Ground Lease: Definition, Pros, and Cons

Ground Lease
Ground Lease

When you buy a home as part of a land lease, you don’t own the land on which the house is built, which is a significant difference from a typical residential real estate transaction. A land lease, also known as a ground lease, allows you to own only the house while leasing the land from an owner, who could be an individual or a company. We will look at a ground lease vs. a land lease agreement for real estate, as well as an example of a ground lease.

Ground leases are much more common for commercial properties, but they are also used for residential homes in some cases. A residential land-lease arrangement may appear to be more appropriate for a mobile home, as you can move the home when the lease expires.

What Is a Ground Lease

A ground lease is an agreement that allows a tenant to develop a piece of property during the lease period, after which the land and all improvements are returned to the property owner.

How Does a Ground Lease Work?

A ground lease for real estate specifies that, unless an exception is made, improvements will be owned by the property owner and that all relevant taxes incurred during the lease period will be paid by the tenant. Because a ground lease allows the landlord to assume all improvements at the end of the lease term, the landlord may be able to sell the property at a higher price. In real estate, ground leases are also known as land leases because landlords only lease out the land.

Although they are used primarily in commercial space, ground leases differ greatly from other types of commercial leases like those found in shopping complexes and office buildings. Other leases typically do not assign the lessee responsible for the unit. Instead, these tenants must pay rent to run their businesses.

A ground lease involves leasing land for a long-term period—typically 50 to 99 years—to a tenant who constructs a building on the property.
A 99-year ground lease is generally the longest possible lease term for a piece of real estate property. It used to be the longest allowed by common law. However, 99-year leases continue to be common but are no longer the longest possible under the law.

The ground lease defines who owns the land, who owns the building, and improvements on the property. Many landlords use ground leases as a way to retain ownership of their property for planning reasons, to avoid any capital gains, and to generate income and revenue. Tenants generally assume responsibility for any and all expenses. This includes construction, repairs, renovations, improvements, taxes, insurance, and any financing costs associated with the property.

Advantages and Disadvantages of a Ground Lease

A ground lease agreement can benefit both the tenant and the landlord in real estate.

Tenant benefits

The ground lease lets a tenant build on property in a prime location they could not themselves purchase. For this reason, large chain stores such as Whole Foods and Starbucks often utilize ground leases in their corporate expansion plans.

A ground lease also does not require the tenant to have a down payment for securing the land, as purchasing the property would require. Therefore, less equity is involved in acquiring a ground lease, which frees up cash for other purposes and improves the yield on utilizing the land.

Landlord benefits

The landowner retains ownership of the property while receiving a consistent stream of income from the tenant. A ground lease typically includes an escalation clause that guarantees rent increases and eviction rights that provide protection in the event of rent or other expense default.

A landlord who uses ground leases can also save money on taxes. They will make a profit if they sell a property to a tenant outright. They avoid having to report any gains by executing this type of lease. However, the rent they receive may be subject to taxation.
Depending on the ground lease provisions, a landlord may also be able to retain some control over the property, including its use and development. This means that the landlord has the authority to approve or deny any changes to the land.

Disadvantages of a tenant

Because landlords may require approval before making changes, the tenant may face difficulties in using or developing the property. As a result, the tenant may face more restrictions and less flexibility.

The costs of the ground lease agreement process may be higher than if the tenant purchased a property outright. Rent, taxes, improvements, permits, and any wait times for landlord approval can all be expensive.

Disadvantages of a landlord

Landlords who fail to include the necessary provisions and clauses in their leases risk losing control of tenants whose properties are being developed. This is why it is critical that both parties have their leases reviewed before signing.

Using a ground lease may have higher tax implications for a landlord depending on where the property is located. Rent is considered income even if they do not make a profit on the sale. As a result, rent is taxed at the ordinary rate, potentially increasing the tax burden.

Ground Lease Example

Ground leases are frequently used by franchises, big box stores, and other commercial entities. Typically, the corporate headquarters will purchase the land and allow the tenant/developer to build and operate the facility. A McDonald’s, Starbucks, or Dunkin’ Donuts near you is almost certainly bound by a ground lease.

Alliance Bernstein, a New York-based investment firm, paid $100.4 million for a 99-year ground lease from BLDG Management for New York City’s George Washington Hotel in July 2016. In 1994, BLDG purchased the hotel when it was in foreclosure. Although the building was previously used as a student dormitory by the Manhattan-based School of Visual Arts, BLDG filed plans in April 2016 to convert it to a hotel with a restaurant, bar, and ground-level stores. The Freehand Hotel, a boutique hotel in New York City’s Flatiron District, is currently in operation.

The following are some example of ground lease fundamentals:

  • Lease conditions
  • Rights of both the landlord and the tenant. Financing conditions
  • Make use of provisions.
  • Fees
  • Title protection
  • Default

Types of Ground Leases: Subordinated vs. Unsubordinated

There are two types of ground leases: subordinated and unsubordinated. The distinction between these two types concerns what happens if a tenant experiences financial difficulties during the term of the lease. Tenants frequently incur debt to finance projects on the land they lease.

Subordinated

When signing a subordinated, a landlord agrees to be a lower priority in terms of any other financing obtained on the property. If a tenant signs a subordinated ground lease on a plot of land; borrows money to build on that land, and then defaults on the loan; the lender has the right to seize the property (including the land itself) as collateral.

In other words, in a subordinated ground lease, the landlord allows the property deed to serve as collateral if the tenant defaults on a loan used to make improvements. Because they are taking on additional risk with subordinated leases, the landlord can negotiate higher rent payments. A landlord may also choose to create a subordinated ground lease because constructing the building on their land can increase the property’s value.

Unsubordinated

If there are claims on the property, a landlord who signs an unsubordinated has first priority. This means that if the tenant defaults on the loan, the tenant’s lender cannot foreclose on the land. If the tenant fails to pay, the lender may seize the tenant’s business assets. However, unlike a subordinated ground lease, the lenders cannot gain complete control of the property.

Prospective lenders may be hesitant to extend a mortgage so a tenant can make improvements; because the lender cannot take ownership of the land in an unsubordinated ground lease if the tenant fails to pay their loan. As a result, landlords are often forced to charge lower rent to tenants.

Ground Lease vs Land Lease

In real estate, a ground lease is also known as a land lease, because landlords only lease out the land. Although they are mostly used in commercial space, ground leases are very different from other types of commercial leases; found in shopping malls and office buildings.

Conclusion

Finally, a ground lease agreement is a complex, but highly advantageous solution for developers looking to begin a commercial project; without investing a large sum of money upfront. Furthermore, the benefits provided to the landowner make leasing land for an extended period of time a relatively simple process that benefits both parties.

Frequently Asked Questions

What is a ground lease Australia?

A ground lease is a lease of vacant land that gives the tenant the right to build a building on the land at the tenant’s expense. Many municipalities have granted, and continue to grant, ground leases on council-owned land.

What is a ground lease NYC?

A ground lease is usually a long-term land lease. The leased land could be, unimproved land on which the tenant (also known as a ground tenant) builds new improvements. Previously developed land with existing improvements such as buildings and roads.

Can I build on leasehold land?

However, if you own a leasehold property and want to make a structural change, such as building an extension, knocking down walls, or installing new windows, you must first obtain permission from the freeholder/landlord.

What happens when land lease expires?

According to the SLA, when a lease expires, the government will take back the land, and the residents living there will lose all rights to the property, including the right to live there.

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