When renting a business residential or commercial property, there are a variety of different types of industrial leases one could experience. In many cases occupants may be searching for a residential or commercial property they can build on and produce improvements that fit their specific requirements. If this is the case, then a ground lease might be the best choice.

A ground lease is a type of lease contract in which the tenant rents 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 improvements made on the land. Once the lease ends, the land and any construction or enhancements 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, stated 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 accountable for paying residential or commercial property taxes, insurance and upkeep.

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

There are 2 types of ground leases: subordinated and unsubordinated. The difference in between the two involves what occurs if the occupant is dealing with monetary trouble during the regard to the lease.

Subordinated Ground Lease

With a subordinated ground lease, the property owner concurs to be a lower priority with concerns to any other funding obtained on the residential or commercial property. If a renter gets a loan to develop on the land and after that defaults on the loan, the lender can pursue the residential or commercial property, including the land, as security. For circumstances, a renter who signs a subordinated ground lease might secure a loan for $400,000 to develop a retail residential or commercial property. However, if that renter encounters monetary problem and is not able to make loan payments, the lending institution can go after the building and the land.

"Typically, this is done to facilitate financial obligation financing to build structures on the residential or commercial property," Miller and Peden stated. In numerous cases with a subordinated ground lease, the property manager might require higher lease payments because they're taking on some amount of threat.

Unsubordinated Ground Lease

With an unsubordinated ground lease, the landlord maintains greater priority than the lending institution. Lenders are unable to foreclose on the land or use it as security if an occupant is unable to make their loan payments. Rather, if the tenant defaults on the loan, the lending institution can only pursue their business properties. Some lending institutions might be unwilling to offer a mortgage to occupants who have actually signed an unsubordinated ground lease. Because of this added difficulty for the tenants, property managers will usually charge lower rent.

Advantages and disadvantages of Ground Leases for Tenants

Like all leases, ground leases come with their advantages and drawbacks, for both renters and property managers. For tenants, the pros and cons might differ depending upon what you're searching for in a business residential or commercial property.

Location: With a ground lease, renters can construct a residential or commercial property in a location of their picking, without being bound to pre-existing buildings in a place that might not be perfect for their specific service requirements.

Lower Taxes: For both federal and state taxes, the rent paid on a ground lease is tax deductible. The occupant is paying less taxes than they would be if they just bought the land.

No Down Payment: With a land purchase, the tenant would be paying a large down payment to purchase the land, after which they would still require to build on that land. However, with a ground lease, there is no downpayment, and more money can approach building on the land instead.

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

Building Customization: When renting an already existing space, the renter is not able to tailor the structure to fit their particular requirements. However, with a ground lease, tenants are only renting the land and can tailor the residential or commercial property as they see fit.

Some Higher Costs: Developing a residential or commercial property is costly, and although renters have the ability to customize their structure as they choose, often the monetary costs might exceed those advantages.

Doesn't Retain Ownership After the Lease Expires: After putting money and time into constructing a residential or commercial property and making improvements, the tenant will need to offer up ownership of the residential or commercial property once the lease ends, if they choose not to renew the lease. At that point, the landowner stands to make money from the improvements the renter made.

Responsible for Fees: The occupant needs to pay residential or commercial property taxes, insurance coverage and upkeep expenditures on the residential or commercial property for the regard to the lease.

Advantages and disadvantages of Ground Leases for Landlords

For property managers, a ground lease could be advantageous for a variety of reasons, however obviously it includes both benefits and downsides.

Pros

Lower Taxes: With a ground lease, landlords 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 getting month-to-month lease on the land, thus approving them a constant income stream. In addition, numerous ground leases also include an escalation provision, which ensures a rent increase and expulsion rights when it comes to a renter defaulting on payments.

Retains Ownership of Improvements: After the lease duration ends, the property manager keeps ownership of any improvements made on the land and can therefore offer the residential or commercial property at an earnings.

Cons

Lack of Control: In the scenario where a property manager does not 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 property manager will not have to pay capital gains taxes, the lease they receive from the tenant counts as income, and so they will need to pay higher earnings taxes.

Example of a Ground Lease

In Houston last June, Peden and Miller negotiated a 20-year, 2.64-acre ground lease for a brand-new automotive car dealership. The land was leased to Grubbs Automotive, with strategies to convert the existing structures into a brand-new Volvo vehicle dealer. In this example, Grubbs Automotive is leasing the land but has the flexibility to build new residential or commercial properties and make improvements on the land and any existing structures as they see fit. Once the lease term ends, if they do not restore, then all of those improvements end up being the residential or commercial property of the property manager.

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

A leasehold estate is very 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 renter 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 structure and any improvements end up being residential or commercial property of the landowner, comparable 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 buildings that are on it for the duration that has actually been accepted. With a leasehold, there is an arrangement between the owner of the residential or commercial property and the lessee with usually more restrictions on the lessee on what can be made with the residential or commercial property." Essentially, leasehold contracts come with more restrictions than ground leases but are otherwise relatively similar.

Is a Ground Lease Right for You?

While a ground lease features its advantages and downsides for both the renter and the property manager, it is essential to know what you're looking for in a rental contract before picking a kind of lease. Ground leases are beneficial because of their durability and surefire earnings for property managers. And for occupants, ground leases enable you to develop a residential or commercial property that fits your custom-made requires. However, there are several lease structures. Before choosing what fits your needs, make certain to do your due diligence and find out about the different kinds of business leases out there.