Benefits of ground lease

A lease refers to a contractual agreement between two parties, the lessee and the lessor, wherein the former pays a specified sum for using property, land or services owned by the latter.

This property can be anything, ranging from land to vehicles. However, the meaning of a ground lease is specific to the real estate sector.

What is a ground lease?

At times, for businesses, leasing a property can be a more cost-effective option than buying it outright. 

A ground lease or land lease involves leasing the land and then making improvements over it as deemed fit by the tenant. 

How does a Ground Lease work?

Mostly seen in the commercial property sector, businesses have certain specifications with respect to the property they need. A common way to achieve these specifications is through a ground lease. 

By undertaking a ground lease, the lessee gains the right to develop on the leased land whatever they find suitable. Once the lease period ends, the leased land along with any improvements made on it returns to the landowner. 

A common ground lease example can be traced to popular, commercial food & beverage franchises such as Starbucks and McDonalds. The corporate parent of these companies will likely acquire land and then hand it to a tenant to construct on it and utilise the property.

A ground lease can be beneficial for landowner and  tenant. 

• For landowners

Once the ground lease has expired, the landowner legally owns any developments on their land. Improvements made during the ground lease may boost the property’s value, which the landowner can capitalise on.

• For the tenants

From a tenant’s perspective, a ground lease enables them to gain access to prime locations that would have been extremely expensive to acquire.

Businesses tend to build on leased land. Ground leases can be long-term, ranging typically from 50 to 99 years. Ground leases help businesses to manage their cash, making it a cost-effective choice. 

Any improvements and development costs made on leased land would have to be borne by the tenant. However, the rent paid for the ground lease may entail certain tax deductions. 

Types of ground lease

There are two types of ground lease: subordinated and unsubordinated.

In order to negotiate a higher rent and get more value back at the end of the lease, landowners can agree to a subordinate lease. Under this type of contract, the landowner lets the tenant take on loans for making improvements over the leased land, by allowing the leased land to be pegged as collateral for these development loans. By doing so, the landowner will automatically settle to be on the lower priority of claims, in case the tenant defaults on the loan. 

Under an unsubordinated ground lease, it can be tough for tenants to get an improvement loan. This is because under this type of lease the landowner will hold their right to get priority compensation in case the tenant defaults and accepts a lower rent payment compared to subordinate leases. In turn, this would adversely impact the willingness of financial lenders to extend an improvement loan to the tenant.