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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 a renter is permitted to develop a piece of residential or commercial property throughout the lease period, after which the land and all enhancements are turned over to the residential or commercial property owner.

- A ground lease is an arrangement in which a renter can develop residential or commercial property during the lease period, after which it is turned over to the residential or commercial property owner.
- Ground leases are typically made by business proprietors, who usually rent land for 50 to 99 years to renters who build buildings on the residential or commercial property.
- Tenants who otherwise can't manage to purchase land can develop residential or commercial property with a ground lease, while property owners get a constant earnings and keep control over the usage 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 specifies that all relevant taxes sustained during the lease period will be paid by the renter. Because a ground lease allows the proprietor to presume all enhancements once the lease term ends, the property owner might offer the residential or commercial property at a higher rate. Ground leases are also often called land leases, as property managers rent out the land only.

Although they are utilized mainly in business space, ground leases vary greatly from other kinds of industrial leases, like those found in shopping center and office complex. These other leases normally do not designate the lessee to handle responsibility for the unit. Instead, these occupants are charged rent in order to operate their organizations. A ground lease includes leasing land for a long-lasting period-typically for 50 to 99 years-to a renter who constructs a building on the residential or commercial property.

Tenants generally assume responsibility for all monetary elements of a ground lease, consisting of lease, taxes, building, insurance, 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 defines who owns the land and who owns the structure and enhancements on the residential or commercial property. Many property owners use ground leases as a method to maintain ownership of their residential or commercial property for planning factors, to prevent any capital gains, and to generate earnings and income. Tenants normally presume duty for any and all expenditures. This includes construction, repair work, renovations, improvements, taxes, insurance coverage, and any financing costs related to the residential or commercial property.

Example of a Ground Lease

Ground leases are frequently used by franchises and huge box shops, along with other commercial entities. The business head office will usually acquire 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

A lot of Macy's stores are . Macy's owns the structures but still pays lease on the ground the structure is on. As of February 3, 2024, Macy's reported long-lasting lease liabilities of just under $3 billion. This leased real estate includes small-format shops, circulation centers, workplace, and full-line stores.

Some of the basics of any ground lease ought to consist of:

- Terms of the lease.
- Rights of both the landlord and occupant
- Conditions on financing
- Use provisions
- Fees
- Title insurance coverage
- Default

Subordinated vs. Unsubordinated Ground Leases

Ground lease occupants typically finance enhancements by taking on debt. In a subordinated ground lease, the landlord accepts a lower priority of claims on the residential or commercial property in case the tenant defaults on the loan for improvements. To put it simply, a subordinated ground lease-landlord essentially allows for the residential or commercial property deed to serve as collateral in the case of tenant default on any improvement-related loan.

For this type of ground lease, the landlord might negotiate greater rent payments in return for the risk taken on in case of tenant default. This may also benefit the landlord since constructing a building on their land increases the value of their residential or commercial property.

On the other hand, an unsubordinated ground lease lets the property manager retain the top priority of claims on the residential or commercial property in case the tenant defaults on the loan for enhancements. Because the loan provider might not take ownership of the land if the loan goes unpaid, loan specialists might be hesitant to extend a mortgage for enhancements. Although the property manager keeps ownership of the residential or commercial property, they normally have to charge the renter a lower amount of lease.

Advantages and Disadvantages of a Ground Lease

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

Tenant Benefits

The ground lease lets a renter construct on residential or commercial property in a prime place they might not themselves acquire. For this reason, big chain stores such as Whole Foods and Starbucks typically utilize ground leases in their corporate growth plans.

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

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

Landlord Benefits

The landowner gets a steady stream of income from the tenant while maintaining ownership of the residential or commercial property. A ground lease usually contains an escalation clause that ensures increases in rent and eviction rights that supply defense in case of default on rent or other expenditures.

There are also tax cost savings for a property owner who uses ground leases. If they offer a residential or commercial property to a renter outright, they will understand a gain on the sale. By executing this kind of lease, they avoid having to report any gains. But there may be some tax implications on the lease they get.

Depending upon the arrangements put into the ground lease, a proprietor might also be able to keep some control over the residential or commercial property including its usage and how it is established. This means the proprietor can authorize or reject any changes to the land.

Tenant Disadvantages

Because landlords may require approval before any modifications are made, the renter might come across roadblocks in the use or advancement of the residential or commercial property. As a result, there might be more restrictions and less flexibility for the tenant.

Costs associated with the ground lease process may be greater than if the tenant were to purchase a residential or commercial property outright. Rents, taxes, enhancements, permitting, in addition to any wait times for property manager approval, can all be pricey.

Landlord Disadvantages

Landlords who don't put in the proper provisions and provisions in their leases stand to lose control of occupants whose residential or commercial properties go through advancement. This is why it's always crucial for both celebrations to have their leases evaluated before finalizing.

Depending on where the residential or commercial property lies, using a ground lease may have higher tax implications for a landlord. Although they might not realize a gain from a sale, lease is considered income. So rent is taxed at the common 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 boosts aren't constructed into the arrangement, and tax drawbacks, such as devaluation and other expenses that can't offset earnings.

Is a Ground Lease a Great Investment?

It can be. A ground lease lets a renter construct on residential or commercial property in a prime location they might not themselves acquire. They can invest their cash in improving the residential or commercial property. On the other hand, an occupant may deal with limitations on what they can do with the residential or commercial property.

What Happens When a Ground Lease Expires?

Ground leases generally 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 improvements revert to the property manager. However, a lease can be extended. Prior to the expiration date, unless you or your property manager take particular actions to end the arrangement, it will simply advance precisely the exact same terms until its end. You do not require to do anything unless you get a notice from your landlord.

A ground lease is a contract in which an occupant can establish residential or commercial property during the lease period, after which it is turned over to the residential or commercial property owner. Ground leases are commonly made by commercial landlords, who usually lease land for 50 years to 99 years to tenants who build structures on the residential or commercial property.

Tenants who can't pay for to buy land can develop on the residential or commercial property and utilize the land, while landlords get a steady income and maintain control of their residential or commercial property.

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

Macy's. "Macy's, Inc.
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