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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 tenant is permitted to develop a piece of residential or commercial property during the lease duration, after which the land and all enhancements are committed the residential or commercial property owner.

- A ground lease is an agreement in which a renter can establish 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 property managers, who typically rent land for 50 to 99 years to renters who build buildings on the residential or commercial property.
- Tenants who otherwise can't pay for to buy land can construct residential or commercial property with a ground lease, while landlords get a stable earnings and retain control over the usage and advancement of their residential or commercial property.
How a Ground Lease Works

A ground lease indicates that improvements will be owned by the residential or commercial property owner unless an exception is created and stipulates that all appropriate taxes incurred throughout the lease period will be paid by the tenant. Because a ground lease allows the property owner to assume all improvements once the lease term ends, the proprietor may sell the residential or commercial property at a higher rate. Ground leases are also typically called land leases, as property managers rent out the land only.

Although they are used primarily in business area, ground leases vary greatly from other kinds of commercial leases, like those found in shopping center and office complex. These other leases normally do not assign the lessee to handle responsibility for the unit. Instead, these tenants are charged rent in order to run their organizations. A ground lease includes renting land for a long-lasting period-typically for 50 to 99 years-to a renter who constructs a structure on the residential or commercial property.

Tenants typically assume responsibility for all financial aspects of a ground lease, including lease, taxes, building, insurance, and funding.

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 allowed. Most U.S. states still have a 99-year maximum.

The ground lease specifies who owns the land and who owns the building and improvements on the residential or commercial property. Many property managers utilize ground leases as a way to maintain ownership of their residential or commercial property for planning factors, to avoid any capital gains, and to produce income and earnings. Tenants generally assume obligation for any and all costs. This consists of construction, repair work, restorations, enhancements, taxes, insurance coverage, and any financing costs connected with the residential or commercial property.

Example of a Ground Lease

Ground leases are often utilized by franchises and huge box shops, along with other industrial entities. The corporate head office will normally purchase the land, and enable the tenant/developer to construct and use 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 shops are ground rented. Macy's owns the buildings however still pays lease on the ground the building is on. Since February 3, 2024, Macy's reported long-lasting lease liabilities of simply under $3 billion. This leased property consists of small-format shops, distribution centers, office area, and full-line stores.

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

- Regards to the lease.
- Rights of both the property manager and tenant
- Conditions on financing
- Use provisions
- Fees
- Title insurance
- Default

Subordinated vs. Unsubordinated Ground Leases

Ground lease renters frequently finance improvements by handling financial obligation. In a subordinated ground lease, the property owner agrees to a lower priority of claims on the residential or commercial property in case the tenant defaults on the loan for enhancements. To put it simply, a subordinated ground lease-landlord essentially enables the residential or commercial property deed to serve as collateral in the case of renter default on any improvement-related loan.

For this kind of ground lease, the landlord may negotiate greater rent payments in return for the risk taken on in case of tenant default. This may also benefit the property manager because building a building on their land increases the worth of their residential or commercial property.

In contrast, an unsubordinated ground lease lets the landlord retain the leading priority of claims on the residential or commercial property in case the renter defaults on the loan for enhancements. Because the lending institution may not take ownership of the land if the loan goes overdue, loan specialists may be hesitant to extend a mortgage for improvements. Although the property owner retains ownership of the residential or commercial property, they usually need to charge the tenant a lower quantity of lease.

Advantages and Disadvantages of a Ground Lease

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

Tenant Benefits

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

A ground lease likewise does not need the renter to have a deposit for securing the land, as buying the residential or commercial property would need. Therefore, less equity is involved in acquiring a ground lease, which maximizes cash for other functions and improves the yield on utilizing the land.

Any lease paid on a ground lease might be deductible for state and federal earnings taxes, meaning a decrease in the tenant's total tax burden.

Landlord Benefits

The landowner acquires a steady stream of earnings from the renter while keeping ownership of the residential or commercial property. A ground lease typically contains an escalation clause that ensures increases in lease and expulsion rights that supply security in case of default on rent or other costs.

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

Depending upon the provisions put into the ground lease, a landlord may also have the ability to maintain some control over the residential or commercial property including its use and how it is developed. This implies the property manager can approve or deny any modifications to the land.

Tenant Disadvantages

Because landlords may need approval before any modifications are made, the tenant might come across obstructions in the use or development of the residential or commercial property. As an outcome, there may be more limitations and less flexibility for the tenant.

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

Landlord Disadvantages

Landlords who do not put in the proper provisions and stipulations in their leases stand to lose control of tenants whose residential or commercial properties go through advancement. This is why it's constantly important for both parties to have their leases examined before signing.

Depending on where the residential or commercial property is located, utilizing a ground lease may have greater tax for a proprietor. Although they might not realize a gain from a sale, lease is considered income. So lease is taxed at the ordinary rate, which may increase the tax concern.

What Are the Disadvantages of a Ground Lease?

Some of the drawbacks of ground leases include the possibility of residential or commercial property loss, loss of higher earnings due to market changes if rent increases aren't built into the contract, and tax disadvantages, such as devaluation and other costs that can't offset earnings.

Is a Ground Lease an Excellent Investment?

It can be. A ground lease lets a renter build on residential or commercial property in a prime location they could not themselves acquire. They can invest their money in improving the residential or commercial property. On the other hand, a tenant may face restrictions 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 won't end anytime quickly. When it does, you'll have to leave the residential or commercial property, and all structures and improvements revert to the proprietor. However, a lease can be extended. Prior to the expiration date, unless you or your proprietor take particular steps to end the contract, it will just continue on precisely the same terms up until its end. You do not require to do anything unless you receive a notification from your proprietor.

A ground lease is an agreement 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 commonly made by business landlords, who normally rent land for 50 years to 99 years to tenants who construct 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 use the land, while proprietors get a steady income and keep control of their residential or commercial property.

Schorr Law. "Lease Over 99 Years Is Void, Not Voidable."
cornell.edu
Macy's. "Macy's, Inc.
.realtor.com