When leasing a commercial property, there are a number of different types of commercial leases one could encounter. In some cases tenants may be looking for a property they can build on and create improvements that fit their specific needs. If this is the case, then a ground lease might be the best option.
A ground lease is a type of lease agreement in which the tenant rents a piece of land and is permitted to develop that property during the period of the lease. During the lease term, the tenant owns any buildings, developments or improvements made on the land. Once the lease ends, the land and any construction or improvements on that land become the property owner’s. Usually, ground leases are long-term, 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 typically net leases, they added, in which the tenant is responsible for paying property taxes, insurance and maintenance.
There are two types of ground leases: subordinated and unsubordinated. The difference between the two has to do with what happens if the tenant is dealing with financial trouble during the term of the lease.
With a subordinated ground lease, the landlord agrees to be a lower priority with regards to any other financing obtained on the property. If a tenant takes out a loan to build on the land and then defaults on the loan, the lender can go after the property, including the land, as collateral. For instance, a tenant who signs a subordinated ground lease might take out a loan for $400,000 to build a retail property. However, if that tenant runs into financial trouble and is unable to make loan payments, the lender can go after the building and the land.
“Typically, this is done to facilitate debt financing to construct buildings on the property,” Miller and Peden said. In many cases with a subordinated ground lease, the landlord might require higher rent payments because they’re taking on some amount of risk.
With an unsubordinated ground lease, the landlord retains higher priority than the lender. Lenders are not able to foreclose on the land or use it as collateral if a tenant is unable to make their loan payments. Rather, if the tenant defaults on the loan, the lender can only go after their business assets. Some lenders may be unwilling to give out a mortgage to tenants who have signed an unsubordinated ground lease. Because of this added difficulty for the tenants, landlords will usually charge lower rent.
Like all leases, ground leases come with their advantages and disadvantages, for both tenants and landlords. For tenants, the pros and cons may vary depending on what you’re looking for in a commercial property.
For landlords, a ground lease could be beneficial for a number of reasons, but of course it comes with both advantages and disadvantages.
In Houston last June, Peden and Miller negotiated a 20-year, 2.64-acre ground lease for a new automotive dealership. The land was leased to Grubbs Automotive, with plans to convert the existing structures into a new Volvo automotive dealership. In this example, Grubbs Automotive is leasing the land but has the freedom to build new properties and make improvements on the land and any existing buildings as they see fit. Once the lease term ends, if they do not renew, then all of those improvements become the property of the landlord.
A leasehold estate is very similar to a ground lease, in that with a leasehold estate, the physical structures are owned by the tenant, and the land is owned by another party, from which the tenant is renting. The party that is leasing the land from the landowner has the right to use the land for the duration of the lease. When the lease ends, the building and any improvements become 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 property or buildings that are on it for the period that has been agreed to. With a leasehold, there is an agreement between the owner of the property and the lessee with typically more restrictions on the lessee on what can be done with the property.” Essentially, leasehold agreements come with more restrictions than ground leases but are otherwise fairly similar.
While a ground lease comes with its advantages and disadvantages for both the tenant and the landlord, it’s important to know what you’re looking for in a rental agreement before deciding on a type of lease. Ground leases are beneficial because of their longevity and guaranteed income for landlords. And for tenants, ground leases allow you to build a property that fits your custom needs. However, there are many different lease structures. Before deciding on what fits your needs, make sure to do your due diligence and learn about the different types of commercial leases in existence.
