What is a Ground Lease?

Do you own land, perhaps with shabby residential or commercial property on it? One way to extract value from the land is to sign a ground lease. This will allow you to make earnings and perhaps capital gains. In this post, we'll explore,

- What is a Ground Lease?

How to Structure Them
Examples of Ground Leases
Advantages and disadvantages
Commercial Lease Calculator
How Assets America Can Help
Frequently Asked Questions

What is a Ground Lease?

In a ground lease (GL), a tenant establishes a piece of land during the lease duration. Once the lease ends, the tenant turns over the residential or commercial property improvements to the owner, unless there is an exception.

Importantly, the tenant is accountable for paying all residential or commercial property taxes throughout the lease period. The acquired enhancements allow the owner to sell the residential or commercial property for more money, if so desired.

Common Features

Typically, a ground lease lasts from 35 to 99 years. Normally, the lessee takes a lease on some raw or ready land and constructs a building on it. Sometimes, the land has a structure already on it that the lessee must demolish.
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The GL specifies who owns the land and the enhancements, i.e., residential or commercial property that the lessee constructs. Typically, the lessee controls and depreciates the improvements throughout the lease duration. That control reverts to the owner/lessor upon the expiration of the lease.

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Ground Lease Subordination

One important element of a ground lease is how the lessee will finance enhancements to the land. An essential arrangement is whether the property owner will concur to subordinate his concern on claims if the lessee defaults on its debt.

That's exactly what takes place in a subordinated ground lease. Thus, the residential or commercial property deed ends up being collateral for the lending institution if the lessee defaults. In return, the property owner requests greater lease on the residential or commercial property.

Alternatively, an unsubordinated ground lease keeps the proprietor's top priority claims if the leaseholder defaults on his payments. However this may discourage lending institutions, who wouldn't have the ability to occupy in case of default. Accordingly, the property owner will normally charge lower rent on unsubordinated ground leases.

How to Structure a Ground Lease

A ground lease is more complex than regular industrial leases. Here are some elements that enter into structuring a ground lease:

1. Term

The lease must be sufficiently long to allow the lessee to amortize the expense of the improvements it makes. In other words, the lessee needs to make enough revenues during the lease to spend for the lease and the enhancements. Furthermore, the lessee must make a reasonable return on its financial investment after paying all expenses.

The most significant driver of the lease term is the funding that the lessee organizes. Normally, the lessee will want a term that is 5 to 10 years longer than the loan amortization schedule.

On a 30-year mortgage, that means a lease term of at least 35 to 40 years. However, fast food ground leases with shorter amortization durations may have a 20-year lease term.

2. Rights and Responsibilities

Beyond the plans for paying rent, a ground lease has a number of special features.

For instance, when the lease ends, what will occur to the enhancements? The lease will define whether they go back to the lessor or the lessee must eliminate them.

Another function is for the lessor to assist the lessee in acquiring essential licenses, authorizations and zoning variances.

3. Financeability

The lender should have option to secure its loan if the lessee defaults. This is hard in an unsubordinated ground lease because the lessor has first top priority in the case of default. The lending institution just has the right to claim the leasehold.

However, one solution is a stipulation that needs the successor lessee to utilize the loan provider to finance the new GL. The topic of financeability is complex and your legal professionals will need to wade through the various complexities.

Bear in mind that Assets America can help finance the construction or restoration of business residential or commercial property through our network of private financiers and banks.

4. Title Insurance

The lessee should organize title insurance coverage for its leasehold. This requires special recommendations to the routine owner's policy.

5. Use Provision

Lenders desire the broadest use provision in the lease. Basically, the provision would enable any legal purpose for the residential or commercial property. In this method, the lender can more easily sell the leasehold in case of default.

The lessor may can consent in any brand-new purpose for the residential or commercial property. However, the loan provider will seek to limit this right. If the lessor feels strongly about restricting particular uses for the residential or commercial property, it needs to specify them in the lease.

6. Casualty and Condemnation

The lender controls insurance coverage profits coming from casualty and condemnation. However, this might conflict with the standard phrasing of a ground lease, which gives some control to the lessor.

Unsurprisingly, lending institutions desire the insurance coverage proceeds to go toward the loan, not residential or commercial property repair. Lenders likewise need that neither lessors nor lessees can end ground leases due to a casualty without their approval.

Regarding condemnation, lending institutions firmly insist upon taking part in the procedures. The lender's requirements for applying the condemnation profits and controlling termination rights mirror those for casualty events.

7. Leasehold Mortgages

These are mortgages funding the lessee's enhancements to the ground lease residential or commercial property. Typically, lending institutions balk at lessor's keeping an unsubordinated position with respect to default.

If there is a pre-existing mortgage, the mortgagee should concur to an SNDA arrangement. Usually, the GL lender wants very first concern relating to subtenant defaults.

Moreover, lenders need that the ground lease remains in force if the lessee defaults. If the lessor sends out a notification of default to the lessee, the loan provider should receive a copy.

Lessees desire the right to get a leasehold mortgage without the lender's consent. Lenders want the GL to work as security should the lessee default.

Upon foreclosure of the residential or commercial property, the loan provider receives the lessee's leasehold interest in the residential or commercial property. Lessors might wish to limit the kind of entity that can hold a leasehold mortgage.

8. Rent Escalation

Lessors desire the right to increase rents after specified durations so that it preserves market-level leas. A "ratchet" increase uses the lessee no defense in the face of an economic decline.

Ground Lease Example

As an example of a ground lease, think about one signed for a Starbucks drive-through shipping container shop in Portland.

Starbucks' concept is to offer decommissioned shipping containers as an environmentally friendly alternative to conventional construction. The very first store opened in Seattle, followed by Kansas City, Denver, Chicago, and one in Portland, OR.

It was a rather uncommon ground lease, in that it was a 10-year triple-net ground lease with four 5-year choices to extend.

This gives the GL an optimal regard to 30 years. The rent escalation stipulation supplied for a 10% rent boost every 5 years. The lease worth was simply under $1 million with a cap rate of 5.21%.

The initial lease terms, on a yearly basis, were:

- 09/01/2014 - 08/31/2019 @ $52,000.
09/01/2019 - 08/31/2024 @ $57,200.
09/01/2024 - 08/31/2029 @ $62,920.
09/01/2029 - 08/31/2034 @ $69,212.
09/01/2034 - 08/31/2039 @ $76,133.
09/01/2039 - 08/31/2044 @ $83,747

Ground Lease Pros & Cons

Ground leases have their benefits and disadvantages.

The advantages of a ground lease include:

Affordability: Ground leases enable renters to develop on residential or commercial property that they can't afford to purchase. Large chain stores like Starbucks and Whole Foods use ground leases to expand their empires. This allows them to grow without saddling the companies with excessive financial obligation. No Deposit: Lessees do not have to put any money down to take a lease. This stands in stark contrast to residential or commercial property acquiring, which might require as much as 40% down. The lessee gets to save cash it can deploy elsewhere. It also improves its return on the leasehold financial investment. Income: The lessor receives a stable stream of earnings while keeping ownership of the land. The lessor keeps the value of the income through using an escalation provision in the lease. This entitles the lessor to increase rents regularly. Failure to pay lease offers the lessor the right to kick out the renter.

The downsides of a ground lease include:

Foreclosure: In a subordinated ground lease, the owner risks of losing its residential or commercial property if the lessee defaults. Taxes: Had the owner simply sold the land, it would have received capital gains treatment. Instead, it will pay ordinary business rates on its lease income. Control: Without the necessary lease language, the owner might over the land's advancement and use. Borrowing: Typically, ground leases forbid the lessor from obtaining versus its equity in the land throughout the ground lease term.
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Ground Lease Calculator

This is a fantastic industrial lease calculator. You enter the area, rental rate, and agent's fee. It does the rest.

How Assets America Can Help

Assets America ® will set up financing for industrial projects beginning at $20 million, without any ceiling. We welcome you to call us to find out more about our total financial services.

We can assist finance the purchase, construction, or restoration of commercial residential or commercial property through our network of private investors and banks. For the finest in business realty financing, Assets America ® is the smart option.

- What are the different kinds of leases?

They are gross leases, modified gross leases, single net leases, double net leases and triple net leases. The likewise include absolute leases, percentage leases, and the subject of this post, ground leases. All of these leases provide benefits and drawbacks to the lessor and lessee.

- Who pays residential or commercial property taxes on a ground lease?

Typically, ground leases are triple net. That means that the lessee pays the residential or commercial property taxes during the lease term. Once the lease ends, the lessor ends up being responsible for paying the residential or commercial property taxes.

- What occurs at the end of a ground lease?

The land constantly goes back to the lessor. Beyond that, there are 2 possibilities for the end of a ground lease. The first is that the lessor seizes all improvements that the lessee made throughout the lease. The second is that the lessee must destroy the enhancements it made.

- For how long do ground leases generally last?

Typically, a ground lease term extends to at lease 5 to 10 years beyond the leasehold mortgage. For instance, if the lessee takes a 30-year mortgage on its improvements, the lease term will run for a minimum of 35 to 40 years. Some ground leases extend as far as 99 years.