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

When renting a commercial residential or commercial property, there are a variety of different kinds of business leases one could experience. In some cases occupants might be trying to find a residential or commercial property they can construct on and produce improvements that fit their specific requirements. If this holds true, then a ground lease may be the finest choice.

A ground lease is a type of lease contract in which the occupant rents a piece of land and is permitted to develop that residential or commercial property throughout the period of the lease. During the lease term, the renter owns any buildings, developments 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-lasting, with a lease period 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 usually net leases, they added, in which the tenant is accountable for paying residential or commercial property taxes, insurance coverage and upkeep.

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

There are 2 kinds of ground leases: subordinated and unsubordinated. The distinction in between the 2 pertains to what occurs if the occupant is handling financial difficulty during the term of the lease.

Subordinated Ground Lease

With a subordinated ground lease, the property owner consents to be a lower concern with regards to any other funding acquired on the residential or commercial property. If a tenant gets a loan to develop on the land and then defaults on the loan, the lending institution can go after the residential or commercial property, consisting of the land, as security. For example, an occupant who signs a subordinated ground lease may get a loan for $400,000 to construct a retail residential or commercial property. However, if that tenant faces financial problem and is unable to make loan payments, the loan provider can pursue the building and the land.

“Typically, this is done to help with financial obligation financing to build buildings on the residential or commercial property,” Miller and Peden said. Oftentimes with a subordinated ground lease, the property manager may need higher lease payments since they’re taking on some quantity of danger.

Unsubordinated Ground Lease

With an unsubordinated ground lease, the proprietor retains greater top priority than the loan provider. Lenders are unable to foreclose on the land or use it as security if a renter is not able to make their loan payments. Rather, if the tenant defaults on the loan, the loan provider can just pursue their service properties. Some loan providers might hesitate to provide a mortgage to occupants who have actually signed an unsubordinated ground lease. Because of this added problem for the tenants, proprietors will normally charge lower rent.

Benefits and of Ground Leases for Tenants

Like all leases, ground leases include their benefits and disadvantages, for both renters and landlords. For renters, the advantages and disadvantages may differ depending on what you’re looking for in a commercial residential or commercial property.

Location: With a ground lease, tenants can develop a residential or commercial property in a location of their picking, without being bound to pre-existing buildings in an area that might not be ideal for their specific 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 simply purchased the land.

No Deposit: With a land purchase, the tenant would be paying a large down payment to purchase the land, after which they would still require to construct on that land. However, with a ground lease, there is no downpayment, and more cash can go towards building on the land instead.

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

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

Some Higher Costs: Developing a residential or commercial property is expensive, and although renters have the ability to personalize their building as they choose, in some cases the financial expenses might exceed those advantages.

Doesn’t Retain Ownership After the Lease Expires: After putting cash and time into building a residential or commercial property and making enhancements, the renter will need to quit ownership of the residential or commercial property once the lease ends, if they pick not to restore the lease. At that point, the landowner stands to make money from the enhancements the occupant made.

Responsible for Fees: The renter needs to pay residential or commercial property taxes, insurance and maintenance expenses on the residential or commercial property for the regard to the lease.

Benefits and drawbacks of Ground Leases for Landlords

For property managers, a ground lease might be useful for a variety of reasons, but obviously it includes both benefits and drawbacks.

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 benefit of receiving monthly rent on the land, thus giving them a steady income stream. In addition, numerous ground leases likewise include an escalation stipulation, which ensures a rent boost and expulsion rights when it comes to an occupant defaulting on payments.

Retains Ownership of Improvements: After the lease duration ends, the property owner maintains ownership of any improvements made on the land and can therefore sell the residential or commercial property at a revenue.

Lack of Control: In the situation where a property owner doesn’t consist of particular clauses in the lease, they might not have any say in what the occupant finishes with the land.

Higher Income Tax: Although a proprietor will not have to pay capital gains taxes, the rent they receive from the renter counts as earnings, therefore they will have to pay greater income 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 rented to Grubbs Automotive, with strategies to convert the existing structures into a brand-new Volvo automobile car dealership. In this example, Grubbs Automotive is renting the land however has the freedom to develop new residential or commercial properties and make enhancements on the land and any existing structures as they choose. Once the lease term ends, if they do not restore, then all of those enhancements end up being the residential or commercial property of the property owner.

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 celebration, from which the occupant is leasing. The party that is leasing the land from the landowner deserves to utilize the land for the period 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 essentially have the rights as an owner of the land and the residential or commercial property or structures that are on it for the period that has been agreed to. With a leasehold, there is a contract between the owner of the residential or commercial property and the lessee with generally more restrictions on the lessee on what can be done with the residential or commercial property.” Essentially, leasehold arrangements include more limitations than ground leases however are otherwise relatively comparable.

Is a Ground Lease Right for You?

While a ground lease features its advantages and drawbacks for both the tenant and the property owner, it is necessary to understand what you’re looking for in a rental arrangement before choosing a type of lease. Ground leases are useful since of their longevity and surefire earnings for property managers. And for occupants, ground leases enable you to build a residential or commercial property that fits your customized requires. However, there are many different lease structures. Before choosing what fits your needs, ensure to do your due diligence and learn more about the various types of commercial leases in presence.