains, and to produce earnings and earnings. Tenants typically assume responsibility for any and all costs. This consists of building, repairs, remodellings, improvements, taxes, insurance coverage, and any funding costs associated with the residential or commercial property.

Example of a Ground Lease

Ground leases are often utilized by franchises and huge box stores, along with other commercial entities. The business headquarters will typically purchase the land, and enable the tenant/developer to construct and utilize the facility. There's a great opportunity that a McDonald's, Starbucks, or Dunkin Donuts near you are bound by a ground lease

Much of Macy's shops are ground leased. Macy's owns the buildings but still pays rent 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 property consists of small-format stores, warehouse, office, and full-line stores.

Some of the principles of any ground lease must consist of:

- Terms of the lease.

- Rights of both the property owner and tenant

- Conditions on financing

- Use provisions

- Fees

- Title insurance

- Default

Subordinated vs. Unsubordinated Ground Leases

Ground lease tenants frequently fund improvements by taking on debt. In a subordinated ground lease, the proprietor agrees to a lower top priority of claims on the residential or commercial property in case the occupant defaults on the loan for enhancements. In other words, a subordinated ground lease-landlord basically permits for the residential or commercial property deed to function as security when it comes to renter default on any improvement-related loan.

For this kind of ground lease, the property manager might work out greater lease payments in return for the danger taken on in case of tenant default. This may also benefit the landlord due to the fact that constructing a structure on their land increases the worth of their residential or commercial property.

In contrast, an unsubordinated ground lease lets the property owner maintain the top concern of claims on the residential or commercial property in case the occupant defaults on the loan for improvements. Because the lender may not take ownership of the land if the loan goes overdue, loan specialists might be hesitant to extend a mortgage for enhancements. Although the property manager keeps ownership of the residential or commercial property, they typically need to charge the tenant a lower amount of lease.

Advantages and Disadvantages of a Ground Lease

A ground lease can benefit both the renter and the proprietor.

Tenant Benefits

The ground lease lets an occupant develop on residential or commercial property in a prime area they might not themselves purchase. For this reason, big store such as Whole Foods and Starbucks often make use of ground leases in their corporate growth plans.

A ground lease likewise does not need the tenant to have a deposit for securing the land, as purchasing the residential or commercial property would need. Therefore, less equity is associated with obtaining a ground lease, which releases up money for other functions and enhances the yield on utilizing the land.

Any rent paid on a ground lease may be deductible for state and federal income taxes, implying a reduction in the renter's overall tax concern.

Landlord Benefits

The landowner acquires a stable stream of earnings from the occupant while retaining ownership of the residential or commercial property. A ground lease usually consists of an escalation stipulation that guarantees increases in rent and expulsion rights that provide defense in case of default on rent or other costs.

There are also tax cost savings for a property owner who uses ground leases. If they offer a residential or commercial property to an occupant outright, they will realize a gain on the sale. By executing this type of lease, they prevent needing to report any gains. But there may be some tax implications on the rent they get.

Depending on the arrangements put into the ground lease, a property owner may also have the ability to retain some control over the residential or commercial property including its usage and how it is developed. This indicates the landlord can authorize or reject any changes to the land.

Tenant Disadvantages

Because proprietors might need approval before any changes are made, the occupant may come across obstructions in the use or advancement of the residential or commercial property. As a result, there may be more restrictions and less flexibility for the renter.

Costs related to the ground lease process may be greater than if the occupant were to purchase a residential or commercial property outright. Rents, taxes, improvements, allowing, in addition to any wait times for property manager approval, can all be expensive.

Landlord Disadvantages

Landlords who do not put in the appropriate provisions and clauses 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 parties to have their leases evaluated before finalizing.

Depending upon where the residential or commercial property lies, using a ground lease may have higher tax implications for a property owner. Although they might not recognize a gain from a sale, lease is considered earnings. So lease is taxed at the ordinary rate, which may increase the tax burden.

What Are the Disadvantages of a Ground Lease?

Some of the downsides of ground leases include the possibility of residential or commercial property loss, loss of greater earnings due to market modifications if rent boosts aren't developed into the agreement, and tax drawbacks, such as depreciation and other expenditures that can't offset earnings.

Is a Ground Lease a Good Investment?

It can be. A ground lease lets a tenant build 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, an occupant might deal with constraints on what they can do with the residential or commercial property.

What Happens When a Ground Lease Expires?

Ground leases normally last decades so it won't expire anytime soon. When it does, you'll need to leave the residential or commercial property, and all buildings and improvements go back to the property owner. However, a lease can be extended. Prior to the expiration date, unless you or your property manager take particular actions to end the contract, it will just continue exactly the very same terms up until its end. You do not need to do anything unless you receive a notification from your proprietor.

A ground lease is an agreement in which an occupant 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 typically made by business proprietors, who generally lease land for 50 years to 99 years to tenants who build buildings on the residential or commercial property.

Tenants who can't pay for to buy land can build on the residential or commercial property and use the land, while property managers get a stable earnings and retain control of their residential or commercial property.

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