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 a renter is permitted to develop a piece of residential or commercial property throughout the lease period, after which the land and all enhancements are committed the residential or commercial property owner.

- A ground lease is an arrangement in which an occupant can develop residential or commercial property throughout the lease duration, after which it is committed the residential or commercial property owner.

- Ground leases are typically made by business proprietors, who typically rent land for 50 to 99 years to occupants who construct 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 property owners get a steady income and maintain control over the usage and advancement of their residential or commercial property.


How a Ground Lease Works

A ground lease shows that enhancements will be owned by the residential or commercial property owner unless an exception is created and stipulates that all appropriate taxes sustained during the lease duration will be paid by the renter. Because a ground lease allows the proprietor to presume all enhancements once the lease term ends, the property owner might offer the residential or commercial property at a higher rate. Ground leases are also often called land leases, as proprietors lease out the land just.

Although they are used mostly in business area, ground leases differ greatly from other kinds of business leases, like those found in mall and office complex. These other leases generally do not assign the lessee to take on responsibility for the unit. Instead, these renters are charged rent in order to run their services. A ground lease includes leasing land for a long-term period-typically for 50 to 99 years-to a renter who constructs a structure on the residential or commercial property.

Tenants normally presume duty for all monetary aspects of a ground lease, including lease, taxes, building and construction, insurance, and financing.

A 99-year lease is typically the longest possible lease term for a piece of genuine estate residential or commercial property. Historically, it was the longest possible under typical law. Nowadays, it depends on 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 structure and improvements on the residential or commercial property. Many property owners 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 produce earnings and profits. Tenants normally assume obligation for any and all expenses. This consists of building and construction, repairs, restorations, enhancements, taxes, insurance coverage, 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, along with other commercial entities. The business headquarters will generally purchase the land, and allow 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 lot of Macy's shops are ground rented. Macy's owns the structures however still pays rent on the ground the structure is on. Since February 3, 2024, Macy's reported long-term lease liabilities of just under $3 billion. This rented realty consists of small-format shops, circulation centers, workplace area, and full-line stores.

A few of the principles of any ground lease ought to include:

- Terms of the lease.

- Rights of both the property manager and renter

- Conditions on funding

- Use provisions

- Fees

- Title insurance coverage

- Default

Subordinated vs. Unsubordinated Ground Leases

Ground lease occupants frequently finance improvements by taking on financial obligation. In a subordinated ground lease, the property manager accepts a lower top priority of claims on the residential or commercial property in case the occupant defaults on the loan for improvements. In other words, a subordinated ground lease-landlord essentially enables the residential or commercial property deed to act as collateral in the case of renter default on any improvement-related loan.

For this type of ground lease, the property owner might negotiate greater lease payments in return for the danger handled in case of tenant default. This might also benefit the landlord due to the fact that constructing 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 manager retain the leading concern of claims on the residential or commercial property in case the renter defaults on the loan for enhancements. Because the loan provider might not take ownership of the land if the loan goes unpaid, loan professionals might be reluctant to extend a mortgage for enhancements. Although the property owner retains ownership of the residential or commercial property, they generally need to charge the occupant a lower quantity of lease.

Advantages and Disadvantages of a Ground Lease

A ground lease can benefit both the occupant and the proprietor.

Tenant Benefits

The ground lease lets a tenant construct on residential or commercial property in a prime area they could not themselves purchase. For this factor, large store such as Whole Foods and Starbucks frequently use ground leases in their business expansion plans.

A ground lease likewise does not need the tenant to have a down payment for protecting the land, as buying the residential or commercial property would need. Therefore, less equity is associated with acquiring a ground lease, which frees up money for other functions and improves the yield on making use of the land.

Any lease paid on a ground lease may be deductible for state and federal earnings taxes, meaning a reduction in the renter's overall tax problem.

Landlord Benefits

The landowner gets a stable stream of earnings from the occupant while retaining ownership of the residential or commercial property. A ground lease typically consists of an escalation clause that guarantees boosts in lease and expulsion rights that supply security in case of default on lease or other expenditures.

There are likewise tax savings for a property owner who uses 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 might be some tax ramifications on the rent they receive.

Depending upon the arrangements took into the ground lease, a proprietor may also have the ability to keep some control over the residential or commercial property including its use and how it is developed. This indicates the property owner can approve or deny any modifications to the land.

Tenant Disadvantages

Because property managers might need approval before any changes are made, the renter might come across roadblocks in the use or advancement of the residential or commercial property. As a result, there may be more constraints and less flexibility for the tenant.

Costs connected with the ground lease process might be higher than if the renter were to purchase a residential or commercial property outright. Rents, taxes, improvements, allowing, along with any wait times for landlord approval, can all be costly.

Landlord Disadvantages

Landlords who do not put in the correct arrangements and clauses in their leases stand to lose control of tenants whose residential or commercial properties go through advancement. This is why it's always essential for both parties to have their leases examined before signing.

Depending upon where the residential or commercial property is located, utilizing a ground lease might have greater tax ramifications for a landlord. Although they might not recognize a gain from a sale, rent is considered income. So lease is taxed at the regular rate, which might increase the tax burden.

What Are the Disadvantages of a Ground Lease?

Some of the drawbacks of ground leases include the possibility of residential or commercial property loss, loss of higher earnings due to market modifications if lease increases aren't built into the arrangement, and tax downsides, such as devaluation and other costs that can't offset earnings.

Is a Ground Lease a Good Investment?

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

What Happens When a Ground Lease Expires?

Ground leases typically last decades so it will not expire anytime quickly. When it does, you'll need to leave the residential or commercial property, and all buildings and improvements revert to the property owner. However, a lease can be extended. Prior to the expiration date, unless you or your property manager take specific actions to end the contract, it will simply advance exactly the very same terms till its end. You do not require to do anything unless you receive a notification from your landlord.

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 typically made by business proprietors, who typically lease land for 50 years to 99 years to occupants who build structures on the residential or commercial property.

Tenants who can't afford to purchase land can develop on the residential or commercial property and utilize the land, while property owners get a constant 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.