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 an occupant is permitted to establish 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 a contract in which a renter can establish residential or commercial property throughout the lease duration, after which it is committed the residential or commercial property owner.
- Ground leases are frequently made by business property managers, who typically lease land for 50 to 99 years to renters who build buildings on the residential or commercial property.
- Tenants who otherwise can't afford to buy land can develop residential or commercial property with a ground lease, while landlords get a consistent income and maintain control over the use and advancement of their residential or commercial property.
How a Ground Lease Works

A ground lease indicates that enhancements will be owned by the residential or commercial property owner unless an exception is produced and states that all appropriate taxes sustained throughout the lease period will be paid by the renter. Because a ground lease allows the landlord to presume all enhancements once the lease term ends, the proprietor may offer the residential or commercial property at a greater rate. Ground leases are also frequently called land leases, as landlords lease out the land only.

Although they are utilized mostly in business space, ground leases differ greatly from other kinds of business leases, like those discovered in mall and office buildings. These other leases generally do not assign the lessee to take on duty for the unit. Instead, these tenants are charged lease in order to operate their organizations. A ground lease involves renting land for a long-lasting period-typically for 50 to 99 years-to a renter who constructs a building on the residential or commercial property.

Tenants typically presume obligation for all financial elements of a ground lease, including lease, taxes, building and construction, insurance coverage, and funding.

A 99-year lease is usually 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 managers use ground leases as a way to maintain ownership of their residential or commercial property for planning reasons, to avoid any capital gains, and to generate earnings and income. Tenants typically presume responsibility for any and all costs. This includes construction, repair work, remodellings, improvements, taxes, insurance, and any financing expenses associated with the residential or commercial property.

Example of a Ground Lease

Ground leases are typically utilized by franchises and huge box stores, as well as other industrial entities. The business head office will typically acquire the land, and permit 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

Many of Macy's stores are ground leased. Macy's owns the structures but still pays lease on the ground the building 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, warehouse, office, and full-line stores.

Some of the basics of any ground lease must include:

- Terms of the lease.
- Rights of both the property manager and renter
- Conditions on funding
- Use arrangements
- Fees
- coverage
- Default

Subordinated vs. Unsubordinated Ground Leases

Ground lease tenants often fund improvements by handling financial obligation. In a subordinated ground lease, the property owner accepts a lower top priority of claims on the residential or commercial property in case the tenant defaults on the loan for enhancements. Simply put, a subordinated ground lease-landlord essentially allows for the residential or commercial property deed to serve as security in the case of tenant default on any improvement-related loan.

For this type of ground lease, the proprietor may work out greater lease payments in return for the risk taken on in case of tenant default. This may also benefit the property owner since building a building on their land increases the worth of their residential or commercial property.

In contrast, an unsubordinated ground lease lets the proprietor retain the leading priority of claims on the residential or commercial property in case the renter defaults on the loan for improvements. Because the loan provider may not take ownership of the land if the loan goes overdue, loan experts may be hesitant to extend a mortgage for improvements. Although the proprietor keeps ownership of the residential or commercial property, they normally have to charge the renter a lower amount of rent.

Advantages and Disadvantages of a Ground Lease

A ground lease can benefit both the occupant and the property owner.

Tenant Benefits

The ground lease lets an occupant construct on residential or commercial property in a prime location they could not themselves buy. For this factor, big chain stores such as Whole Foods and Starbucks often make use of ground leases in their business growth strategies.

A ground lease also does not need the tenant to have a down payment for securing the land, as acquiring the residential or commercial property would require. Therefore, less equity is involved in getting a ground lease, which maximizes money for other functions and improves the yield on making use of the land.

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

Landlord Benefits

The landowner gets a consistent stream of earnings from the occupant while maintaining ownership of the residential or commercial property. A ground lease normally consists of an escalation stipulation that guarantees boosts in rent and eviction rights that supply protection in case of default on rent or other expenditures.

There are also tax savings for a property owner who utilizes ground leases. If they sell a residential or commercial property to a renter outright, they will recognize a gain on the sale. By performing this kind of lease, they prevent having to report any gains. But there may be some tax implications on the lease they receive.

Depending upon the arrangements took into the ground lease, a property owner may likewise be able to maintain some control over the residential or commercial property including its use and how it is developed. This means the property manager can approve or reject any changes to the land.

Tenant Disadvantages

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

Costs related to the ground lease process may be greater than if the tenant were to purchase a residential or commercial property outright. Rents, taxes, enhancements, allowing, in addition to any wait times for landlord approval, can all be expensive.

Landlord Disadvantages

Landlords who do not put in the proper provisions and clauses in their leases stand to lose control of occupants whose residential or commercial properties undergo development. This is why it's always crucial for both parties to have their leases reviewed before finalizing.

Depending upon where the residential or commercial property is located, using a ground lease may have greater tax ramifications for a property manager. Although they might not realize a gain from a sale, lease is considered earnings. So rent is taxed at the common rate, which may increase the tax burden.

What Are the Disadvantages of a Ground Lease?

A few of the downsides of ground leases consist of the possibility of residential or commercial property loss, loss of greater earnings due to market modifications if lease increases aren't developed into the agreement, and tax drawbacks, such as depreciation and other expenditures that can't balance out income.

Is a Ground Lease an Excellent Investment?

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

What Happens When a Ground Lease Expires?

Ground leases usually last years so it won't end anytime soon. When it does, you'll need to leave the residential or commercial property, and all structures and enhancements revert to the proprietor. However, a lease can be extended. Prior to the expiration date, unless you or your landlord take particular steps to end the arrangement, it will merely continue on exactly the exact same terms until 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 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 commonly made by commercial landlords, who usually lease land for 50 years to 99 years to renters who build buildings on the residential or commercial property.

Tenants who can't manage to buy land can build on the residential or commercial property and use the land, while proprietors get a stable earnings and keep control of their residential or commercial property.

Schorr Law. "Lease Over 99 Years Is Void, Not Voidable."
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Macy's. "Macy's, Inc.
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