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When leasing a business residential or commercial property, there are a number of various kinds of industrial leases one might experience. In some cases renters might be looking for a residential or commercial property they can develop on and create enhancements that fit their specific needs. If this holds true, then a ground lease might be the finest alternative.

A ground lease is a type of lease contract in which the renter 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 tenant owns any structures, developments or improvements made on the land. Once the lease ends, the land and any building and construction or improvements on that land become the residential or commercial 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 generally net leases, they included, in which the tenant is accountable for paying residential or commercial property taxes, insurance and maintenance.

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

There are two types of ground leases: subordinated and unsubordinated. The difference in between the two involves what takes place if the renter is dealing with monetary problem 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 financing gotten on the residential or commercial property. If an occupant secures a loan to develop on the land and then defaults on the loan, the loan provider can go after the residential or commercial property, including the land, as collateral. For instance, a renter who signs a subordinated ground lease might take out a loan for $400,000 to build a retail residential or commercial property. However, if that renter faces monetary problem and is unable to make loan payments, the lender can pursue the building and the land.

"Typically, this is done to help with debt funding to construct structures on the residential or commercial property," Miller and Peden said. In lots of cases with a subordinated ground lease, the landlord may need higher rent payments due to the fact that they're handling some quantity of danger.

Unsubordinated Ground Lease

With an unsubordinated ground lease, the property manager retains greater priority than the lender. Lenders are not able to foreclose on the land or use it as collateral if a renter is not able to make their loan payments. Rather, if the occupant defaults on the loan, the lender can only pursue their business properties. Some lending institutions may hesitate to offer a mortgage to occupants who have signed an unsubordinated ground lease. Because of this added problem for the occupants, property owners will usually charge lower rent.

Pros and Cons of Ground Leases for Tenants

Like all leases, ground leases include their advantages and drawbacks, for both occupants and property owners. For occupants, the benefits and drawbacks may vary depending on what you're trying to find in an industrial residential or commercial property.

Location: With a ground lease, tenants can construct a residential or commercial property in an area of their picking, without being bound to pre-existing buildings in an area that might not be perfect for their specific company requirements.
Lower Taxes: For both federal and state taxes, the lease paid on a ground lease is tax deductible. The renter is paying less taxes than they would be if they simply acquired the land.
No Deposit: With a land purchase, the tenant would be paying a big down payment to purchase the land, after which they would still need to develop on that land. However, with a ground lease, there is no downpayment, and more money can go towards structure on the land instead.
Reduced Lease Payments: If the renter were renting both the land and the structure, then lease payments would be much greater. With a ground lease, the renter is making lower monthly payments.
Building Customization: When renting a currently existing area, 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 please.

Some Higher Costs: Developing a residential or commercial property is costly, and although occupants have the ability to tailor their structure as they choose, sometimes the monetary costs might outweigh those advantages.
Doesn't Retain Ownership After the Lease Expires: After putting cash and time into building a residential or commercial property and making improvements, the renter will need to provide up ownership of the residential or commercial property once the lease ends, if they pick not to renew the lease. At that point, the landowner stands to make money from the improvements the renter made.
Responsible for Fees: The renter has to pay residential or commercial property taxes, insurance coverage and upkeep expenditures on the residential or commercial property for the term of the lease.

Pros and Cons of Ground Leases for Landlords

For property owners, a ground lease could be helpful for a variety of reasons, however obviously it includes both advantages and disadvantages.

Lower Taxes: With a ground lease, property managers do not need to report any capital gains as they would with a land sale. On top of that, the renter is responsible for residential or taxes.
Steady Income: Landlords have the benefit of receiving month-to-month lease on the land, therefore giving them a constant earnings stream. In addition, numerous ground leases likewise include an escalation clause, which ensures a rent increase and expulsion rights when it comes to a renter defaulting on payments.
Retains Ownership of Improvements: After the lease period ends, the proprietor retains ownership of any enhancements made on the land and can therefore offer the residential or commercial property at a revenue.

Lack of Control: In the situation where a landlord does not consist of certain clauses in the lease, they might not have any say in what the tenant does with the land.
Higher Income Tax: Although a property owner won't need to pay capital gains taxes, the lease they receive from the occupant counts as earnings, and so they will have to pay higher earnings taxes.

In Houston last June, Peden and Miller worked out a 20-year, 2.64-acre ground lease for a new vehicle car dealership. The land was rented to Grubbs Automotive, with strategies to convert the existing structures into a new Volvo automotive car dealership. In this example, Grubbs Automotive is leasing the land however has the flexibility to develop new residential or commercial properties and make improvements on the land and any existing structures as they please. Once the lease term ends, if they do not renew, then all of those enhancements become the residential or commercial property of the property manager.

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

A leasehold estate is very comparable 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 celebration that is renting 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 basically have the rights as an owner of the land and the residential or commercial property or structures that are on it for the duration that has been consented to. With a leasehold, there is an agreement in between the owner of the residential or commercial property and the lessee with normally more limitations on the lessee on what can be finished with the residential or commercial property." Essentially, leasehold arrangements feature more restrictions than ground leases however are otherwise relatively comparable.

Is a Ground Lease Right for You?

While a ground lease features its advantages and disadvantages for both the renter and the property owner, it is necessary to understand what you're searching for in a rental agreement before deciding on a type of lease. Ground leases are helpful since of their longevity and surefire income for proprietors. And for tenants, ground leases enable you to construct a residential or commercial property that fits your custom-made requires. However, there are various lease structures. Before selecting what fits your needs, make certain to do your due diligence and learn more about the different kinds of industrial leases out there.
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