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Subordinated vs. Unsubordinated


What Is a Ground Lease? How It Works, Advantages, and Example

Investopedia/ Tara Anand

A ground lease is an arrangement in which a renter is permitted to develop a piece of residential or commercial property during 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 tenant can establish residential or commercial property throughout the lease duration, after which it is committed the residential or commercial property owner.
- Ground leases are typically made by business property owners, who typically lease land for 50 to 99 years to tenants who construct structures on the residential or commercial property.
- Tenants who otherwise can't manage to buy land can develop residential or commercial property with a ground lease, while property managers get a steady income and retain control over the use and advancement of their residential or commercial property.
How a Ground Lease Works

A ground lease shows that improvements will be owned by the residential or commercial property owner unless an exception is developed and states that all pertinent taxes incurred throughout the lease period will be paid by the tenant. Because a ground lease allows the landlord to assume all improvements once the lease term ends, the property manager may offer the residential or commercial property at a greater rate. Ground leases are likewise typically called land leases, as landlords lease out the land only.

Although they are used mainly in industrial space, ground leases differ greatly from other kinds of industrial leases, like those discovered in shopping center and office complex. These other leases usually do not appoint the lessee to take on obligation for the unit. Instead, these occupants are charged lease in order to operate their organizations. A ground lease includes renting land for a long-term period-typically for 50 to 99 years-to an occupant who constructs a building on the residential or commercial property.

Tenants usually assume responsibility for all monetary elements of a ground lease, including lease, taxes, building, insurance, and financing.

A 99-year lease is usually the longest possible lease term for a piece of real estate residential or commercial property. Historically, it was the longest possible under common 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 building and improvements on the residential or commercial property. Many landlords use ground leases as a method to maintain ownership of their residential or commercial property for preparing factors, to avoid any capital gains, and to produce income and revenue. Tenants generally assume obligation for any and all expenses. This consists of construction, repair work, remodellings, enhancements, taxes, insurance, and any funding costs associated with the residential or commercial property.

Example of a Ground Lease

Ground leases are frequently used by franchises and big box shops, along with other industrial entities. The business head office will generally acquire the land, and allow the tenant/developer to construct and use the facility. There's a likelihood that a McDonald's, Starbucks, or Dunkin Donuts near you are bound by a ground lease

Much of Macy's shops are ground rented. Macy's owns the structures however still pays rent on the ground the building is on. Since February 3, 2024, Macy's reported long-lasting lease liabilities of simply under $3 billion. This rented property includes small-format stores, distribution centers, office, and full-line stores.

A few of the fundamentals of any ground lease need to include:

- Terms of the lease.
- Rights of both the property manager and renter
- Conditions on financing
- Use arrangements
- Fees
- Title insurance
- Default

Subordinated vs. Unsubordinated Ground Leases

Ground lease tenants typically finance enhancements by taking on financial obligation. In a subordinated ground lease, the property owner consents to a lower priority of claims on the residential or commercial property in case the renter defaults on the loan for improvements. To put it simply, a subordinated ground lease-landlord basically enables the residential or commercial property deed to act as collateral in the case of tenant default on any improvement-related loan.

For this type of ground lease, the property manager might work out higher rent payments in return for the danger handled in case of tenant default. This might also benefit the proprietor since constructing a structure 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 tenant defaults on the loan for enhancements. Because the lender may not take ownership of the land if the loan goes unpaid, loan professionals may be reluctant to extend a mortgage for improvements. Although the property manager retains ownership of the residential or commercial property, they typically need to charge the occupant a lower amount of lease.

Advantages and Disadvantages of a Ground Lease

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

Tenant Benefits

The ground lease lets a renter develop on residential or commercial property in a prime place they could not themselves purchase. For this reason, big store such as Whole Foods and Starbucks frequently utilize ground leases in their corporate growth plans.

A ground lease likewise does not require the occupant to have a deposit for securing the land, as purchasing the residential or commercial property would require. Therefore, less equity is included in obtaining a ground lease, which releases up cash for other purposes and improves the yield on making use of the land.

Any lease paid on a ground lease might be deductible for state and federal income taxes, meaning a reduction in the tenant's general tax burden.

Landlord Benefits

The landowner acquires a constant stream of income from the occupant while keeping ownership of the residential or commercial property. A ground lease generally contains an escalation provision that guarantees increases in lease and eviction rights that supply defense in case of default on lease or other expenses.

There are also tax cost savings for a landlord who utilizes ground leases. If they sell a residential or commercial property to a tenant outright, they will recognize a gain on the sale. By performing this type of lease, they prevent needing to report any gains. But there might be some tax ramifications on the rent they receive.

Depending on the provisions took into the ground lease, a landlord may also be able to retain some control over the residential or commercial property including its use and how it is established. This indicates the landlord can approve or reject any changes to the land.

Tenant Disadvantages

Because proprietors may need approval before any changes are made, the tenant might experience roadblocks in the usage or advancement of the residential or commercial property. As a result, there may be more limitations and less versatility for the occupant.

Costs associated with the ground lease procedure may be greater than if the occupant were to acquire a residential or commercial property outright. Rents, taxes, enhancements, permitting, in addition to any wait times for property manager approval, can all be pricey.

Landlord Disadvantages

Landlords who don't put in the correct provisions and provisions in their leases stand to lose control of occupants whose residential or commercial properties undergo advancement. This is why it's constantly important for both parties to have their leases reviewed before signing.

Depending upon where the residential or commercial property is situated, utilizing a ground lease may have higher tax implications for a landlord. Although they might not understand a gain from a sale, lease is thought about earnings. So rent is taxed at the common rate, which may increase the tax concern.

What Are the Disadvantages of a Ground Lease?

Some of the disadvantages 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 built into the arrangement, and tax downsides, such as devaluation and other expenses that can't offset earnings.

Is a Ground Lease a Good Investment?

It can be. A ground lease lets a tenant develop on residential or commercial property in a prime location they might not themselves acquire. They can invest their money in enhancing the residential or commercial property. On the other hand, a tenant may face restrictions on what they can do with the residential or commercial property.

What Happens When a Ground Lease Expires?

Ground leases generally last decades so it will not end anytime quickly. When it does, you'll need to leave the residential or commercial property, and all buildings and improvements go back to the property owner. However, a lease can be extended. Prior to the expiration date, unless you or your landlord take particular steps to end the contract, it will simply advance precisely the very same terms up until its end. You do not need to do anything unless you get a notice from your landlord.

A ground lease is a contract in which a renter can develop residential or commercial property throughout the lease period, after which it is turned over to the residential or commercial property owner. Ground leases are typically made by business landlords, who usually lease land for 50 years to 99 years to occupants who build buildings on the residential or commercial property.

who can't manage to buy land can build on the residential or commercial property and use the land, while landlords get a steady earnings and maintain control of their residential or commercial property.

Schorr Law. "Lease Over 99 Years Is Void, Not Voidable."

Macy's. "Macy's, Inc.
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