What is a Ground Lease?
Do you own land, maybe with shabby residential or commercial property on it? One method to extract value from the land is to sign a ground lease. This will enable you to earn earnings and possibly capital gains. In this article, we'll explore,
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- What is a Ground Lease?
- How to Structure Them
- Examples of Ground Leases
- Advantages and disadvantages
- Commercial Lease Calculator
- How Assets America Can Help
- Frequently Asked Questions
What is a Ground Lease?
In a ground lease (GL), an occupant develops a piece of land during the lease period. Once the lease expires, the renter turns over the residential or commercial property improvements to the owner, unless there is an exception.
Importantly, the occupant is accountable for paying all residential or commercial property taxes during the lease period. The inherited improvements enable the owner to offer the residential or commercial property for more cash, if so wanted.
Common Features
Typically, a ground lease lasts from 35 to 99 years. Normally, the lessee takes a lease on some raw or prepared land and constructs a structure on it. Sometimes, the land has a structure currently on it that the lessee must demolish.
The GL defines who owns the land and the enhancements, i.e., residential or commercial property that the lessee constructs. Typically, the lessee controls and diminishes the enhancements during the lease period. That control goes back to the owner/lessor upon the expiration of the lease.
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Ground Lease Subordination
One essential aspect of a ground lease is how the lessee will fund improvements to the land. An essential arrangement is whether the property owner will accept subordinate his top priority on claims if the lessee defaults on its financial obligation.
That's exactly what happens in a subordinated ground lease. Thus, the residential or commercial property deed becomes security for the loan provider if the lessee defaults. In return, the landlord requests for greater rent on the residential or commercial property.
Alternatively, an unsubordinated ground lease maintains the proprietor's top priority claims if the leaseholder defaults on his payments. However this might discourage lending institutions, who wouldn't be able to occupy in case of default. Accordingly, the proprietor will generally charge lower lease on unsubordinated ground leases.
How to Structure a Ground Lease
A ground lease is more complicated than routine industrial leases. Here are some components that go into structuring a ground lease:
1. Term
The lease needs to be adequately long to allow the lessee to amortize the expense of the enhancements it makes. In other words, the lessee should make sufficient profits throughout the lease to spend for the lease and the enhancements. Furthermore, the lessee needs to make a sensible return on its investment after paying all expenses.
The greatest driver of the lease term is the financing that the lessee arranges. Normally, the lessee will want a term that is 5 to 10 years longer than the loan amortization schedule.
On a 30-year mortgage, that means a lease term of at least 35 to 40 years. However, quick food ground rents with much shorter amortization periods might have a 20-year lease term.
2. Rights and Responsibilities
Beyond the plans for paying rent, a ground lease has several unique features.
For example, when the lease expires, what will happen to the improvements? The lease will specify whether they revert to the lessor or the lessee should remove them.
Another function is for the lessor to help the lessee in getting essential licenses, authorizations and zoning variances.
3. Financeability
The lender needs to draw on secure its loan if the lessee defaults. This is tough in an unsubordinated ground lease due to the fact that the lessor has first priority when it comes to default. The lender only has the right to claim the leasehold.
However, one treatment is a stipulation that requires the successor lessee to utilize the loan provider to fund the brand-new GL. The subject of financeability is complicated and your legal professionals will need to learn the different complexities.
Keep in mind that Assets America can help finance the construction or renovation of industrial residential or commercial property through our network of private financiers and banks.
4. Title Insurance
The lessee needs to organize title insurance coverage for its leasehold. This requires unique recommendations to the routine owner's policy.
5. Use Provision
Lenders desire the broadest usage arrangement in the lease. Basically, the provision would permit any legal purpose for the residential or commercial property. In this way, the loan provider can more quickly sell the leasehold in case of default.
The lessor might can consent in any new purpose for the residential or commercial property. However, the loan provider will seek to limit this right. If the lessor feels highly about prohibiting particular uses for the residential or commercial property, it needs to define them in the lease.
6. Casualty and Condemnation
The loan provider controls insurance profits coming from casualty and condemnation. However, this may the standard phrasing of a ground lease, which provides some control to the lessor.
Unsurprisingly, lenders desire the insurance coverage continues to go toward the loan, not residential or commercial property repair. Lenders also require that neither lessors nor lessees can end ground leases due to a casualty without their authorization.
Regarding condemnation, lenders firmly insist upon taking part in the procedures. The loan provider's requirements for applying the condemnation earnings and controlling termination rights mirror those for casualty occasions.
7. Leasehold Mortgages
These are mortgages funding the lessee's enhancements to the ground lease residential or commercial property. Typically, lenders balk at lessor's keeping an unsubordinated position with respect to default.
If there is a pre-existing mortgage, the mortgagee needs to accept an SNDA arrangement. Usually, the GL loan provider desires very first priority relating to subtenant defaults.
Moreover, lenders require that the ground lease remains in force if the lessee defaults. If the lessor sends out a notification of default to the lessee, the lending institution must receive a copy.
Lessees desire the right to acquire a leasehold mortgage without the loan provider's consent. Lenders desire the GL to act as security needs to the lessee default.
Upon foreclosure of the residential or commercial property, the lender gets the lessee's leasehold interest in the residential or commercial property. Lessors may want to limit the kind of entity that can hold a leasehold mortgage.
8. Rent Escalation
Lessors want the right to increase leas after specified periods so that it keeps market-level leas. A "ratchet" increase provides the lessee no defense in the face of a financial downturn.
Ground Lease Example
As an example of a ground lease, consider one signed for a Starbucks drive-through shipping container shop in Portland.
Starbucks' concept is to sell decommissioned shipping containers as an eco-friendly option to standard building and construction. The first shop opened in Seattle, followed by Kansas City, Denver, Chicago, and one in Portland, OR.
It was a rather uncommon ground lease, in that it was a 10-year triple-net ground lease with four 5-year choices to extend.
This offers the GL an optimal term of 30 years. The rent escalation stipulation offered for a 10% rent increase every five years. The lease worth was simply under $1 million with a cap rate of 5.21%.
The initial lease terms, on a yearly basis, were:
- 09/01/2014 - 08/31/2019 @ $52,000. - 09/01/2019 - 08/31/2024 @ $57,200.
- 09/01/2024 - 08/31/2029 @ $62,920.
- 09/01/2029 - 08/31/2034 @ $69,212.
- 09/01/2034 - 08/31/2039 @ $76,133.
- 09/01/2039 - 08/31/2044 @ $83,747
Ground Lease Pros & Cons
Ground leases have their benefits and drawbacks.
The advantages of a ground lease include:
Affordability: Ground rents allow renters to construct on residential or commercial property that they can't pay for to purchase. Large store like Starbucks and Whole Foods use ground leases to broaden their empires. This allows them to grow without saddling the business with too much financial obligation. No Down Payment: Lessees do not need to put any cash to take a lease. This stands in plain contrast to residential or commercial property acquiring, which might require as much as 40% down. The lessee gets to conserve cash it can deploy somewhere else. It likewise enhances its return on the leasehold financial investment. Income: The lessor gets a stable stream of earnings while keeping ownership of the land. The lessor maintains the value of the income through the usage of an escalation clause in the lease. This entitles the lessor to increase rents periodically. Failure to pay rent offers the lessor the right to kick out the occupant.
The drawbacks of a ground lease consist of:
Foreclosure: In a subordinated ground lease, the owner runs the risk of losing its residential or commercial property if the lessee defaults. Taxes: Had the owner just sold the land, it would have gotten approved for capital gains treatment. Instead, it will pay ordinary corporate rates on its lease income. Control: Without the needed lease language, the owner might lose control over the land's development and use. Borrowing: Typically, ground leases forbid the lessor from obtaining versus its equity in the land during the ground lease term.
Ground Lease Calculator
This is a terrific commercial lease calculator. You go into the area, rental rate, and agent's charge. It does the rest.
How Assets America Can Help
Assets America ® will arrange funding for industrial projects beginning at $20 million, with no upper limit. We welcome you to contact us for more details about our total financial services.
We can assist finance the purchase, building, or restoration of commercial residential or commercial property through our network of personal financiers and banks. For the finest in commercial realty funding, Assets America ® is the wise choice.
- What are the various types of leases?
They are gross leases, modified gross leases, single net leases, double net leases and triple net leases. The also include absolute leases, portion leases, and the subject of this post, ground leases. All of these leases offer benefits and downsides to the lessor and lessee.
- Who pays residential or commercial property taxes on a ground lease?
Typically, ground leases are triple web. That means that the lessee pays the residential or commercial property taxes during the lease term. Once the lease ends, the lessor ends up being responsible for paying the residential or commercial property taxes.
- What occurs at the end of a ground lease?
The land constantly goes back to the lessor. Beyond that, there are 2 possibilities for completion of a ground lease. The first is that the lessor takes possession of all improvements that the lessee made during the lease. The 2nd is that the lessee must demolish the improvements it made.
- How long do ground leases normally last?
Typically, a ground lease term reaches at lease 5 to ten years beyond the leasehold mortgage. For example, if the lessee takes a 30-year mortgage on its improvements, the lease term will run for at least 35 to 40 years. Some ground rents extend as far as 99 years.
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