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When renting a business residential or commercial property, there are a variety of different kinds of commercial leases one could encounter. In some cases tenants might be looking for a residential or commercial property they can build on and create enhancements that fit their particular needs. If this is the case, then a ground lease might be the best alternative.

A ground lease is a kind of lease arrangement in which the tenant leases a piece of land and is allowed to establish that residential or commercial property during the duration of the lease. During the lease term, the tenant owns any buildings, developments or enhancements made on the land. Once the lease ends, the land and any building or enhancements on that land end up being the residential or commercial property owner's. Usually, ground leases are long-term, 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 usually net leases, they included, in which the occupant is responsible for paying residential or commercial property taxes, insurance coverage and maintenance.

What's the Difference Between a Subordinated vs Unsubordinated Ground Lease?
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There are two types of ground leases: subordinated and unsubordinated. The difference between the 2 pertains to what occurs if the occupant is dealing with monetary trouble throughout the term of the lease.

Subordinated Ground Lease

With a subordinated ground lease, the landlord concurs to be a lower top priority with concerns to any other funding obtained on the residential or commercial property. If a tenant secures a loan to develop on the land and then defaults on the loan, the lender can go after the residential or commercial property, consisting of the land, as security. For instance, a tenant who signs a subordinated ground lease may take out a loan for $400,000 to build a retail residential or commercial property. However, if that occupant faces financial trouble and is not able to make loan payments, the lending institution can go after the structure and the land.
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"Typically, this is done to assist in debt funding to construct buildings on the residential or commercial property," Miller and Peden stated. In a lot of cases with a subordinated ground lease, the property manager might require greater lease payments due to the fact that they're taking on some amount of danger.

Unsubordinated Ground Lease

With an unsubordinated ground lease, the proprietor retains greater concern than the lender. Lenders are not able to foreclose on the land or use it as collateral if a renter is unable to make their loan payments. Rather, if the renter defaults on the loan, the lending institution can just pursue their business assets. Some loan providers might hesitate to give out a mortgage to occupants who have actually signed an unsubordinated ground lease. Because of this added trouble for the renters, landlords will normally charge lower rent.

Pros and Cons of Ground Leases for Tenants

Like all leases, ground leases include their benefits and downsides, for both occupants and landlords. For tenants, the advantages and disadvantages might vary depending upon what you're searching for in a business residential or commercial property.

Location: With a ground lease, renters can develop a residential or commercial property in a place of their choosing, without being bound to pre-existing structures in a place that might not be ideal for their specific company requirements.
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 merely 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 need to develop on that land. However, with a ground lease, there is no downpayment, and more money can go toward building on the land instead.
Reduced Lease Payments: If the occupant were leasing both the land and the structure, then lease payments would be much higher. With a ground lease, the tenant is making lower monthly payments.
Building Customization: When renting a currently existing space, the occupant is unable to customize the structure to fit their particular needs. However, with a ground lease, renters are just leasing the land and can personalize the residential or commercial property as they please.

Some Higher Costs: Developing a residential or commercial property is costly, and although renters have the ability to customize their structure as they choose, sometimes the financial costs might exceed those benefits.
Doesn't Retain Ownership After the Lease Expires: After putting cash and time into constructing a residential or commercial property and making improvements, the tenant will have to quit ownership of the residential or commercial property once the lease ends, if they select not to restore the lease. At that point, the landowner stands to benefit from the enhancements the occupant made.
Responsible for Fees: The renter needs to pay residential or commercial property taxes, insurance and upkeep expenditures on the residential or commercial property for the regard to the lease.

Pros and Cons of Ground Leases for Landlords

For property managers, a ground lease could be beneficial for a of factors, but obviously it features both advantages and downsides.

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 accountable for residential or commercial property taxes.
Steady Income: Landlords have the advantage of getting monthly rent on the land, consequently approving them a consistent income stream. In addition, many ground leases also include an escalation provision, which ensures a rent increase and expulsion rights when it comes to an occupant 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 a revenue.

Lack of Control: In the circumstance where a property manager does not consist of particular stipulations in the lease, they may not have any say in what the tenant does with the land.
Higher Income Tax: Although a landlord won't need to pay capital gains taxes, the lease they receive from the tenant counts as income, therefore they will have to pay greater income taxes.

In Houston last June, Peden and Miller negotiated a 20-year, 2.64-acre ground lease for a brand-new automobile dealer. The land was rented 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 liberty to develop brand-new residential or commercial properties and make enhancements on the land and any existing buildings as they please. Once the lease term ends, if they do not renew, then all of those improvements become the residential or commercial property of the property manager.

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

A leasehold estate is really comparable to a ground lease, because with a leasehold estate, the physical structures are owned by the tenant, and the land is owned by another celebration, from which the tenant is renting. The celebration that is renting the land from the landowner deserves to utilize the land throughout 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 likewise 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 period that has actually been concurred to. With a leasehold, there is a contract in between the owner of the residential or commercial property and the lessee with usually more constraints on the lessee on what can be made with the residential or commercial property." Essentially, leasehold agreements include more constraints than ground leases but are otherwise relatively comparable.

Is a Ground Lease Right for You?

While a ground lease comes with its benefits and drawbacks for both the renter and the proprietor, it is essential to understand what you're looking for in a rental arrangement before selecting a type of lease. Ground leases are beneficial because of their durability and guaranteed earnings for landlords. And for occupants, ground leases permit you to build a residential or commercial property that fits your custom-made requires. However, there are several lease structures. Before choosing what fits your requirements, make sure to do your due diligence and find out about the various kinds of business leases around.