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 an occupant is allowed to develop a piece of residential or commercial property during the lease duration, after which the land and all improvements are committed the residential or commercial property owner.

- A ground lease is a contract in which a tenant can develop residential or commercial property during the lease period, after which it is committed 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 construct structures on the residential or commercial property.
- Tenants who otherwise can't afford to buy land can build residential or commercial property with a ground lease, while property managers get a constant income and keep control over the use and advancement of their residential or commercial property.
How a Ground Lease Works

A ground lease suggests that enhancements will be owned by the residential or commercial property owner unless an exception is developed and specifies that all relevant taxes sustained during the lease period will be paid by the renter. Because a ground lease allows the proprietor to assume all enhancements once the lease term ends, the property owner might sell the residential or commercial property at a higher rate. Ground leases are also typically called land leases, as property managers lease out the land only.

Although they are utilized mostly in industrial space, ground leases vary considerably from other kinds of industrial leases, like those found in shopping center and office complex. These other leases normally don't appoint the lessee to take on responsibility for the unit. Instead, these occupants are charged rent in order to operate their businesses. A ground lease involves leasing land for a long-lasting period-typically for 50 to 99 years-to an occupant who constructs a structure on the residential or commercial property.

Tenants generally presume responsibility for all financial elements of a ground lease, including rent, taxes, building, insurance coverage, and funding.
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A 99-year lease is generally the longest possible lease term for a piece of property 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 defines who owns the land and who owns the building and enhancements 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 prevent any capital gains, and to generate income and income. Tenants generally assume responsibility for any and all expenses. This includes building, repairs, renovations, improvements, taxes, insurance, and any funding costs associated with the residential or commercial property.

Example of a Ground Lease

Ground leases are typically used by franchises and big box stores, in addition to other business entities. The business headquarters will normally buy the land, and permit 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 stores are ground leased. Macy's owns the structures however still pays lease on the ground the building is on. As of February 3, 2024, Macy's reported long-term lease liabilities of just under $3 billion. This leased realty consists of small-format shops, circulation centers, workplace, and full-line shops.

A few of the principles of any ground lease should include:

- Terms of the lease.
- Rights of both the property owner and tenant
- Conditions on financing
- Use arrangements
- Fees
- Title insurance
- Default

Subordinated vs. Unsubordinated Ground Leases

Ground lease occupants often finance enhancements by handling financial obligation. In a subordinated ground lease, the landlord accepts a lower top priority 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 for the residential or commercial property deed to act as collateral in the case of occupant default on any improvement-related loan.

For this kind of ground lease, the property manager may negotiate higher rent payments in return for the threat handled in case of tenant default. This may also benefit the property owner due to the fact that building a structure on their land increases the worth of their residential or commercial property.

In contrast, an unsubordinated ground lease lets the landlord keep the top concern of claims on the residential or commercial property in case the occupant defaults on the loan for improvements. Because the lender might not take ownership of the land if the loan goes overdue, loan professionals might be reluctant to extend a mortgage for enhancements. Although the landlord retains ownership of the residential or commercial property, they typically have to charge the occupant a lower amount of lease.

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 an occupant develop on residential or commercial property in a prime location they could not themselves acquire. For this reason, large chain stores such as Whole Foods and Starbucks frequently use ground leases in their corporate growth strategies.

A ground lease also does not need the occupant to have a down payment for securing the land, as acquiring the residential or commercial property would require. Therefore, less equity is included in acquiring a ground lease, which maximizes cash for other purposes and improves the yield on using 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 overall tax problem.

Landlord Benefits

The landowner gets a constant stream of income from the renter while maintaining ownership of the residential or commercial property. A ground lease usually consists of an escalation clause that guarantees increases in lease and expulsion rights that supply defense in case of default on lease or other expenditures.

There are also tax cost savings for a property owner who utilizes ground leases. If they sell a residential or commercial property to an occupant outright, they will realize a gain on the sale. By performing this kind of lease, they avoid needing to report any gains. But there may be some tax implications on the lease they receive.

Depending upon the provisions took into the ground lease, a landlord may also be able to maintain some control over the residential or commercial property including its use and how it is developed. This suggests the property owner can approve or deny any changes to the land.

Tenant Disadvantages

Because landlords might need approval before any changes are made, the renter may experience roadblocks in the usage or advancement of the residential or commercial property. As an outcome, there might be more constraints and less flexibility for the occupant.

Costs related to the ground lease process may be higher than if the tenant were to acquire a residential or commercial property outright. Rents, taxes, enhancements, allowing, along with any wait times for proprietor approval, can all be costly.

Landlord Disadvantages

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

Depending upon where the residential or commercial property is situated, utilizing a ground lease may have higher tax implications for a property owner. Although they may not understand 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?

A few of the disadvantages of ground leases consist of the possibility of residential or commercial property loss, loss of higher income due to market changes if rent boosts aren't developed into the agreement, and tax drawbacks, 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 a tenant build on residential or commercial property in a prime place they could not themselves buy. They can invest their cash in enhancing the residential or commercial property. On the other hand, an occupant might deal with limitations 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 quickly. When it does, you'll need to leave the residential or commercial property, and all buildings and enhancements revert to the landlord. However, a lease can be extended. Prior to the expiration date, unless you or your landlord take particular steps to end the agreement, it will simply continue exactly the very same terms up until its end. You do not need to do anything unless you get a notification from your landlord.

A ground lease is a contract in which a renter can develop residential or commercial property throughout the lease period, 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 renters who build buildings on the residential or commercial property.

Tenants who can't afford to purchase land can build on the residential or commercial property and utilize the land, while proprietors 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.
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