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When leasing a commercial residential or commercial property, there are a variety of different kinds of business leases one might come across. In some cases occupants may be looking for a residential or commercial property they can develop on and create enhancements that fit their specific needs. If this is the case, then a ground lease might be the finest option.

A ground lease is a type of lease agreement in which the tenant rents a piece of land and is allowed to establish that residential or commercial property throughout the period of the lease. During the lease term, the occupant owns any buildings, developments or improvements made on the land. Once the lease ends, the land and any construction or improvements on that land become the residential or commercial property owner's. Usually, ground leases are long-lasting, with a lease duration in between 20 to 99 years, said Scott Miller, Senior Director of Land Services, and Jeff Peden, Executive Managing Director of Land Services at Transwestern. Ground leases are typically net leases, they included, in which the occupant is responsible for paying residential or commercial property taxes, insurance coverage and maintenance.

What's the Difference Between a Subordinated vs Unsubordinated Ground Lease?

There are two types of ground leases: subordinated and unsubordinated. The distinction between the 2 pertains to what occurs if the occupant is handling financial difficulty throughout the regard to the lease.

Subordinated Ground Lease

With a subordinated ground lease, the property owner accepts be a lower concern with concerns to any other financing gotten on the residential or commercial property. If a tenant gets a loan to construct on the land and after that defaults on the loan, the lender can pursue the residential or commercial property, consisting of the land, as security. For circumstances, an occupant who signs a subordinated ground lease might get a loan for $400,000 to construct a retail residential or commercial property. However, if that occupant faces financial trouble and is unable to make loan payments, the loan provider can go after the structure and the land.

"Typically, this is done to facilitate debt financing to construct structures on the residential or commercial property," Miller and Peden stated. In a lot of cases with a subordinated ground lease, the property owner might need higher rent payments due to the fact that they're taking on some amount of risk.

Unsubordinated Ground Lease

With an unsubordinated ground lease, the proprietor retains higher concern than the lending institution. Lenders are not able to foreclose on the land or use it as security if a renter is not able to make their loan payments. Rather, if the occupant defaults on the loan, the lender can just go after their company assets. Some lending institutions may be reluctant to offer out a mortgage to tenants who have actually signed an unsubordinated ground lease. Because of this added problem for the renters, property owners will typically charge lower lease.

Advantages and disadvantages of Ground Leases for Tenants

Like all leases, ground leases come with their advantages and downsides, for both renters and property owners. For tenants, the benefits and drawbacks may vary depending on what you're searching for in a commercial residential or commercial property.

Location: With a ground lease, occupants can build a residential or commercial property in a location of their choosing, without being bound to pre-existing buildings in an area that might not be perfect for their particular business needs.
Lower Taxes: For both federal and state taxes, the lease paid on a ground lease is tax deductible. The tenant is paying less taxes than they would be if they simply bought the land.
No Deposit: With a land purchase, the occupant would be paying a large deposit to purchase the land, after which they would still need to build on that land. However, with a ground lease, there is no downpayment, and more cash can approach building on the land rather.
Reduced Lease Payments: If the renter were renting both the land and the building, then lease payments would be much higher. With a ground lease, the occupant is making lower regular monthly payments.
Building Customization: When leasing a currently existing area, the occupant is unable to customize the structure to fit their particular needs. However, with a ground lease, occupants are just renting the land and can customize the residential or commercial property as they choose.


Some Higher Costs: Developing a residential or commercial property is costly, and although tenants are able to customize their structure as they see healthy, sometimes the financial expenses might exceed those advantages.
Doesn't Retain Ownership After the Lease Expires: After putting cash and time into developing a residential or commercial property and making improvements, the tenant will have to quit ownership of the residential or commercial property once the lease ends, if they choose not to renew the lease. At that point, the landowner stands to benefit from the enhancements the occupant made.
Responsible for Fees: The occupant has to pay residential or commercial property taxes, insurance and maintenance expenses on the residential or commercial property for the term of the lease.


Benefits and drawbacks of Ground Leases for Landlords

For proprietors, a ground lease could be helpful for a variety of reasons, however obviously it comes with both advantages and disadvantages.

Lower Taxes: With a ground lease, proprietors do not have to report any capital gains as they would with a land sale. On top of that, the tenant is responsible for residential or commercial property taxes.
Steady Income: Landlords have the benefit of getting month-to-month lease on the land, consequently approving them a steady income stream. In addition, many ground leases also consist of an escalation clause, which guarantees a rent increase and expulsion rights in the case of a tenant defaulting on payments.
Retains Ownership of Improvements: After the lease period ends, the property owner keeps ownership of any enhancements made on the land and can for that reason offer the residential or commercial property at a profit.


Lack of Control: In the circumstance where a property owner doesn't include particular stipulations in the lease, they might not have any say in what the tenant makes with the land.
Higher Income Tax: Although a landlord won't have to pay capital gains taxes, the lease they get from the renter counts as earnings, therefore they will have to pay greater income taxes.

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In Houston last June, Peden and Miller worked out a 20-year, 2.64-acre ground lease for a new automobile dealership. The land was rented to Grubbs Automotive, with plans to transform the existing structures into a new Volvo automotive dealer. In this example, Grubbs Automotive is leasing the land however has the freedom to construct brand-new residential or commercial properties and make enhancements on the land and any existing structures as they please. Once the lease term ends, if they do not renew, then all of those improvements become the residential or commercial property of the property manager.

What's the Difference Between a Ground Lease vs Leasehold?

A leasehold estate is really similar to a ground lease, because with a leasehold estate, the physical structures are owned by the renter, and the land is owned by another celebration, from which the tenant is leasing. The celebration that is leasing the land from the landowner has the right to the land throughout of the lease. When the lease ends, the structure and any enhancements become residential or commercial property of the landowner, similar to a ground lease. See likewise appurtenance.

However, according to Miller and Peden, "With a ground lease, you basically have the rights as an owner of the land and the residential or commercial property or buildings that are on it for the duration that has actually been consented to. With a leasehold, there is an arrangement between the owner of the residential or commercial property and the lessee with normally more limitations on the lessee on what can be finished with the residential or commercial property." Essentially, leasehold arrangements feature more constraints than ground leases however are otherwise relatively similar.

Is a Ground Lease Right for You?

While a ground lease features its benefits and drawbacks for both the occupant and the property manager, it is very important to know what you're searching for in a rental agreement before deciding on a type of lease. Ground leases are advantageous because of their durability and surefire earnings for property managers. And for tenants, ground leases allow you to construct a residential or commercial property that fits your custom needs. However, there are several lease structures. Before choosing on what fits your requirements, ensure to do your due diligence and learn more about the various types of commercial leases out there.
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