What is a Ground Lease?
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Do you own land, possibly with worn out residential or commercial property on it? One way to extract value from the land is to sign a ground lease. This will allow you to make income and potentially capital gains. In this post, we'll explore,
- What is a Ground Lease?
- How to Structure Them
- Examples of Ground Leases
- Pros and Cons
- Commercial Lease Calculator
- How Assets America Can Help
- Frequently Asked Questions
What is a Ground Lease?
In a ground lease (GL), a tenant develops a piece of land throughout the lease duration. Once the lease ends, the occupant turns over the residential or commercial property enhancements to the owner, unless there is an exception.
Importantly, the renter is accountable for paying all residential or commercial property taxes during the lease duration. The acquired improvements enable the owner to sell the residential or commercial property for more money, if so preferred.
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 already on it that the lessee should destroy.
The GL specifies who owns the land and the improvements, i.e., residential or commercial property that the lessee constructs. Typically, the lessee controls and diminishes the enhancements throughout the lease duration. That control goes back to the owner/lessor upon the expiration of the lease.
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Ground Lease Subordination
One crucial aspect of a ground lease is how the lessee will fund enhancements to the land. A key arrangement is whether the property owner will consent to subordinate his priority on claims if the lessee defaults on its debt.
That's specifically what occurs in a subordinated ground lease. Thus, the residential or commercial property deed ends up being security for the lender if the lessee defaults. In return, the proprietor requests greater lease on the residential or commercial property.
Alternatively, an unsubordinated ground lease keeps the property manager's top priority claims if the leaseholder defaults on his payments. However this may dissuade lenders, who wouldn't have the ability to take ownership in case of default. Accordingly, the property owner will generally charge lower lease on unsubordinated ground leases.
How to Structure a Ground Lease
A ground lease is more complex than routine business leases. Here are some parts that go into structuring a ground lease:
1. Term
The lease should be sufficiently long to enable the lessee to amortize the expense of the improvements it makes. To put it simply, the lessee should make sufficient earnings throughout the lease to pay for the lease and the enhancements. Furthermore, the lessee should make a sensible return on its investment after paying all costs.
The biggest motorist of the lease term is the financing that the lessee sets up. Normally, the lessee will want a term that is 5 to ten years longer than the loan amortization schedule.
On a 30-year mortgage, that suggests a lease regard to a minimum of 35 to 40 years. However, junk food ground leases with much shorter amortization durations might have a 20-year lease term.
2. Rights and Responsibilities
Beyond the arrangements for paying lease, a ground lease has a number of distinct functions.
For example, when the lease expires, what will occur to the improvements? The lease will define whether they revert to the lessor or the lessee must eliminate them.
Another function is for the lessor to help the lessee in obtaining essential licenses, licenses and zoning differences.
3. Financeability
The lending institution must have option to safeguard its loan if the lessee defaults. This is difficult in an unsubordinated ground lease because the lessor has first priority in the case of default. The lender only can claim the leasehold.
However, one solution is a provision that requires the successor lessee to utilize the loan provider to fund the new GL. The topic of financeability is intricate and your legal specialists will require to learn the different complexities.
Keep in mind that Assets America can assist finance the building or restoration of industrial residential or commercial property through our network of personal investors and banks.
4. Title Insurance
The lessee needs to set up title insurance coverage for its leasehold. This needs special recommendations to the routine owner's policy.
5. Use Provision
Lenders want the broadest use provision in the lease. Basically, the arrangement would allow any legal purpose for the residential or commercial property. In this method, the loan provider can more easily sell the leasehold in case of default.
The lessor may deserve to permission in any new function for the residential or commercial property. However, the loan provider will look for to limit this right. If the lessor feels highly about restricting certain usages for the residential or commercial property, it should define them in the lease.
6. Casualty and Condemnation
The lender controls insurance coverage profits stemming from casualty and condemnation. However, this may contravene the basic phrasing of a ground lease, which offers some control to the lessor.
Unsurprisingly, lending institutions want the insurance continues to go towards the loan, not residential or commercial property remediation. Lenders likewise need that neither lessors nor lessees can terminate ground leases due to a casualty without their permission.
Regarding condemnation, lending institutions firmly insist upon taking part in the procedures. The loan provider's requirements for applying the condemnation proceeds and managing termination rights mirror those for casualty events.
7. Leasehold Mortgages
These are mortgages financing the lessee's improvements to the ground lease residential or commercial property. Typically, lenders balk at lessor's maintaining an unsubordinated position with regard to default.
If there is a preexisting mortgage, the mortgagee needs to accept an SNDA agreement. Usually, the GL lender wants very first top priority relating to subtenant defaults.
Moreover, loan providers require that the ground lease stays in force if the lessee defaults. If the lessor sends out a notification of default to the lessee, the lender must get a copy.
Lessees desire the right to obtain a leasehold mortgage without the lending institution's authorization. Lenders desire the GL to function as security needs to the lessee default.
Upon foreclosure of the residential or commercial property, the lending institution gets the lessee's leasehold interest in the residential or commercial property. Lessors may wish to limit the type of entity that can hold a leasehold mortgage.
8. Rent Escalation
Lessors desire the right to rents after specified durations so that it maintains market-level leas. A "cog" boost provides the lessee no defense in the face of an economic downturn.
Ground Lease Example
As an example of a ground lease, think about one signed for a Starbucks drive-through shipping container store in Portland.
Starbucks' idea is to offer decommissioned shipping containers as an environmentally friendly alternative to standard construction. The very first store 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 4 5-year choices to extend.
This offers the GL an optimal term of thirty years. The lease escalation clause offered for a 10% lease boost every 5 years. The lease worth was just under $1 million with a cap rate of 5.21%.
The preliminary lease terms, on an annual 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 disadvantages.
The advantages of a ground lease include:
Affordability: Ground leases permit occupants to construct on residential or commercial property that they can't pay for to purchase. Large chain stores like Starbucks and Whole Foods use ground leases to expand their empires. This allows them to grow without saddling the business with excessive debt. No Down Payment: Lessees do not have to put any cash down to take a lease. This stands in stark contrast to residential or commercial property acquiring, which may need as much as 40% down. The lessee gets to conserve money it can release elsewhere. It likewise enhances its return on the leasehold financial investment. Income: The lessor gets a constant stream of income while retaining ownership of the land. The lessor maintains the worth of the earnings through using an escalation stipulation in the lease. This entitles the lessor to increase leas regularly. Failure to pay rent provides the lessor the right to force out the renter.
The downsides of a ground lease include:
Foreclosure: In a subordinated ground lease, the owner risks of losing its residential or commercial property if the lessee defaults. Taxes: Had the owner simply sold the land, it would have received capital gains treatment. Instead, it will pay regular corporate rates on its lease earnings. Control: Without the necessary lease language, the owner might lose control over the land's development and usage. Borrowing: Typically, ground leases prohibit the lessor from borrowing against its equity in the land throughout the ground lease term.
Ground Lease Calculator
This is an excellent 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 set up financing for industrial projects starting at $20 million, without any upper limit. We invite you to call us to learn more about our complete financial services.
We can help finance the purchase, building, or restoration of industrial residential or commercial property through our network of private investors and banks. For the finest in industrial realty funding, Assets America® is the clever choice.
- What are the different kinds of leases?
They are gross leases, customized gross leases, single net leases, double net leases and triple net leases. The likewise include absolute leases, percentage leases, and the subject of this short article, ground leases. All of these leases provide advantages and disadvantages to the lessor and lessee.
- Who pays residential or commercial property taxes on a ground lease?
Typically, ground leases are triple web. That indicates that the lessee pays the residential or commercial property taxes during the lease term. Once the lease expires, the lessor becomes accountable for paying the residential or commercial property taxes.
- What happens at the end of a ground lease?
The land constantly goes back to the lessor. Beyond that, there are 2 possibilities for the end of a ground lease. The very first is that the lessor acquires all improvements that the lessee made during the lease. The 2nd is that the lessee should demolish the improvements it made.
- For how long do ground leases generally last?
Typically, a ground lease term encompasses at lease 5 to 10 years beyond the leasehold mortgage. For instance, if the lessee takes a 30-year mortgage on its improvements, the lease term will run for a minimum of 35 to 40 years. Some ground rents extend as far as 99 years.
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