When renting a commercial residential or commercial property, there are a number of various types of commercial leases one could come across. In some cases tenants may be looking for a residential or commercial property they can build on and create 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 tenant rents a piece of land and is allowed to develop that residential or commercial property during the duration of the lease. During the lease term, the renter owns any structures, advancements or enhancements made on the land. Once the lease ends, the land and any building or improvements on that land become the residential or commercial property owner's. Usually, ground leases are long-lasting, with a lease duration in between 20 to 99 years, stated Scott Miller, Senior Director of Land Services, and Jeff Peden, Executive Managing Director of Land Services at Transwestern. Ground leases are typically net leases, they included, in which the tenant is accountable for paying residential or commercial property taxes, insurance and maintenance.

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

There are two types of ground leases: subordinated and unsubordinated. The distinction in between the 2 relates to what occurs if the renter is dealing with financial trouble throughout the term of the lease.

Subordinated Ground Lease

With a subordinated ground lease, the proprietor accepts be a lower concern with regards to any other funding acquired on the residential or commercial property. If a tenant gets a loan to construct on the land and after that defaults on the loan, the lender can go after the residential or commercial property, including the land, as collateral. For example, an occupant who signs a subordinated ground lease may secure a loan for $400,000 to construct a retail residential or commercial property. However, if that tenant runs into monetary problem and is unable to make loan payments, the lending institution can pursue the structure and the land.

"Typically, this is done to facilitate financial obligation financing to construct buildings on the residential or commercial property," Miller and Peden said. In most cases with a subordinated ground lease, the property manager might need greater rent payments because they're taking on some quantity of risk.

Unsubordinated Ground Lease

With an unsubordinated ground lease, the proprietor maintains greater priority than the lending institution. Lenders are unable to foreclose on the land or utilize it as collateral if a renter is unable to make their loan payments. Rather, if the tenant defaults on the loan, the loan provider can only go after their business assets. Some lending institutions might hesitate to offer a mortgage to renters who have signed an unsubordinated ground lease. Because of this included difficulty for the renters, property managers will typically charge lower rent.

Pros and Cons of Ground Leases for Tenants

Like all leases, ground leases feature their benefits and downsides, for both renters and property managers. For tenants, the benefits and drawbacks might 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 company requirements.

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

No Deposit: With a land purchase, the occupant would be paying a big deposit to purchase 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 go towards building on the land rather.

Reduced Lease Payments: If the renter were leasing both the land and the building, then lease payments would be much higher. With a ground lease, the renter is making lower regular monthly payments.

Building Customization: When renting an already existing space, the tenant is unable to tailor the structure to fit their specific needs. However, with a ground lease, occupants are just renting the land and can personalize the residential or commercial property as they choose.

Some Higher Costs: Developing a residential or commercial property is pricey, and although renters have the ability to tailor their building as they see healthy, sometimes the monetary costs may outweigh those advantages.

Doesn't Retain Ownership After the Lease Expires: After putting money and time into developing a residential or commercial property and making improvements, the tenant will need to quit ownership of the residential or commercial property once the lease expires, if they select not to restore the lease. At that point, the landowner stands to benefit from the improvements the occupant made.

Responsible for Fees: The occupant has to pay residential or commercial property taxes, insurance coverage and upkeep costs on the residential or commercial property for the regard to the lease.

Pros and Cons of Ground Leases for Landlords

For property managers, a ground lease could be useful for a variety of reasons, but naturally it includes both advantages and disadvantages.

Pros

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

Steady Income: Landlords have the advantage of receiving month-to-month rent on the land, consequently giving them a consistent income stream. In addition, numerous ground leases likewise include an escalation provision, which guarantees a lease boost and expulsion rights when it comes to an occupant defaulting on payments.

Retains Ownership of Improvements: After the lease period ends, the property manager maintains ownership of any improvements made on the land and can therefore sell the residential or commercial property at an earnings.

Cons

Lack of Control: In the circumstance where a landlord doesn't include certain provisions in the lease, they may not have any say in what the renter does with the land.

Higher Income Tax: Although a property manager won't have to pay capital gains taxes, the rent they receive from the occupant counts as earnings, therefore they will have to pay higher earnings taxes.

Example of a Ground Lease

In Houston last June, Peden and Miller worked out a 20-year, 2.64-acre ground lease for a brand-new vehicle dealership. The land was rented to Grubbs Automotive, with plans to convert the existing structures into a brand-new Volvo vehicle car dealership. In this example, Grubbs Automotive is renting the land however has the freedom to develop brand-new residential or commercial properties and make enhancements on the land and any existing buildings as they choose. Once the lease term ends, if they do not renew, then all of those improvements become the residential or commercial property of the property manager.

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

A leasehold estate is extremely similar 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 party, from which the occupant is renting. The celebration that is renting the land from the landowner has the right to use the land throughout of the lease. When the lease ends, the building and any enhancements 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 duration that has actually been concurred to. 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 made with the residential or commercial property." Essentially, leasehold agreements come with more restrictions than ground leases but are otherwise relatively similar.

Is a Ground Lease Right for You?

While a ground lease comes with its benefits and drawbacks for both the occupant and the proprietor, it is necessary to know what you're looking for in a rental contract before choosing on a kind of lease. Ground leases are advantageous because of their longevity and guaranteed income for proprietors. And for tenants, ground leases allow you to construct a residential or commercial property that fits your customized requires. However, there are many different lease structures. Before selecting what fits your requirements, make certain to do your due diligence and find out about the different kinds of commercial leases around.