Subordinated vs. Unsubordinated

What Is a Ground Lease? How It Works, Advantages, and Example

Investopedia/ Tara Anand

A ground lease is an agreement in which an occupant is allowed 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 a contract in which a tenant 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 frequently made by industrial property owners, who generally lease land for 50 to 99 years to occupants who build buildings on the residential or commercial property.

- Tenants who otherwise can't manage to buy land can develop residential or commercial property with a ground lease, while landlords get a constant income and keep control over the use and development of their residential or commercial property.


How a Ground Lease Works

A ground lease shows that improvements will be owned by the residential or commercial property owner unless an exception is developed and states that all appropriate taxes sustained during the lease period will be paid by the renter. Because a ground lease permits the property owner to presume all enhancements once the lease term expires, the property owner may sell the residential or commercial property at a greater rate. Ground leases are also frequently called land leases, as proprietors lease out the land just.

Although they are used mostly in commercial area, ground leases differ significantly from other types of industrial leases, like those found in mall and office complex. These other leases typically do not designate the lessee to take on obligation for the unit. Instead, these occupants are charged lease in order to operate their services. A ground lease involves renting land for a long-term period-typically for 50 to 99 years-to an occupant who constructs a building on the residential or commercial property.

Tenants usually presume responsibility for all monetary elements of a ground lease, consisting of rent, taxes, building and construction, 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 common 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 improvements on the residential or commercial property. Many proprietors use ground leases as a method to keep ownership of their residential or commercial property for preparing reasons, to prevent any capital gains, and to produce income and earnings. Tenants normally assume responsibility for any and all costs. This consists of building and construction, repairs, restorations, improvements, taxes, insurance, and any funding expenses connected with the residential or commercial property.

Example of a Ground Lease

Ground leases are typically utilized by franchises and huge box stores, along with other business entities. The corporate head office will normally acquire the land, and enable the tenant/developer to construct and use the center. There's a great chance that a McDonald's, Starbucks, or Dunkin Donuts near you are bound by a ground lease

Much of Macy's stores are ground leased. Macy's owns the structures however still pays lease on the ground the structure is on. Since February 3, 2024, Macy's reported long-term lease liabilities of just under $3 billion. This leased property consists of small-format shops, warehouse, office, and full-line stores.

Some of the principles of any ground lease ought to include:

- Regards to the lease.

- Rights of both the property manager and occupant

- Conditions on financing

- Use arrangements

- Fees

- Title insurance

- Default

Subordinated vs. Unsubordinated Ground Leases

Ground lease renters typically fund enhancements by taking on financial obligation. In a subordinated ground lease, the proprietor accepts a lower priority of claims on the residential or commercial property in case the tenant defaults on the loan for improvements. Simply put, a subordinated ground lease-landlord essentially permits for the residential or commercial property deed to function as collateral when it comes to renter default on any improvement-related loan.

For this kind of ground lease, the property owner may work out greater lease payments in return for the danger handled in case of tenant default. This may also benefit the landlord since 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 maintain the top priority of claims on the residential or commercial property in case the occupant defaults on the loan for improvements. Because the lending institution might not take ownership of the land if the loan goes overdue, loan specialists may be hesitant to extend a mortgage for enhancements. Although the property owner retains ownership of the residential or commercial property, they normally have to charge the renter a lower quantity of rent.

Advantages and Disadvantages of a Ground Lease

A ground lease can benefit both the occupant and the property manager.

Tenant Benefits

The ground lease lets an occupant build on residential or commercial property in a prime area they might not themselves buy. For this reason, big chain stores such as Whole Foods and Starbucks typically use ground leases in their business growth strategies.

A ground lease likewise does not need the occupant to have a deposit for protecting the land, as buying the residential or commercial property would require. Therefore, less equity is associated with getting a ground lease, which frees up money for other purposes and improves the yield on using the land.

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

Landlord Benefits

The landowner gains a steady stream of income from the occupant while keeping ownership of the residential or commercial property. A ground lease generally includes an escalation stipulation that ensures boosts in lease and eviction 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 a tenant outright, they will recognize a gain on the sale. By executing this kind of lease, they avoid having to report any gains. But there may be some tax ramifications on the rent they receive.

Depending upon the provisions took into the ground lease, a property manager might likewise have the ability to maintain some control over the residential or commercial property including its usage and how it is developed. This means the proprietor can approve or reject any changes to the land.

Tenant Disadvantages

Because proprietors might require approval before any changes are made, the occupant may experience roadblocks in the use or advancement of the residential or commercial property. As a result, there might be more restrictions and less flexibility for the tenant.

Costs associated with the ground lease process might be greater than if the occupant were to buy a residential or commercial property outright. Rents, taxes, improvements, allowing, as well as any wait times for property manager approval, can all be pricey.

Landlord Disadvantages

Landlords who do not 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 important for both celebrations to have their leases examined before signing.

Depending on where the residential or commercial property is situated, utilizing a ground lease might have greater tax ramifications for a landlord. Although they might not recognize a gain from a sale, rent is thought about earnings. So rent is taxed at the common rate, which may increase the tax burden.

What Are the Disadvantages of a Ground Lease?

Some of the disadvantages of ground leases include the possibility of residential or commercial property loss, loss of greater earnings due to market modifications if lease boosts aren't constructed 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 an occupant develop on residential or commercial property in a prime area they could not themselves buy. They can invest their money in improving the residential or commercial property. On the other hand, a renter may deal with 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 expire anytime soon. When it does, you'll have to leave the residential or commercial property, and all buildings and enhancements go back to the property owner. However, a lease can be extended. Prior to the expiration date, unless you or your property manager take particular actions to end the agreement, it will just advance exactly the very same terms up until its end. You do not need to do anything unless you receive a notification from your proprietor.

A ground lease is an arrangement in which a tenant can establish residential or commercial property throughout the lease period, after which it is committed the residential or commercial property owner. Ground leases are commonly made by business property owners, who normally lease land for 50 years to 99 years to tenants who build structures on the residential or commercial property.

Tenants who can't manage to buy land can develop on the residential or commercial property and use the land, while proprietors get a consistent income and keep control of their residential or commercial property.

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

Macy's. "Macy's, Inc.