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When renting an industrial residential or commercial property, there are a number of different kinds of business leases one could come across. In some cases occupants may be searching for a residential or commercial property they can develop on and produce improvements that fit their particular needs. If this is the case, then a ground lease might be the best option.

A ground lease is a type of lease arrangement in which the tenant rents a piece of land and is allowed to establish that residential or commercial 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 building or enhancements on that land become the residential or commercial property owner's. Usually, ground leases are long-term, with a lease duration in 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 added, in which the tenant is responsible for paying residential or commercial property taxes, insurance coverage 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 has to do with what occurs if the tenant is handling financial difficulty during the regard to the lease.

Subordinated Ground Lease

With a subordinated ground lease, the proprietor accepts be a lower top priority with regards to any other financing obtained on the residential or commercial property. If a tenant gets a loan to build on the land and after that defaults on the loan, the lender can go after the residential or commercial property, consisting of the land, as security. For example, a renter who signs a subordinated ground lease may get a loan for $400,000 to construct a retail residential or commercial property. However, if that tenant runs into financial trouble and is not able to make loan payments, the loan provider can pursue the building and the land.

"Typically, this is done to help with debt financing to construct structures on the residential or commercial property," Miller and Peden said. In numerous cases with a subordinated ground lease, the property manager may require greater rent payments since they're taking on some quantity of danger.

Unsubordinated Ground Lease

With an unsubordinated ground lease, the property owner retains higher concern than the lender. Lenders are unable to foreclose on the land or utilize it as collateral if an occupant is not able to make their loan payments. Rather, if the occupant defaults on the loan, the lending institution can just pursue their organization properties. Some lenders may be unwilling to offer a mortgage to renters who have actually signed an unsubordinated ground lease. Because of this included difficulty for the renters, proprietors will typically charge lower rent.

Advantages and disadvantages of Ground Leases for Tenants

Like all leases, ground leases include their benefits and drawbacks, for both tenants and proprietors. For renters, the advantages and disadvantages might differ depending on what you're searching for in a commercial residential or commercial property.

Location: With a ground lease, tenants can build a residential or commercial property in a location of their choosing, without being bound to pre-existing structures in an area that might not be ideal for their specific organization needs.
Lower Taxes: For both federal and state taxes, the lease paid on a ground lease is tax deductible. The occupant is paying less taxes than they would be if they simply acquired the land.
No Down Payment: With a land purchase, the renter would be paying a large deposit to purchase the land, after which they would still require to construct on that land. However, with a ground lease, there is no downpayment, and more money can approach building on the land rather.
Reduced Lease Payments: If the occupant were renting both the land and the structure, then lease payments would be much greater. With a ground lease, the occupant is making lower month-to-month payments.
Building Customization: When leasing an already existing area, the occupant is not able to customize the building to fit their particular needs. However, with a ground lease, occupants are just renting the land and can personalize the residential or commercial property as they see fit.

Some Higher Costs: Developing a residential or commercial property is expensive, and although tenants have the ability to customize their building as they see healthy, often the financial expenses may exceed those advantages.
Doesn't Retain Ownership After the Lease Expires: After putting money and time into developing a residential or commercial property and making enhancements, the renter will need to quit ownership of the residential or commercial property once the lease ends, if they select not to renew the lease. At that point, the landowner stands to make money from the enhancements the tenant made.
Responsible for Fees: The renter needs to pay residential or commercial property taxes, insurance coverage and upkeep costs on the residential or commercial property for the regard to the lease.

Benefits and drawbacks of Ground Leases for Landlords

For property owners, a ground lease could be beneficial for a number of factors, but of course it features both advantages and drawbacks.

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 occupant is accountable for residential or commercial property taxes.
Steady Income: Landlords have the benefit of getting monthly lease on the land, thus approving them a steady earnings stream. In addition, numerous ground leases also include an escalation stipulation, which ensures a lease boost and expulsion rights in the case of a tenant defaulting on payments.
Retains Ownership of Improvements: After the lease period ends, the landlord maintains ownership of any improvements made on the land and can therefore offer the residential or commercial property at an earnings.

Lack of Control: In the circumstance where a proprietor doesn't consist of particular clauses in the lease, they might not have any say in what the tenant makes with the land.
Higher Income Tax: Although a proprietor will not have to pay capital gains taxes, the rent they receive from the tenant counts as earnings, and so they will need to pay greater earnings taxes.

In Houston last June, Peden and Miller negotiated a 20-year, 2.64-acre ground lease for a new automobile dealer. The land was rented to Grubbs Automotive, with plans to convert the existing structures into a brand-new Volvo vehicle dealership. In this example, Grubbs Automotive is leasing the land but has the freedom to develop new residential or commercial properties and make enhancements 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 owner.

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

A leasehold estate is really similar to a ground lease, because with a leasehold estate, the physical structures are owned by the occupant, and the land is owned by another party, from which the renter is leasing. The party that is renting the land from the landowner has the right to use the land throughout of the lease. When the lease ends, the building and any enhancements become 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 basically have the rights as an owner of the land and the residential or commercial property or buildings that are on it for the period that has been consented to. With a leasehold, there is an arrangement between the owner of the residential or commercial property and the lessee with typically more limitations on the lessee on what can be made with the residential or commercial property." Essentially, leasehold arrangements come with more restrictions than ground leases but are otherwise fairly similar.

Is a Ground Lease Right for You?

While a ground lease features its advantages and drawbacks for both the and the property owner, it's important to understand what you're trying to find in a rental arrangement before choosing a kind of lease. Ground leases are advantageous due to the fact that of their longevity and surefire income for property managers. And for renters, ground leases enable you to build a residential or commercial property that fits your custom-made requires. However, there are various lease structures. Before selecting what fits your requirements, make certain to do your due diligence and find out about the various types of business leases in existence.