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

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

- Ground leases are commonly made by business proprietors, who usually lease land for 50 to 99 years to tenants who construct buildings 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 constant income and retain control over the usage and advancement of their residential or commercial property.


How a Ground Lease Works

A ground lease suggests that enhancements will be owned by the residential or commercial property owner unless an exception is created and states that all pertinent taxes incurred during the lease period will be paid by the tenant. Because a ground lease enables the property manager to presume all enhancements once the lease term expires, the property manager might offer the residential or commercial property at a higher rate. Ground leases are likewise frequently called land leases, as proprietors rent out the land only.

Although they are utilized mainly in business space, ground leases vary significantly from other types of business leases, like those found in shopping complexes and workplace structures. These other leases normally don't appoint the lessee to handle obligation for the unit. Instead, these tenants are charged rent in order to run their services. A ground lease involves renting land for a long-term period-typically for 50 to 99 years-to a renter who constructs a building on the residential or commercial property.

Tenants typically presume responsibility for all financial elements of a ground lease, including rent, taxes, building and construction, insurance, and financing.

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

The ground lease specifies who owns the land and who owns the building and enhancements on the residential or commercial property. Many proprietors utilize ground leases as a way to maintain ownership of their residential or commercial property for planning reasons, to avoid any capital gains, and to produce earnings and revenue. Tenants usually presume obligation for any and all expenditures. This includes building, repair work, remodellings, enhancements, taxes, insurance, and any financing expenses connected with the residential or commercial property.

Example of a Ground Lease

Ground leases are typically utilized by franchises and big box stores, as well as other commercial entities. The home office will typically buy the land, and permit the tenant/developer to construct and utilize the facility. There's a great chance that a McDonald's, Starbucks, or Dunkin Donuts near you are bound by a ground lease

A number of Macy's stores are ground rented. Macy's owns the buildings but still pays rent on the ground the structure is on. Since February 3, 2024, Macy's reported long-lasting lease liabilities of just under $3 billion. This leased realty consists of small-format stores, distribution centers, office, and full-line stores.

Some of the basics of any ground lease should include:

- Regards to the lease.

- Rights of both the proprietor and renter

- Conditions on funding

- Use provisions

- Fees

- Title insurance

- Default

Subordinated vs. Unsubordinated Ground Leases

Ground lease tenants frequently fund enhancements by taking on financial obligation. In a subordinated ground lease, the property owner accepts a lower priority of claims on the residential or commercial property in case the occupant defaults on the loan for improvements. Simply put, a subordinated ground lease-landlord basically enables the residential or commercial property deed to act as security when it comes to tenant default on any improvement-related loan.

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

In contrast, an unsubordinated ground lease lets the property manager keep the top concern of claims on the residential or commercial property in case the renter defaults on the loan for improvements. Because the lender might not take ownership of the land if the loan goes unsettled, loan professionals might be reluctant to extend a mortgage for improvements. Although the landlord maintains ownership of the residential or commercial property, they usually have to charge the tenant a lower quantity of rent.

Advantages and Disadvantages of a Ground Lease

A ground lease can benefit both the occupant and the landlord.

Tenant Benefits

The ground lease lets a renter develop on residential or commercial property in a prime location they could not themselves purchase. For this factor, large store such as Whole Foods and Starbucks often use ground leases in their corporate expansion strategies.

A ground lease also does not need the occupant to have a down payment for securing the land, as purchasing the residential or commercial property would require. Therefore, less equity is involved in getting a ground lease, which releases up money for other functions and improves the yield on using the land.

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

Landlord Benefits

The landowner gets a steady stream of earnings from the occupant while keeping ownership of the residential or commercial property. A ground lease usually contains an escalation provision that guarantees increases in lease and expulsion rights that supply security in case of default on lease or other costs.

There are also tax savings for a proprietor 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 avoid having to report any gains. But there might be some tax ramifications on the lease they receive.

Depending on the provisions put into the ground lease, a proprietor might likewise have the ability to retain some control over the residential or commercial property including its use and how it is established. This suggests the proprietor can authorize or deny any modifications to the land.

Tenant Disadvantages

Because proprietors may require approval before any changes are made, the renter might encounter obstructions in the use or development of the residential or commercial property. As a result, there might be more limitations and less versatility for the renter.

Costs related to the ground lease procedure may be greater than if the renter were to acquire a residential or commercial property outright. Rents, taxes, improvements, permitting, in addition to any wait times for proprietor approval, can all be costly.

Landlord Disadvantages

Landlords who don't put in the appropriate arrangements and clauses in their leases stand to lose control of occupants whose residential or commercial properties go through development. This is why it's always essential for both celebrations to have their leases reviewed before signing.

Depending upon where the residential or commercial property is situated, using a ground lease may have greater tax ramifications for a property manager. Although they may not recognize a gain from a sale, lease is considered income. So lease is taxed at the regular rate, which may increase the tax burden.

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 greater earnings due to market modifications if lease increases aren't built into the contract, and tax disadvantages, such as devaluation and other costs that can't balance out income.

Is a Ground Lease a Good Investment?

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

What Happens When a Ground Lease Expires?

Ground leases normally last years so it won't expire anytime soon. When it does, you'll have to leave the residential or commercial property, and all structures and enhancements go back to the property owner. However, a lease can be extended. Prior to the expiration date, unless you or your landlord take specific steps to end the arrangement, it will merely advance exactly the exact same terms until its end. You do not need to do anything unless you receive a notification from your property owner.

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 industrial landlords, who usually rent land for 50 years to 99 years to renters who build buildings on the residential or commercial property.

Tenants who can't afford to purchase land can build on the residential or commercial property and utilize the land, while property owners get a consistent income and retain control of their residential or commercial property.

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

Macy's. "Macy's, Inc.