What is a Ground Lease?
Do you own land, perhaps with dilapidated residential or commercial property on it? One method to extract worth from the land is to sign a ground lease. This will enable you to make income and possibly capital gains. In this article, 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), an occupant establishes a piece of land during the lease duration. Once the lease ends, the renter turns over the residential or commercial property improvements to the owner, unless there is an exception.
Importantly, the tenant is responsible for paying all residential or commercial property taxes during the lease duration. The inherited enhancements enable the owner to offer the residential or commercial property for more cash, if so wanted.
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 building on it. Sometimes, the land has a structure already on it that the lessee must destroy.
The GL specifies who owns the land and the enhancements, i.e., residential or commercial property that the lessee constructs. Typically, the lessee controls and depreciates the improvements throughout the lease duration. That control reverts to the owner/lessor upon the expiration of the lease.
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Ground Lease Subordination
One important element of a ground lease is how the lessee will finance improvements 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 financial obligation.
That's specifically what happens in a subordinated ground lease. Thus, the residential or commercial property deed becomes security for the lending institution if the lessee defaults. In return, the asks for greater rent on the residential or commercial property.
Alternatively, an unsubordinated ground lease maintains the property owner's top concern claims if the leaseholder defaults on his payments. However this may prevent lenders, who would not be able to take possession in case of default. Accordingly, the property manager will normally charge lower lease on unsubordinated ground leases.
How to Structure a Ground Lease
A ground lease is more complicated than routine business leases. Here are some parts that enter into structuring a ground lease:
1. Term
The lease should be adequately long to allow the lessee to amortize the cost of the improvements it makes. To put it simply, the lessee should make adequate earnings during the lease to spend for the lease and the improvements. Furthermore, the lessee needs to make an affordable return on its investment after paying all costs.
The biggest driver of the lease term is the financing that the lessee arranges. Normally, the lessee will want a term that is 5 to 10 years longer than the loan amortization schedule.
On a 30-year mortgage, that indicates a lease regard to a minimum of 35 to 40 years. However, junk food ground leases with shorter amortization periods might have a 20-year lease term.
2. Rights and Responsibilities
Beyond the arrangements for paying rent, a ground lease has numerous distinct features.
For example, when the lease ends, what will occur to the enhancements? The lease will specify whether they revert to the lessor or the lessee should eliminate them.
Another function is for the lessor to assist the lessee in obtaining required licenses, licenses and zoning differences.
3. Financeability
The lending institution should have option to safeguard its loan if the lessee defaults. This is challenging in an unsubordinated ground lease since the lessor has initially concern when it comes to default. The lender just deserves to claim the leasehold.
However, one treatment is a clause that needs the follower lessee to use the lending institution to fund the brand-new GL. The topic of financeability is intricate and your legal professionals will need to wade through the different intricacies.
Keep in mind that Assets America can assist fund the building and construction or remodelling of industrial residential or commercial property through our network of private financiers and banks.
4. Title Insurance
The lessee needs to arrange title insurance for its leasehold. This needs unique endorsements to the regular owner's policy.
5. Use Provision
Lenders desire the broadest use arrangement in the lease. Basically, the provision would permit any legal purpose for the residential or commercial property. In this method, the lending institution can more quickly offer the leasehold in case of default.
The lessor may have the right to consent in any brand-new function for the residential or commercial property. However, the loan provider will seek to restrict this right. If the lessor feels highly about restricting specific uses for the residential or commercial property, it needs to specify them in the lease.
6. Casualty and Condemnation
The lending institution controls insurance coverage earnings coming from casualty and condemnation. However, this might clash with the basic wording of a ground lease, which gives some control to the lessor.
Unsurprisingly, lenders want the insurance continues to approach the loan, not residential or commercial property repair. Lenders likewise require that neither lessors nor lessees can terminate ground leases due to a casualty without their approval.
Regarding condemnation, lending institutions insist upon getting involved in the proceedings. The lending institution's requirements for applying the condemnation proceeds and managing termination rights mirror those for casualty occasions.
7. Leasehold Mortgages
These are mortgages funding the lessee's enhancements to the ground lease residential or commercial property. Typically, lenders balk at lessor's preserving an unsubordinated position with respect to default.
If there is a preexisting mortgage, the mortgagee needs to consent to an SNDA contract. Usually, the GL loan provider wants very first top priority relating to subtenant defaults.
Moreover, lenders need that the ground lease stays in force if the lessee defaults. If the lessor sends out a notice of default to the lessee, the lender must get a copy.
Lessees desire the right to get a leasehold mortgage without the loan provider's authorization. Lenders desire the GL to act as collateral ought to the lessee default.
Upon foreclosure of the residential or commercial property, the lender receives the lessee's leasehold interest in the residential or commercial property. Lessors might wish to limit the kind of entity that can hold a leasehold mortgage.
8. Rent Escalation
Lessors desire the right to increase leas after defined durations so that it maintains market-level rents. A "ratchet" boost uses the lessee no protection in the face of an economic recession.
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' concept is to offer decommissioned shipping containers as an ecologically friendly alternative to conventional building. The very first shop opened in Seattle, followed by Kansas City, Denver, Chicago, and one in Portland, OR.
It was a rather unusual ground lease, because it was a 10-year triple-net ground lease with four 5-year options to extend.
This offers the GL a maximum term of thirty years. The lease escalation provision provided for a 10% lease increase every 5 years. The lease worth was just under $1 million with a cap rate of 5.21%.
The initial lease terms, on an annual basis, were:
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- 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 drawbacks.
The benefits of a ground lease consist of:
Affordability: Ground leases permit tenants to build on residential or commercial property that they can't pay for to buy. Large store like Starbucks and Whole Foods use ground leases to broaden their empires. This allows them to grow without saddling the companies with excessive financial obligation. 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 buying, which might require as much as 40% down. The lessee gets to conserve cash it can release somewhere else. It likewise enhances its return on the leasehold investment. Income: The lessor receives a steady stream of earnings while retaining ownership of the land. The lessor maintains the value of the earnings through using an escalation provision in the lease. This entitles the lessor to increase leas occasionally. Failure to pay lease gives the lessor the right to evict the renter.
The disadvantages of a ground lease consist of:
Foreclosure: In a subordinated ground lease, the owner risks of losing its residential or commercial property if the lessee defaults. Taxes: Had the owner just offered the land, it would have gotten approved for capital gains treatment. Instead, it will pay ordinary business rates on its lease earnings. Control: Without the needed lease language, the owner may lose control over the land's advancement and usage. Borrowing: Typically, ground leases restrict the lessor from borrowing versus its equity in the land throughout the ground lease term.
Ground Lease Calculator
This is a great commercial lease calculator. You get in the area, rental rate, and agent's fee. It does the rest.
How Assets America Can Help
Assets America ® will arrange funding for commercial projects beginning at $20 million, without any ceiling. We invite you to call us for more info about our complete financial services.
We can help fund the purchase, building and construction, or renovation of commercial residential or commercial property through our network of private financiers and banks. For the very best in industrial realty funding, Assets America ® is the smart option.
- What are the various kinds of leases?
They are gross leases, modified gross leases, single net leases, double net leases and triple net leases. The also consist of outright leases, percentage leases, and the subject of this article, ground leases. All of these leases supply benefits and drawbacks 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 throughout the lease term. Once the lease expires, the lessor becomes accountable for paying the residential or commercial property taxes.
- What occurs at the end of a ground lease?
The land constantly goes back to the lessor. Beyond that, there are two possibilities for the end of a ground lease. The first is that the lessor seizes all enhancements that the lessee made throughout the lease. The 2nd is that the lessee should demolish the improvements it made.
- The length of time do ground leases generally last?
Typically, a ground lease term reaches at lease 5 to 10 years beyond the leasehold mortgage. For instance, if the lessee takes a 30-year mortgage on its enhancements, the lease term will run for a minimum of 35 to 40 years. Some ground rents extend as far as 99 years.