Ground Lease

What is a Ground Lease?

A ground lease is a type of contract where the parties are interested in transacting on land. A ground lease is an agreement between a landowner and a tenant for unimproved land. It is also known as Land Lease. The piece of land under the lease can either have a rudimentary infrastructure in place or could even be bare. This lease is a long-term arrangement typically lasting between 50 to 99 years.

Importance and Need for Ground / Land Lease

Such types of leases created basically to monetize, make use of the land available with the owner. And due to some or other reasons, the Land Owner is not in a position to monetize that himself. Such an arrangement creates a win-win situation for both parties. Here both parties complement each other. And the land under question becomes the earning resource for both the parties. The following could be the circumstances which prompt such a lease arrangement for both the parties:

Win-Win Circumstances Land Owners Lessee
Efforts to Monetize The owner is not willing to make any more efforts to develop the available land. Lessee is ready to make the efforts to implement, sell, and operate the project.
Idea/Plan He does not have a proper plan or project or the idea to develop the land. The party has a financially viable project or a proper plan.
Resources – Financial or Physical The owner does not have enough financial and physical resources for development. The leasing party is prepared to invest as well as will be able to fetch financial funding and resources for the project.
Ownership He continues to retain the ownership with him. Still, the owner wants to earn from that land use The lessee does not want to waste the available limited financial resources on paying the ownership cost.

Commercial Terms of the Ground Lease Arrangement

The terms of the arrangement/lease are discussed and agreed between the parties. The arrangement is finalized, as per the convenience of the parties. And that also depends upon the extent of ownership control; the lessor would like to exercise. Generally, the agreement could be on the following lines:

  1. The lessor may get a fixed lease amount per year for the entire term of the lease. It may also incorporate a clause for a fixed increment over the base lease amount after every three years or five years or so.
  2. The lessor may be entitled to a fixed lease rental plus a percentage of profits or revenue from the proposed project.
  3. The lessor may also agree to invest in the proposed project partially and thus may become a partner in the project. The investment could be in the form of land or cash.
  4. The lessor may be entitled to receive back the property with all its improvements once the lease period is over. It is in addition to the amount which the lessor is supposed to get as per points 1 or 2 above.
  5. The lessee may be permitted to arrange finance for the proposed project with a right to mortgage the land.

Execution of Lease Arrangement

  • Once the lease terms are finalized, the tenant/lessee makes improvements to the land by undertaking construction on the property.
  • The tenant is also responsible for paying expenses for insurance, taxes, and repair and maintenance.
  • The ground lease outlines the ownership of the land and the construction and improvements made on it.

Types of Ground Leases

Though the terms and conditions for the lease could vary as may be agreed between the parties, however, there are mainly two types of leases that are in practice.

  1. Subordinated
  2. Unsubordinated

Subordinated Ground Lease

In a subordinated ground lease, the landowner gets a lower priority on claims on the land in question by agreeing to such terms. Here the owner allows the mortgage of the land to the lender whose rights remain overriding to the owner.

While the fact that the owner itself would agree to take on a lower priority on the land that he owns may seem counterintuitive, but it’s not so. Because the owner benefits from the improvement of his property and which increases the overall value of the property. Further, giving up the first claim on the land also allows him to negotiate favorable terms, including a higher rent.

Unsubordinated Ground Lease

In an unsubordinated ground lease, the landowner retains top priority on the property in case the tenant defaults on loans taken for undertaking improvements on the land. It means that lenders to the tenant cannot take ownership of the land in the case of a default by the tenant. This top priority usually means that the landowner charges lower rent to the tenant. And even though it makes his position safer than it would be in a subordinated lease, the lender becomes hesitant to extend loans to the tenant as they cannot claim the property in case of a default.

Ground Lease

Advantages and Disadvantages of a Ground Lease

Pros to the Tenant

  • For a tenant, a ground lease is a useful method to gain access to prime locations, which would otherwise be very expensive to purchase outright.
  • A ground lease also helps a tenant to focus on taking out loans to make improvements on the land and begin doing business instead of being bogged down by the cost of land acquisition.
  • There is a tax benefit as well. The tenant can claim the deduction on rent payments under a ground lease from federal and state governments.

Pros to the Landowner

  • For a landowner, a ground lease provides a means to retain the ownership of land and a steady stream of revenue in the form of lease payments, which would not be the case in an outright sale.
  • Further, he does not have to worry about the hassle of making improvements on the land, which a tenant does.
  • In terms of the lease, all improvements made on the land can become the property of the landowner. It thus provides another benefit to the landowner.
  • The names of the agreement may also help the landowner have some control over the kind of construction made on the land and its regular use.

Cons to the Tenant

  • Given the terms of an agreement, a tenant may find the intended development and use of the land in question restrictive, which would not be the case if the tenant would have gone for outright purchase.
  • Also, the cost of leasing land, taking into account escalation clauses which outline rent increases over the term of the agreement, may turn out to be higher for the tenant in the long-term, as compared to an outright purchase. It, however, depends on the viability and success of the project or business undertaken on the property.

Cons to the Landowner

  • Depending upon a landowner’s tax situation, a ground lease may be disadvantageous. As the rent received is taxed at ordinary rates instead of capital gain rates.
  • Further, some contracts prohibit or severely restrict a landowner’s ability to borrow against the equity ownership of the land for the terms of the lease.
  • He also needs to be very careful about the terms of the lease agreement, failing which he may lose control over the improvements on his land and their end-use.1–3
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Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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