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Subordinated vs. Unsubordinated
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What Is a Ground Lease? How It Works, Advantages, and Example

Investopedia/ Tara Anand

A ground lease is a contract in which an occupant is allowed to establish a piece of residential or commercial property throughout the lease duration, 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 develop residential or commercial property during the lease period, after which it is turned over to the residential or commercial property owner.
- Ground leases are frequently made by commercial property owners, who generally lease land for 50 to 99 years to tenants who build structures on the residential or commercial property.
- Tenants who otherwise can't manage to buy land can build residential or commercial property with a ground lease, while proprietors get a stable earnings and retain control over the use and advancement of their residential or commercial property.
How a Ground Lease Works

A ground lease shows that enhancements will be owned by the residential or commercial property owner unless an exception is developed and specifies that all relevant taxes sustained during the lease period will be paid by the renter. Because a ground lease permits the proprietor to assume all improvements once the lease term ends, the landlord may sell the residential or commercial property at a higher rate. Ground leases are also frequently called land leases, as property owners lease out the land only.

Although they are utilized mainly in industrial area, ground leases vary significantly from other types of industrial leases, like those discovered in shopping center and workplace structures. These other leases typically do not appoint the lessee to handle responsibility for the system. Instead, these occupants are charged lease in order to run their services. A ground lease includes leasing land for a long-lasting period-typically for 50 to 99 years-to a renter who constructs a structure on the residential or commercial property.

Tenants generally assume duty for all financial aspects of a ground lease, including lease, taxes, building and construction, insurance, and financing.

A 99-year lease is typically the longest possible lease term for a piece of realty residential or commercial property. Historically, it was the longest possible under typical law. Nowadays, it depends upon the jurisdiction whether leases longer than 99 years are permitted. Most U.S. states still have a 99-year maximum.

The ground lease defines who owns the land and who owns the structure and improvements on the residential or commercial property. Many property owners use ground leases as a method to retain ownership of their residential or commercial property for preparing reasons, to prevent any capital gains, and to produce earnings and revenue. Tenants normally presume responsibility for any and all expenditures. This includes building and construction, repair work, remodellings, improvements, taxes, insurance, and any financing expenses related to the residential or commercial property.

Example of a Ground Lease

Ground leases are frequently used by franchises and big box shops, along with other business entities. The home office will normally acquire the land, and enable 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 stores are ground rented. Macy's owns the buildings however still pays lease on the ground the building is on. As of February 3, 2024, Macy's reported long-term lease liabilities of simply under $3 billion. This leased genuine estate includes small-format stores, warehouse, office, and full-line stores.

Some of the basics of any ground lease ought to include:

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

Subordinated vs. Unsubordinated Ground Leases

Ground lease tenants often fund enhancements by taking on debt. In a subordinated ground lease, the landlord accepts a lower top priority of claims on the residential or commercial property in case the occupant defaults on the loan for enhancements. Simply put, a subordinated ground lease-landlord essentially permits the residential or commercial property deed to serve as collateral when it comes to occupant default on any improvement-related loan.

For this type of ground lease, the landlord may negotiate higher rent payments in return for the risk taken on in case of renter default. This may also benefit the property manager because building a building on their land increases the worth of their residential or commercial property.

In contrast, an unsubordinated ground lease lets the landlord keep the leading priority of claims on the residential or commercial property in case the renter defaults on the loan for enhancements. Because the loan provider might not take ownership of the land if the loan goes unpaid, loan specialists may be reluctant to extend a mortgage for improvements. Although the landlord maintains ownership of the residential or commercial property, they usually need to charge the renter a lower quantity of rent.

Advantages and Disadvantages of a Ground Lease

A ground lease can benefit both the occupant and the landlord.

Tenant Benefits

The ground lease lets an occupant develop on or commercial property in a prime place they could not themselves buy. For this factor, large chain stores such as Whole Foods and Starbucks often make use of ground leases in their corporate expansion strategies.

A ground lease also does not need the tenant to have a down payment for securing the land, as buying the residential or commercial property would need. Therefore, less equity is involved in obtaining a ground lease, which maximizes money for other purposes and enhances the yield on making use of the land.

Any lease paid on a ground lease may be deductible for state and federal earnings taxes, suggesting a reduction in the occupant's total tax problem.

Landlord Benefits

The landowner gets a stable stream of income from the tenant while maintaining ownership of the residential or commercial property. A ground lease normally includes an escalation provision that guarantees increases in lease and eviction rights that offer defense in case of default on rent or other costs.

There are also tax savings for a property manager who utilizes ground leases. If they offer a residential or commercial property to an occupant outright, they will understand a gain on the sale. By performing this kind of lease, they avoid needing to report any gains. But there might be some tax ramifications on the lease they receive.

Depending on the arrangements took into the ground lease, a proprietor may likewise be able to retain some control over the residential or commercial property including its use and how it is established. This indicates the property owner can approve or deny any modifications to the land.

Tenant Disadvantages

Because proprietors might need approval before any modifications are made, the occupant might encounter roadblocks in the usage or advancement of the residential or commercial property. As a result, there might be more restrictions and less versatility for the renter.

Costs associated with the ground lease process may be higher than if the renter 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 clauses in their leases stand to lose control of tenants whose residential or commercial properties undergo advancement. This is why it's constantly important for both parties to have their leases evaluated before finalizing.

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

What Are the Disadvantages of a Ground Lease?

Some of the downsides of ground leases include the possibility of residential or commercial property loss, loss of greater earnings due to market modifications if rent increases aren't developed into the contract, and tax disadvantages, such as devaluation and other costs that can't balance out earnings.

Is a Ground Lease a Great Investment?

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

What Happens When a Ground Lease Expires?

Ground leases usually last years so it will not end anytime quickly. When it does, you'll need to leave the residential or commercial property, and all structures and improvements go back to the property manager. However, a lease can be extended. Prior to the expiration date, unless you or your property owner take specific actions to end the arrangement, it will simply continue precisely the same terms till its end. You do not require to do anything unless you receive a notice from your property manager.

A ground lease is an agreement in which an occupant 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 commonly made by industrial landlords, who usually lease land for 50 years to 99 years to renters who construct structures on the residential or commercial property.

Tenants who can't manage to purchase land can construct on the residential or commercial property and use the land, while proprietors get a steady earnings and retain 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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