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When leasing a commercial residential or commercial property, there are a variety of different kinds of business leases one might experience. In many cases renters may be searching for a residential or commercial property they can develop on and develop enhancements that fit their particular requirements. If this is the case, then a ground lease may be the best option.

A ground lease is a type of lease contract in which the tenant rents a piece of land and is allowed to develop that residential or commercial property throughout the period of the lease. During the lease term, the tenant owns any structures, advancements or improvements made on the land. Once the lease ends, the land and any building and 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 normally net leases, they added, in which the renter is responsible for paying residential or commercial property taxes, insurance and upkeep.

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

There are 2 types of ground leases: subordinated and unsubordinated. The distinction between the 2 relates to what takes place if the renter is handling financial difficulty during the regard to 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 secures a loan to develop on the land and then defaults on the loan, the lending institution can pursue the residential or commercial property, including the land, as security. For circumstances, a tenant who signs a subordinated ground lease might secure a loan for $400,000 to build a retail residential or commercial property. However, if that occupant runs into monetary difficulty and is not able to make loan payments, the lender can go after the building and the land.

"Typically, this is done to help with debt financing to build buildings on the residential or commercial property," Miller and Peden stated. In most cases with a subordinated ground lease, the property owner may require greater rent payments because they're taking on some amount of danger.

Unsubordinated Ground Lease

With an unsubordinated ground lease, the proprietor retains greater priority than the lender. Lenders are not able to foreclose on the land or use it as security if an occupant is not able to make their loan payments. Rather, if the occupant defaults on the loan, the loan provider can only go after their business properties. Some loan providers might hesitate to provide a mortgage to occupants who have signed an unsubordinated ground lease. Because of this included problem for the renters, proprietors will generally charge lower lease.

Benefits and drawbacks of Ground Leases for Tenants

Like all leases, ground leases include their benefits and downsides, for both tenants and proprietors. For tenants, the pros and cons might differ depending upon what you're searching for in an industrial residential or commercial property.

Location: With a ground lease, renters can build a residential or commercial property in a location of their choosing, without being bound to in an area that may not be ideal for their specific business needs.
Lower Taxes: For both federal and state taxes, the lease paid on a ground lease is tax deductible. The renter is paying less taxes than they would be if they simply bought the land.
No Deposit: With a land purchase, the renter would be paying a big deposit to buy the land, after which they would still need to construct 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 leasing both the land and the structure, then lease payments would be much greater. With a ground lease, the occupant is making lower monthly payments.
Building Customization: When leasing an already existing space, the renter is not able to tailor the building to fit their specific requirements. However, with a ground lease, renters are just leasing the land and can personalize the residential or commercial property as they please.

Some Higher Costs: Developing a residential or commercial property is costly, and although occupants have the ability to tailor their building as they choose, often the monetary costs might outweigh those benefits.
Doesn't Retain Ownership After the Lease Expires: After putting money and time into developing a residential or commercial property and making enhancements, the tenant will have to provide up ownership of the residential or commercial property once the lease ends, if they pick not to restore the lease. At that point, the landowner stands to benefit from the improvements the renter made.
Responsible for Fees: The tenant has to pay residential or commercial property taxes, insurance coverage and upkeep 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 advantageous for a variety of factors, however naturally it comes with both advantages and downsides.

Lower Taxes: With a ground lease, property owners do not need to report any capital gains as they would with a land sale. On top of that, the renter is responsible for residential or commercial property taxes.
Steady Income: Landlords have the benefit of getting monthly lease on the land, thus giving them a consistent income stream. In addition, numerous ground leases likewise include an escalation clause, which guarantees a lease increase and expulsion rights in the case of a tenant defaulting on payments.
Retains Ownership of Improvements: After the lease duration ends, the property manager maintains ownership of any enhancements made on the land and can for that reason offer the residential or commercial property at an earnings.

Lack of Control: In the scenario where a property manager doesn't consist of particular provisions in the lease, they might not have any say in what the renter makes with the land.
Higher Income Tax: Although a property manager won't need to pay capital gains taxes, the rent they get from the occupant counts as income, therefore they will have to pay greater income taxes.

In Houston last June, Peden and Miller worked out a 20-year, 2.64-acre ground lease for a brand-new automobile dealership. The land was rented to Grubbs Automotive, with strategies to convert the existing structures into a new Volvo vehicle car dealership. In this example, Grubbs Automotive is leasing the land but has the liberty to build brand-new residential or commercial properties and make improvements 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 property manager.

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

A leasehold estate is really comparable to a ground lease, in that with a leasehold estate, the physical structures are owned by the occupant, and the land is owned by another celebration, from which the renter is leasing. The celebration that is leasing the land from the landowner has the right to utilize the land for the period of the lease. When the lease ends, the building and any improvements end up being residential or commercial property of the landowner, comparable to a ground lease. See likewise appurtenance.

However, according to Miller and Peden, "With a ground lease, you essentially 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 concurred to. With a leasehold, there is an arrangement in between the owner of the residential or commercial property and the lessee with typically more limitations on the lessee on what can be made with the residential or commercial property." Essentially, leasehold arrangements come with more constraints than ground leases however are otherwise fairly comparable.
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Is a Ground Lease Right for You?

While a ground lease features its advantages and disadvantages for both the renter and the proprietor, it is necessary to understand what you're trying to find in a rental contract before picking a kind of lease. Ground leases are advantageous because of their longevity and guaranteed earnings for property owners. And for tenants, ground leases allow you to construct a residential or commercial property that fits your custom needs. However, there are various lease structures. Before choosing on what fits your needs, make certain to do your due diligence and discover the different types of commercial leases in existence.