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1 Does a Ground Lease Fit Your Commercial Residential Or Commercial Property Needs?

When renting a business residential or commercial property, there are a of various types of business leases one might come across. In some cases renters may be trying to find a residential or commercial property they can build on and create improvements that fit their specific needs. If this holds true, then a ground lease may be the very best option.

A ground lease is a type of lease agreement in which the occupant leases a piece of land and is permitted to establish that residential or commercial property during the period of the lease. During the lease term, the tenant owns any structures, advancements or enhancements made on the land. Once the lease ends, the land and any construction or improvements on that land become the residential or commercial property owner's. Usually, ground leases are long-term, with a lease duration 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 generally net leases, they added, in which the renter is accountable for paying residential or commercial property taxes, insurance coverage and maintenance.
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What's the Difference Between a Subordinated vs Unsubordinated Ground Lease?

There are two types of ground leases: subordinated and unsubordinated. The difference between the 2 relates to what happens if the occupant is handling financial trouble throughout the regard to the lease.

Subordinated Ground Lease

With a subordinated ground lease, the landlord concurs to be a lower concern with concerns to any other funding gotten on the residential or commercial property. If a renter takes out a loan to construct on the land and then defaults on the loan, the loan provider can go after the residential or commercial property, consisting of the land, as collateral. For circumstances, a renter who signs a subordinated ground lease might take out a loan for $400,000 to construct a retail residential or commercial property. However, if that renter faces financial trouble and is unable to make loan payments, the lender can go after the structure and the land.

"Typically, this is done to assist in debt financing to build structures on the residential or commercial property," Miller and Peden stated. In a lot of cases with a subordinated ground lease, the proprietor might need higher rent payments due to the fact that they're handling some quantity of risk.

Unsubordinated Ground Lease

With an unsubordinated ground lease, the property manager retains greater top priority than the loan provider. Lenders are unable to foreclose on the land or utilize it as security if an occupant is not able to make their loan payments. Rather, if the renter defaults on the loan, the lending institution can just pursue their company possessions. Some lenders might hesitate to provide out a mortgage to occupants who have actually signed an unsubordinated ground lease. Because of this included trouble for the renters, landlords will usually charge lower lease.

Pros and Cons of Ground Leases for Tenants

Like all leases, ground leases include their advantages and drawbacks, for both renters and property owners. For occupants, the benefits and drawbacks may differ depending on what you're trying to find in a commercial residential or commercial property.

Location: With a ground lease, tenants can build 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 specific company needs.
Lower Taxes: For both federal and state taxes, the rent paid on a ground lease is tax deductible. The renter is paying less taxes than they would be if they just acquired the land.
No Deposit: With a land purchase, the renter would be paying a large down payment to buy the land, after which they would still need to build on that land. However, with a ground lease, there is no downpayment, and more money can go towards structure on the land instead.
Reduced Lease Payments: If the tenant were leasing both the land and the structure, then lease payments would be much greater. With a ground lease, the occupant is making lower month-to-month payments.
Building Customization: When leasing an already existing area, the tenant is unable to personalize the structure to fit their specific needs. However, with a ground lease, tenants are only renting the land and can customize the residential or commercial property as they see fit.

Some Higher Costs: Developing a residential or commercial property is pricey, and although tenants are able to customize their structure as they choose, often the financial costs might 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 renter will have to quit ownership of the residential or commercial property once the lease expires, if they choose not to restore the lease. At that point, the landowner stands to benefit from the enhancements the tenant made.
Responsible for Fees: The tenant has to pay residential or commercial property taxes, insurance and maintenance expenses on the residential or commercial property for the term of the lease.

Benefits and drawbacks of Ground Leases for Landlords

For property managers, a ground lease could be useful for a variety of reasons, however obviously it features both benefits and disadvantages.

Lower Taxes: With a ground lease, proprietors do not need to report any capital gains as they would with a land sale. On top of that, the renter is accountable for residential or commercial property taxes.
Steady Income: Landlords have the advantage of receiving regular monthly rent on the land, thereby giving them a stable income stream. In addition, numerous ground leases likewise include an escalation stipulation, which ensures 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 proprietor retains ownership of any enhancements made on the land and can therefore offer the residential or commercial property at an earnings.

Lack of Control: In the situation where a property manager doesn't include certain stipulations in the lease, they may not have any say in what the occupant makes with the land.
Higher Income Tax: Although a landlord won't have to pay capital gains taxes, the rent they receive from the tenant counts as earnings, and so they will need to pay greater earnings taxes.

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

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

A leasehold estate is extremely similar to a ground lease, because with a leasehold estate, the physical structures are owned by the renter, and the land is owned by another celebration, from which the tenant is leasing. 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 structure and any improvements end up being residential or commercial property of the landowner, similar to a ground lease. See also 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 buildings that are on it for the duration that has been accepted. With a leasehold, there is an agreement between the owner of the residential or commercial property and the lessee with usually more limitations on the lessee on what can be finished with the residential or commercial property." Essentially, leasehold agreements come with more constraints than ground leases but are otherwise relatively comparable.

Is a Ground Lease Right for You?

While a ground lease includes its benefits and downsides for both the tenant and the proprietor, it's essential to know what you're searching for in a rental arrangement before deciding on a kind of lease. Ground leases are advantageous since of their durability and surefire earnings for proprietors. And for occupants, ground leases enable you to develop a residential or commercial property that fits your customized needs. However, there are several lease structures. Before selecting what fits your requirements, make certain to do your due diligence and learn more about the different kinds of commercial leases around.