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What Is a Ground Lease?
A ground lease is an agreement that permits a tenant to develop a piece of property during the period of the lease. After the lease period, the land and all improvements the tenant makes return to the property owner. Ground leases may also be referred to as land leases since the landlord is leasing out only the land.
Ground leases should include the following essential aspects:
- Default conditions
- Financing conditions
- Rights of the landlord
- Rights of the tenant
- Terms of the lease
- Title insurance
- Use provisions
How a Ground Lease Works
Ground leases involve leasing land for a long-term period to a tenant who then constructs a structure on that property. A typical ground lease covers a period from 50 to 99 years.
- Who owns the building
- Who owns the land
- Improvements to the property
A ground lease stipulates that the property owner will own any improvements unless the parties create an exception. This type of contract also stipulates that the tenant will pay relevant taxes during the period of the lease. Landlords may be able to sell the property on the land at a higher rate once the term of the lease expires because they can assume all improvements at that point.
Image via Unsplash by seanpollock
A landlord may choose to use a ground lease in order to:
- Avoid capital gains
- Generate revenue and income
- Retain property ownership for planning reasons
Ground leases are primarily used in commercial agreements. However, these types of leases are very different from other leases that you might find for office buildings and shopping complexes. Other commercial leases do not usually assign the lessee to take responsibility for the unit, charging tenants rent so they can operate their business instead.
When using a ground lease, however, a tenant will usually assume responsibility for any kind of expenses. Expenses that would be the responsibility of the tenant on a ground lease include:
- Financing costs
Types of Ground Leases: Subordinated vs. Unsubordinated
You'll find two main kinds of ground leases: subordinated and unsubordinated. The difference between these two types deals with what happens if a tenant has financial difficulties during the term of the lease. Many times, tenants will take on debt to finance projects on the land they lease.
Subordinated Ground Lease
A landlord will agree to be a lower priority in terms of any other financing obtained on the property when signing a subordinated ground lease. If the tenant signs a subordinated ground lease on a plot of land, borrows money to build on that land, then defaults on the loan, the lender can go after the property (including the land itself) as collateral.
In other words, the landlord in a subordinated ground lease allows the property deed to act as collateral should the tenant default on a loan used to make improvements. The landlord can negotiate higher rent payments since they are taking on additional risk with subordinated leases. A landlord may also choose to create a subordinated ground lease since constructing the building on their land can increase the property's value.
Unsubordinated Ground Lease
A landlord who signs an unsubordinated ground lease retains top priority if there are claims on the property. This means that tenant's lenders cannot foreclose on the land if the tenant defaults on the loan. If the tenant defaults, the lender could go after the tenant's business assets . However, the lenders cannot gain full control of the property as they could do with a subordinated ground lease.
Because the lender cannot take ownership of the land in an unsubordinated ground lease should a tenant not pay their loan, prospective lenders may hesitate to extend a mortgage so a tenant can make improvements. As a result, landlords usually have to charge lower rent to the tenant.
Advantages of a Ground Lease
Ground leases can offer benefits to both landlords and tenants.
Landlords can look forward to certain advantages when signing a ground lease, including:
- Steady income: While still retaining ownership of their property, a landlord can access a steady income stream. Ground leases usually also have an escalation clause. This clause guarantees rent increases as well as eviction rights, which offers protection if a tenant should default on rent or other types of expenses.
- Tax savings: If a landlord sells property outright to a tenant, they realize a gain on that sale. On the other hand, when they execute a ground lease, they don't need to report any gains. However, there still may be tax implications in regard to the rent they receive.
- Retain control: Some ground leases may include provisions that allow a landlord to keep a certain degree of control over their property. This can include how the property is developed and how it is used. In these cases, the landlord will be able to deny or approve changes to their land.
Tenants enjoy a few advantages when signing a ground lease as well:
- Building in a prime location: Tenants gain the ability to build property in a prime location they might not otherwise be able to purchase. That's why you'll often find large chain stores utilizing ground leases in corporate expansion plans.
- No required down payment: As the tenant does not need to have a down payment to secure land (they would if they were purchasing the property), less equity is involved. This, in turn, frees cash for other uses. It also improves the yield on utilizing that land.
- Reduction to tax burden: As rents that are paid on a ground lease can be deductible for income taxes (both federal and state), the overall tax burden of the tenant is reduced.
Disadvantages of a Ground Lease
Certain disadvantages also exist for both landlords and tenants when choosing to use a ground lease.
Landlords looking to execute a ground lease should be wary of potential drawbacks:
- Loss of control: If a landlord doesn't include the proper clauses and provisions in their lease, they can end up losing control of the property.
- Higher tax implications: This varies based on the location of the property, but a ground lease can come with higher tax implications for the landlord. Though landlords don't realize a gain from selling the property, the rent they charge is considered income. That means rent will be taxed at the ordinary rate, and this can increase the landlord's tax burden.
Tenants also should be aware of drawbacks to a ground lease, including:
- Reduced flexibility: Tenants may encounter obstacles in using or developing the property if the landlord requires approval before they make any changes. A tenant may therefore experience more restrictions than they would if they had purchased the property.
- Higher costs: Costs that come along with the ground lease process may end up higher than the costs of just purchasing a property outright. A tenant should be prepared for various costs adding up, which can get expensive, especially when waiting for approval for certain projects. Costs can include improvements, permits, and taxes.
It's very important that both the landlord and tenant review the lease with expert support before they sign it. Working with an expert contract lawyer when creating a ground lease can ensure both parties are protected.
Meet some of our Ground Lease Lawyers
I am a first generation Russian immigrant, a techie, a real estate investor, an entrepreneur and even a bit of a cook. Having emigrated from the Soviet Union in 1989 and having lived in four different countries within that year, I grew up quickly. In fact, I ran my first business in Italy, at the age of 8. More recently, I've been a manager and regional trainer of an automotive chain, and then CEO of an IT company and a financial management company. Then I became a lawyer... My life experiences have certainly helped me understand different mentalities, cultures and points of view, making me an effective advocate for quite a few complex issues... My business experiences have allowed me to offer more than the average commercial lawyer, as I can understand my client's position from a businessman's, rather than a lawyer's, point of view... Since 2008, I've worked as an associate in a boutique firm, ran a solo practice, been managing director of a small 3 attorney firm and then returned to solo practice. My firm now focuses on commercial and real estate matters and is equally split between litigation and transactions. In my spare time, I am highly active with my local Rotary Club, as well as my Rotary District. As of July 1, 2018, I am the President of my Rotary Club, Chair of the IT Committee for the Rotary District, Member of the Rotary District PR Committee, member of the Rotary District Conference Committee and the Conference Registrar. I am also the Rotarian Advisor to the Kings Park High School Interact Club, and am the Attorney Coach of the Ezra Academy High School Mock Trial Team, run as part of the New York State Bar Association's Youth & Citizenship Initiatives. I volunteer my time to sit on three 501(c)(3) non-profit boards, including a domestic violence shelter network called Brighter Tomorrows (Secretary of the Board), a school safety organization known as Safe Halls (President of the Board) and a community improvement charity known as the Commack-Kings Park Charitable Fund (President of the Board). I'm also an avid alpine skier, ice skater, pool volleyball player and swimmer. If there's any time left, I enjoy a good night at the theater and a good roasted duck!
Jay Pink is an attorney who works with businesses and families on estate planning, and business law matters. Having his CPA license, and working in multiple family businesses over his career has positioned him to provide valuable insight on successful business operations. He has formed many entities - LLC's, Corps Partnerships and non-profit organizations.
Skilled in the details of complex corporate transactions, I have 15 years experience working with entrepreneurs and businesses to plan and grow for the future. Clients trust me because of the practical guided advice I provide. No deal is too small or complex for me to handle.
I work with early stage startups (in Georgia and internationally) with their formation, contract and investment needs.
Experienced Attorney focused on transactional law, payments processing, banking and finance law, and working with fintech companies with a demonstrated history of driving successful negotiations in technology sourcing and transactions and strong understanding of government contracts and the procurement process
Seasoned negotiator, mediator, and attorney providing premier legal advice, services, and representation with backgrounds in education, healthcare, and the restaurant and manufacturing industries
I am an experienced technology contracts counsel that has worked with companies that are one-person startups, publicly-traded international corporations, and every size in between. I believe legal counsel should act as a seatbelt and an airbag, not a brake pedal!