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 a tenant is allowed to develop a piece of residential or commercial property throughout the lease duration, 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 establish residential or commercial property during the lease period, after which it is committed the residential or commercial property owner.

- Ground leases are commonly made by commercial property managers, who usually rent land for 50 to 99 years to occupants who construct buildings on the residential or commercial property.

- Tenants who otherwise can't pay for to buy land can construct residential or commercial property with a ground lease, while property managers get a consistent income and retain control over the use and advancement 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 created and states that all relevant taxes incurred throughout the lease duration will be paid by the occupant. Because a ground lease allows the property owner to assume all enhancements once the lease term expires, the property manager might sell the residential or commercial property at a higher rate. Ground leases are likewise typically called land leases, as landlords rent out the land only.

Although they are used mainly in industrial area, ground leases vary greatly from other kinds of commercial leases, like those discovered in shopping center and office complex. These other leases typically do not assign the lessee to handle obligation for the system. Instead, these tenants are charged rent in order to run their companies. A ground lease includes 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 typically presume responsibility for all monetary aspects of a ground lease, consisting of rent, taxes, construction, insurance, and funding.

A 99-year lease is normally 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 permitted. Most U.S. states still have a 99-year maximum.

The ground lease specifies who owns the land and who owns the structure and improvements on the residential or commercial property. Many proprietors utilize ground leases as a method to keep ownership of their residential or commercial property for planning reasons, to prevent any capital gains, and to generate earnings and revenue. Tenants generally assume responsibility for any and all costs. This includes building and construction, repair work, restorations, improvements, taxes, insurance coverage, and any financing costs connected with the residential or commercial property.

Example of a Ground Lease

Ground leases are often used by franchises and huge box stores, in addition to other commercial entities. The home office will generally buy the land, and allow the tenant/developer to construct and use the center. There's a likelihood that a McDonald's, Starbucks, or Dunkin Donuts near you are bound by a ground lease

A lot of Macy's stores are ground leased. Macy's owns the buildings however still pays rent on the ground the structure is on. Since February 3, 2024, Macy's reported long-lasting lease liabilities of just under $3 billion. This rented real estate consists of small-format stores, warehouse, workplace area, and full-line stores.

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

- Terms of the lease.

- Rights of both the proprietor and occupant

- Conditions on financing

- Use arrangements

- Fees

- Title insurance

- Default

Subordinated vs. Unsubordinated Ground Leases

Ground lease occupants frequently fund enhancements by handling debt. In a subordinated ground lease, the property owner consents to a lower top priority of claims on the residential or commercial property in case the occupant defaults on the loan for enhancements. In other words, a subordinated ground lease-landlord essentially permits the residential or commercial property deed to function as security when it comes to renter default on any improvement-related loan.

For this type of ground lease, the proprietor may work out greater lease payments in return for the danger handled in case of renter default. This may also benefit the property owner because constructing a structure on their land increases the worth of their residential or commercial property.

On the other hand, 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 enhancements. Because the loan provider may not take ownership of the land if the loan goes unpaid, loan professionals may be hesitant to extend a mortgage for enhancements. Although the property owner maintains ownership of the residential or commercial property, they normally need to charge the occupant a lower quantity of lease.

Advantages and Disadvantages of a Ground Lease

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

Tenant Benefits

The ground lease lets a tenant construct on residential or commercial property in a prime area they might not themselves acquire. For this factor, large store such as Whole Foods and Starbucks often utilize ground leases in their corporate expansion plans.

A ground lease also does not require the renter to have a down payment for protecting the land, as purchasing the residential or commercial property would need. Therefore, less equity is associated with getting a ground lease, which releases up money for other functions and enhances the yield on utilizing the land.

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

Landlord Benefits

The landowner gets a steady stream of income from the renter while retaining ownership of the residential or commercial property. A ground lease usually contains an escalation provision that guarantees increases in rent and expulsion rights that provide defense in case of default on lease or other expenses.

There are also tax cost savings for a property manager who uses ground leases. If they offer a residential or commercial property to a renter outright, they will understand a gain on the sale. By performing this type of lease, they prevent needing to report any gains. But there might be some tax ramifications on the lease they get.

Depending on the arrangements put into the ground lease, a property owner may likewise be able to keep some control over the residential or commercial property including its usage and how it is established. This indicates the landlord can approve or reject any changes to the land.

Tenant Disadvantages

Because landlords might need approval before any changes are made, the tenant might experience obstructions in the usage or development of the residential or commercial property. As a result, there may be more restrictions and less flexibility for the renter.

Costs related to the ground lease process may be greater than if the renter were to acquire a residential or commercial property outright. Rents, taxes, enhancements, permitting, as well as any wait times for property manager approval, can all be pricey.

Landlord Disadvantages

Landlords who don't put in the appropriate provisions and clauses in their leases stand to lose control of occupants whose residential or commercial properties go through development. This is why it's constantly crucial for both parties to have their leases examined before signing.

Depending on where the residential or commercial property lies, using a ground lease might have higher tax ramifications for a landlord. Although they may not recognize a gain from a sale, lease is considered income. So lease is taxed at the normal rate, which may increase the tax concern.

What Are the Disadvantages of a Ground Lease?

A few of the drawbacks of ground leases consist of the possibility of residential or commercial property loss, loss of greater income due to market modifications if rent boosts aren't constructed into the arrangement, and tax drawbacks, such as depreciation and other costs that can't offset income.

Is a Ground Lease an Excellent Investment?

It can be. A ground lease lets an occupant build on residential or commercial property in a prime place they might not themselves buy. They can invest their money in improving the residential or commercial property. On the other hand, a renter 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 will not expire anytime quickly. When it does, you'll need to leave the residential or commercial property, and all buildings and enhancements go back to the landlord. However, a lease can be extended. Prior to the expiration date, unless you or your landlord take specific actions to end the agreement, it will just continue on exactly the exact same terms up until its end. You do not need to do anything unless you receive a notification from your property manager.

A ground lease is an agreement in which a renter 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 normally rent land for 50 years to 99 years to renters who construct buildings on the residential or commercial property.

Tenants who can't afford to buy land can construct on the residential or commercial property and utilize the land, while landlords get a consistent income and maintain control of their residential or commercial property.

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

Macy's. "Macy's, Inc.