When leasing a commercial residential or commercial property, there are a number of different kinds of industrial leases one could experience. Sometimes occupants might be trying to find a residential or commercial property they can build on and create improvements that fit their specific needs. If this is the case, then a ground lease might be the very best choice.

A is a kind of lease arrangement in which the tenant leases a piece of land and is allowed to develop that residential or commercial property throughout the period of the lease. During the lease term, the occupant owns any structures, advancements or enhancements made on the land. Once the lease ends, the land and any building or improvements on that land end up being the residential or commercial property owner's. Usually, ground leases are long-term, with a lease period 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 normally net leases, they added, in which the renter is accountable for paying residential or commercial property taxes, insurance and upkeep.

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

There are 2 kinds of ground leases: subordinated and unsubordinated. The distinction in between the two relates to what happens if the occupant is dealing with financial trouble during the term of the lease.

Subordinated Ground Lease

With a subordinated ground lease, the proprietor consents to be a lower concern with regards to any other funding obtained on the residential or commercial property. If a tenant gets a loan to build 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 renter who signs a subordinated ground lease might get a loan for $400,000 to develop a retail residential or commercial property. However, if that tenant runs into financial problem and is unable to make loan payments, the lending institution can pursue the building and the land.

"Typically, this is done to facilitate debt financing to build buildings on the residential or commercial property," Miller and Peden said. In lots of cases with a subordinated ground lease, the proprietor might need higher rent payments since they're taking on some amount of threat.

Unsubordinated Ground Lease

With an unsubordinated ground lease, the property manager retains greater top priority than the lender. Lenders are unable to foreclose on the land or use it as security if a tenant is unable to make their loan payments. Rather, if the renter defaults on the loan, the lending institution can only pursue their organization possessions. Some lending institutions may hesitate to offer a mortgage to tenants who have actually signed an unsubordinated ground lease. Because of this included difficulty for the renters, property owners will generally charge lower rent.

Advantages and disadvantages of Ground Leases for Tenants

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

Location: With a ground lease, tenants can develop a residential or commercial property in a place of their choosing, without being bound to pre-existing structures in an area that might not be ideal for their particular service requirements.


Lower Taxes: For both federal and state taxes, the rent paid on a ground lease is tax deductible. The renter is paying less taxes than they would be if they just bought the land.


No Down Payment: With a land purchase, the tenant would be paying a large down payment to purchase the land, after which they would still need to construct on that land. However, with a ground lease, there is no downpayment, and more cash can approach structure on the land rather.


Reduced Lease Payments: If the renter were leasing both the land and the structure, then lease payments would be much higher. With a ground lease, the tenant is making lower month-to-month payments.


Building Customization: When leasing a currently existing space, the occupant is unable to personalize the building to fit their specific requirements. However, with a ground lease, tenants are just leasing the land and can customize the residential or commercial property as they please.

Some Higher Costs: Developing a residential or commercial property is expensive, and although tenants have the ability to tailor their structure as they choose, in some cases the financial expenses might exceed those benefits.


Doesn't Retain Ownership After the Lease Expires: After putting cash and time into building a residential or commercial property and making enhancements, the occupant will have to quit ownership of the residential or commercial property once the lease ends, if they pick not to restore the lease. At that point, the landowner stands to make money from the enhancements the tenant made.


Responsible for Fees: The tenant needs to pay residential or commercial property taxes, insurance coverage and upkeep expenditures on the residential or commercial property for the regard to the lease.

Advantages and disadvantages of Ground Leases for Landlords

For proprietors, a ground lease could be advantageous for a number of reasons, but naturally it features both benefits and disadvantages.

Pros

Lower Taxes: With a ground lease, landlords do not have 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 benefit of receiving month-to-month rent on the land, thereby giving them a stable earnings stream. In addition, numerous ground leases also consist of an escalation stipulation, which ensures a lease boost and expulsion rights when it comes to an occupant defaulting on payments.


Retains Ownership of Improvements: After the lease period ends, the property manager keeps ownership of any enhancements made on the land and can therefore offer the residential or commercial property at an earnings.

Cons

Lack of Control: In the circumstance where a proprietor doesn't include particular provisions in the lease, they may not have any say in what the tenant finishes with the land.


Higher Income Tax: Although a property owner will not have to pay capital gains taxes, the rent they get from the tenant counts as earnings, therefore they will need to pay higher income taxes.

Example of a Ground Lease

In Houston last June, Peden and Miller worked out a 20-year, 2.64-acre ground lease for a new automotive car dealership. The land was rented to Grubbs Automotive, with plans to transform the existing structures into a new Volvo vehicle car dealership. In this example, Grubbs Automotive is renting the land however has the flexibility to construct brand-new residential or commercial properties and make enhancements on the land and any existing buildings as they see fit. Once the lease term ends, if they do not restore, 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 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 celebration, from which the renter is leasing. The celebration that is renting the land from the landowner has the right to use the land for the duration 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 likewise 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 actually been consented to. With a leasehold, there is an agreement in between the owner of the residential or commercial property and the lessee with usually more limitations on the lessee on what can be done with the residential or commercial property." Essentially, leasehold contracts include more constraints than ground leases however are otherwise relatively comparable.

Is a Ground Lease Right for You?

While a ground lease features its benefits and drawbacks for both the occupant and the property manager, it is necessary to understand what you're looking for in a rental arrangement before choosing on a type of lease. Ground leases are helpful since of their longevity and guaranteed income for property managers. And for tenants, 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 on what fits your needs, make certain to do your due diligence and discover the various kinds of industrial leases out there.