Whether you’re a brick-n-mortar startup or established business owner, you might have come across the question “What is a ground lease?” when considering real estate options.
We say this because there are plenty of commercial lease structures and a ground lease is one such example that can provide excellent investment opportunities. If you want a lease structure that can help you deploy capital in the real estate industry without having to worry about property management, a ground lease is the right option.
In many cases, leases have a similar structure, in which tenants typically have no ownership rights. The commercial building belongs to an owner and the renter pays monthly payments.
A ground lease, on the other hand, offers a different kind of land contract and has potential to benefit both landowner and tenants a certain way.
As a real estate investor, learning about this lesser-known leasing structure may help open up new investment opportunities.
Ground Lease Overview
A ground lease refers to an agreement that permits tenants to construct a property or building until the lease period ends. Once the lease period is over, the building owner turns over all land improvements to the landowner.
Ground leases are commonly known as “land leases.”The lease structure is to lease the land only. Typically, a landowner can lease land for a long period (50 to 99 years) to an occupant who constructs a property or building on it.
During the ground lease period, the tenant or renter owns any renovations and improvements he makes to the property. It may also include buildings and other areas constructed during the ground lease term.
Macy’s department stores are a good ground lease example. Macy’s owns all the ground-leased stores or buildings, along with the improvements made to the property and land.However, the company pays rent for the land beneath the building.
The following are some of the essential terms of a ground lease:
- Use provisions
- Financing conditions
- Default conditions
- Landlord rights
- Tenant rights
- Lease terms
- Title insurance
Here is an article on what a ground lease is.
Differences between a Lease and a Ground Lease
Before we delve into a discussion highlighting the differences between a lease and a ground lease, understanding the similarities is important. Like a standard lease, a ground lease requires a lessee or tenants to pay rent to the landlord. In return, the tenant gets the right to use or possess the property for a certain time period.
A ground lease, in general, calls for monthly rent payments on a periodic basis.A landlord ina ground lease can evict the lessee if the tenant fails to make monthly payments. However, the leasing industry includes some set parameters in a ground lease accounting.
And, these parameters distinguish a ground lease froman ordinary lease.
Involvement of a Raw Unimproved Land
A ground lease involves either land with prominent improvements that the owner doesn’t intend to keep in the present condition or raw, unimproved land.
Land Development or Improvement
The second significant difference between an ordinary and a ground lease is the notion that the renter will construct or develop improvement on the piece of land he uses. During the entire ground lease term, the tenant depreciates and owns the improvements.
What happens at the end of a ground lease?
In the end, ownership of the renovations and improvements revert to the ground lessee. He/she may require removing them.
Click here to understand the difference between the types of leases.
Benefits of a Ground Lease
A ground lease offers an array of benefits to both the landlord and tenants.
The ground lease allows a tenant to build or construct on land in a prime location that he or she can‘t afford to purchase. This is the reason why many large chain retailers and Franchises such as Starbucks and Whole Food choose ground lease for their corporate expansion plan.
Plus, a ground lease doesn’t require tenants to pay down payments to secure the land as an ordinary property purchase requires. That means this lease structure requires less equity that frees up cash to use for other purposes such as land improvement.
The ground lease is equally beneficial for the landowner as they can gain a steady stream of money from their tenants while retaining property ownership. The ground lease comprises an escalation clause guaranteeing rent increase and eviction rights. It protects landlords in case of rent default.
The ground lease also offers tax savings to landlords. When selling a property to someone, they can benefit from the sale as they don’t need to report the gains.
Find out more about the benefits of the ground lease here .
Ground Leases and Commercial Real Estate
The ground lease commonly takes place between commercial landlords as they typically need a 50- 99-year lease for the land. The permit to construct a building and simple ground lease pricing make it an ideal type of lease structure for many commercial landlords.
Although it may seem bizarre at first for tenants or developers to construct a property on land owned by another person, it has advantages for both parties. One of the most important advantages for renters is that the lease provides easy access to a desired and well-located piece of land that is otherwise hard to buy.
For instance, you’re a commercial real estate investor and discover a piece of perfect land with excellent visibility. It receives a good amount of traffic and is in the middle of a high-growth city that can offer a high income.You think it is perfect for your customer who is interested in buying a drug store franchise.
But what if you find out that the landlord is not interested in selling the parcel?
It can’t be a dead-end if the landlord is open to creating an income stream from this vacant land with a ground lease. This is perhaps the reason why ground leases are a sought-after option in commercial real estate.
Here is an article on the ground leases and commercial real estate.
What Happens When a Ground Lease Expires?
If your ground lease expires and the tenant doesn’t want to renew it, he has to give up using the land.There are some clauses stipulating that tenants must surrender the changes or improvements they made to the land.
Read more about what happens at the end of a ground lease here .
In a nutshell, a ground lease is a vital component of several commercial real estate deals and transactions. It generally comes with a low yield and an income stream. In fact, the income stream generated from a ground lease is safe, particularly when you choose an unsubordinated type. The type of lease offers attractive benefits to tenants and developers without transferring land ownership.