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When leasing a commercial residential or commercial property, there are a number of various kinds of commercial leases one could experience. Sometimes tenants might be looking for a residential or commercial property they can develop on and develop improvements that fit their particular requirements. If this is the case, then a ground lease may be the very best choice.

A ground lease is a kind of lease arrangement in which the renter rents a piece of land and is allowed to develop that residential or commercial property during the period of the lease. During the lease term, the tenant owns any buildings, developments or enhancements made on the land. Once the lease ends, the land and any construction or enhancements on that land become the residential or commercial property owner's. Usually, ground leases are long-term, 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 usually net leases, they added, in which the occupant is accountable 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 kinds of ground leases: subordinated and unsubordinated. The distinction between the 2 involves what occurs if the tenant is dealing with financial trouble during the term of the lease.

Subordinated Ground Lease

With a subordinated ground lease, the landlord accepts be a lower priority with regards to any other financing acquired on the residential or commercial property. If an occupant gets a loan to build on the land and after that defaults on the loan, the loan provider can pursue the residential or commercial property, consisting of the land, as security. For circumstances, a renter who signs a subordinated ground lease might take out a loan for $400,000 to develop a retail residential or commercial property. However, if that renter faces financial problem and is not able to make loan payments, the lender can go after the structure and the land.

"Typically, this is done to assist in financial obligation financing to build buildings on the residential or commercial property," Miller and Peden stated. In most cases with a subordinated ground lease, the property manager might need greater lease payments since they're taking on some amount of risk.

Unsubordinated Ground Lease

With an unsubordinated ground lease, the property manager maintains greater top priority than the loan provider. Lenders are not able to foreclose on the land or use it as security if a renter is unable to make their loan payments. Rather, if the renter defaults on the loan, the loan provider can only pursue their service possessions. Some lenders may be unwilling to provide a mortgage to occupants who have actually signed an unsubordinated ground lease. Because of this added difficulty for the tenants, landlords will typically charge lower rent.

Advantages and disadvantages of Ground Leases for Tenants

Like all leases, ground leases include their benefits and disadvantages, for both tenants and property managers. For renters, the pros and cons may vary depending upon what you're looking for in an industrial residential or commercial property.

Location: With a ground lease, tenants can develop a residential or commercial property in a place of their picking, without being bound to pre-existing structures in a place that might not be perfect for their particular organization needs.

Lower Taxes: For both federal and state taxes, the rent paid on a ground lease is tax deductible. The occupant is paying less taxes than they would be if they simply bought the land.

No Down Payment: With a land purchase, the tenant would be paying a big deposit to buy the land, after which they would still need to develop on that land. However, with a ground lease, there is no downpayment, and more cash can go toward structure on the land instead.

Reduced Lease Payments: If the renter were leasing both the land and the building, then lease payments would be much greater. With a ground lease, the renter is making lower month-to-month payments.

Building Customization: When renting an already existing area, the occupant is not able to personalize the building to fit their specific requirements. However, with a ground lease, occupants are only the land and can tailor the residential or commercial property as they please.

Some Higher Costs: Developing a residential or commercial property is expensive, and although renters have the ability to tailor their structure as they choose, sometimes the monetary expenses might exceed those advantages.

Doesn't Retain Ownership After the Lease Expires: After putting cash and time into constructing a residential or commercial property and making enhancements, the tenant will need to give up ownership of the residential or commercial property once the lease ends, if they choose not to restore the lease. At that point, the landowner stands to benefit from the improvements the renter made.

Responsible for Fees: The tenant needs to pay residential or commercial property taxes, insurance coverage and maintenance expenditures on the residential or commercial property for the term of the lease.

Pros and Cons of Ground Leases for Landlords

For property owners, a ground lease could be useful for a number of factors, however obviously it includes both advantages and downsides.

Pros

Lower Taxes: With a ground lease, landlords do not need to report any capital gains as they would with a land sale. On top of that, the renter is accountable for residential or commercial property taxes.

Steady Income: Landlords have the advantage of receiving month-to-month lease on the land, thereby approving them a constant earnings stream. In addition, lots of ground leases likewise include an escalation clause, which guarantees a rent increase and eviction rights in the case of a tenant defaulting on payments.

Retains Ownership of Improvements: After the lease duration ends, the proprietor maintains ownership of any enhancements made on the land and can for that reason sell the residential or commercial property at an earnings.

Cons

Lack of Control: In the scenario where a property owner does not include particular stipulations in the lease, they may not have any say in what the renter finishes with the land.

Higher Income Tax: Although a proprietor will not have to pay capital gains taxes, the lease they get from the tenant counts as earnings, and so they will need to pay greater earnings taxes.

Example of a Ground Lease

In Houston last June, Peden and Miller negotiated a 20-year, 2.64-acre ground lease for a new automotive dealer. The land was rented to Grubbs Automotive, with plans to convert the existing structures into a new Volvo automotive car dealership. In this example, Grubbs Automotive is renting the land but 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 restore, then all of those enhancements end up being the residential or commercial property of the proprietor.

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

A leasehold estate is extremely comparable to a ground lease, because with a leasehold estate, the physical structures are owned by the tenant, and the land is owned by another celebration, from which the renter is renting. The party that is leasing the land from the landowner has the right to use the land for the period of the lease. When the lease ends, the structure and any improvements end up being 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 structures that are on it for the period that has been accepted. With a leasehold, there is a contract between the owner of the residential or commercial property and the lessee with generally more constraints on the lessee on what can be done with the residential or commercial property." Essentially, leasehold arrangements feature more restrictions than ground leases however are otherwise fairly comparable.

Is a Ground Lease Right for You?

While a ground lease includes its advantages and downsides for both the occupant and the property owner, it is essential to understand what you're looking for in a rental arrangement before choosing a kind of lease. Ground leases are beneficial since of their longevity and surefire income for property managers. And for tenants, ground leases permit you to construct a residential or commercial property that fits your custom requires. However, there are many different lease structures. Before picking what fits your needs, make sure to do your due diligence and learn more about the different kinds of commercial leases in presence.