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

- A ground lease is an arrangement 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 commercial property owners, who usually rent land for 50 to 99 years to tenants who construct structures 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 stable earnings and keep control over the usage and development of their residential or commercial property.


How a Ground Lease Works

A ground lease suggests that improvements will be owned by the residential or commercial property owner unless an exception is produced and states that all pertinent taxes incurred throughout the lease period will be paid by the occupant. Because a ground lease permits the property manager to presume all enhancements once the lease term ends, the property manager might sell the residential or commercial property at a higher rate. Ground leases are also typically called land leases, as landlords lease out the land just.

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

Tenants normally presume obligation for all monetary elements of a ground lease, consisting of rent, taxes, building, insurance coverage, and financing.

A 99-year lease is normally 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 upon the jurisdiction whether leases longer than 99 years are allowed. 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 use ground leases as a method to retain ownership of their residential or commercial property for preparing factors, to avoid any capital gains, and to generate earnings and revenue. Tenants generally presume obligation for any and all costs. This consists of building and construction, repairs, renovations, 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, in addition to other business entities. The corporate head office will generally buy the land, and allow the tenant/developer to construct and utilize the center. There's a great chance that a McDonald's, Starbucks, or Dunkin Donuts near you are bound by a ground lease

A lot of Macy's shops are ground rented. Macy's owns the buildings however still pays rent on the ground the building is on. Since February 3, 2024, Macy's reported long-lasting lease liabilities of just under $3 billion. This leased property consists of small-format shops, warehouse, office, and full-line stores.

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

- Regards to 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 frequently fund improvements by handling financial obligation. In a subordinated ground lease, the proprietor consents to a lower concern of claims on the residential or commercial property in case the occupant defaults on the loan for improvements. To put it simply, a subordinated ground lease-landlord basically permits 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 proprietor might negotiate higher lease payments in return for the risk handled in case of tenant default. This may likewise benefit the property manager since building 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 owner maintain the leading priority of claims on the residential or commercial property in case the occupant defaults on the loan for improvements. Because the lending institution may not take ownership of the land if the loan goes unpaid, loan specialists may be reluctant to extend a mortgage for improvements. Although the property manager maintains ownership of the residential or commercial property, they typically 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 property owner.

Tenant Benefits

The ground lease lets a tenant construct on residential or commercial property in a prime location they might not themselves buy. For this factor, big store such as Whole Foods and Starbucks often make use of ground leases in their corporate expansion strategies.

A ground lease also does not require the renter to have a deposit for securing the land, as purchasing the residential or commercial property would require. Therefore, less equity is included in getting a ground lease, which maximizes money for other purposes and enhances the yield on utilizing the land.

Any rent paid on a ground lease may be deductible for state and federal income taxes, meaning a reduction in the tenant's general tax problem.

Landlord Benefits

The landowner gets a stable stream of income from the occupant while maintaining ownership of the residential or commercial property. A ground lease generally includes an escalation provision that ensures boosts in lease and eviction rights that provide defense in case of default on rent or other expenses.

There are also tax savings for a property manager who uses ground leases. If they offer a residential or commercial property to a renter outright, they will recognize a gain on the sale. By performing this type of lease, they prevent having to report any gains. But there might be some tax ramifications on the rent they receive.

Depending upon the arrangements took into the ground lease, a proprietor might likewise be able to retain some control over the residential or commercial property including its use and how it is established. This means the proprietor can authorize or deny any changes to the land.

Tenant Disadvantages

Because proprietors may require approval before any modifications are made, the occupant may experience obstructions in the usage or advancement of the residential or commercial property. As a result, there may be more constraints and less flexibility for the occupant.

Costs related to the ground lease process may be greater than if the tenant were to acquire a residential or commercial property outright. Rents, taxes, enhancements, permitting, as well as any wait times for property manager approval, can all be costly.

Landlord Disadvantages

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

Depending on where the residential or commercial property lies, utilizing a ground lease might have greater tax implications for a property owner. Although they may not understand a gain from a sale, rent is considered income. So lease is taxed at the regular 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 greater earnings due to market modifications if rent boosts aren't constructed into the arrangement, and tax downsides, such as devaluation and other expenses that can't balance out income.

Is a Ground Lease an Excellent Investment?

It can be. A ground lease lets an occupant develop on residential or commercial property in a prime area they could not themselves purchase. They can invest their cash in improving the residential or commercial property. On the other hand, a tenant might deal with limitations on what they can do with the residential or commercial property.

What Happens When a Ground Lease Expires?

Ground leases usually last decades 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 go back to the landlord. However, a lease can be extended. Prior to the expiration date, unless you or your property owner take particular actions to end the agreement, it will just continue on exactly the exact same terms until its end. You do not need to do anything unless you receive a notice from your property manager.

A ground lease is a contract in which a tenant can develop residential or commercial property during the lease duration, after which it is committed the residential or commercial property owner. Ground leases are typically made by business property managers, who generally rent land for 50 years to 99 years to tenants who build structures on the residential or commercial property.

Tenants who can't afford to buy land can develop on the residential or commercial property and use the land, while property owners get a consistent earnings and retain control of their residential or commercial property.

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

Macy's. "Macy's, Inc.