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What is a Ground Lease?
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Do you own land, possibly with shabby 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 earn earnings and possibly capital gains. In this article, we'll explore,
- What is a Ground Lease?
- How to Structure Them
- Examples of Ground Leases
- Benefits and drawbacks
- 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 throughout the lease period. Once the lease expires, the renter turns over the residential or commercial property improvements to the owner, unless there is an exception.
Importantly, the occupant is accountable for paying all residential or commercial property taxes throughout the lease period. The inherited enhancements permit the owner to offer the residential or commercial property for more money, 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 structure on it. Sometimes, the land has a structure currently on it that the lessee should 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 enhancements throughout the lease period. That control goes back to the owner/lessor upon the expiration of the lease.
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Ground Lease Subordination
One crucial element of a ground lease is how the lessee will fund improvements to the land. An essential plan is whether the property owner will consent to subordinate his priority on claims if the lessee defaults on its debt.
That's precisely what takes place in a subordinated ground lease. Thus, the residential or commercial property deed ends up being collateral for the loan provider if the lessee defaults. In return, the property owner requests for higher rent on the residential or commercial property.
Alternatively, an unsubordinated ground lease keeps the landlord's top concern claims if the leaseholder defaults on his payments. However this might discourage lenders, who wouldn't be able to occupy in case of default. Accordingly, the property manager will usually charge lower lease on unsubordinated ground leases.
How to Structure a Ground Lease
A ground lease is more complicated than routine commercial leases. Here are some components that enter into structuring a ground lease:
1. Term
The lease needs to be sufficiently long to permit the lessee to amortize the cost of the improvements it makes. In other words, the lessee should make enough earnings throughout the lease to pay for the lease and the enhancements. Furthermore, the lessee should make an affordable return on its investment after paying all expenses.
The biggest driver of the lease term is the financing that the lessee sets up. Normally, the lessee will desire a term that is 5 to ten years longer than the loan amortization schedule.
On a 30-year mortgage, that suggests a lease term of a minimum of 35 to 40 years. However, fast food ground leases with shorter amortization periods might have a 20-year lease term.
2. Rights and Responsibilities
Beyond the arrangements for paying lease, a ground lease has numerous special features.
For example, when the lease ends, what will happen to the enhancements? The lease will define whether they revert to the lessor or the lessee should remove them.
Another feature is for the lessor to assist the lessee in acquiring required licenses, permits and zoning variations.
3. Financeability
The lending institution must have recourse to secure its loan if the lessee defaults. This is tough in an unsubordinated ground lease due to the fact that the lessor has first concern when it comes to default. The lending institution only deserves to declare the leasehold.
However, one treatment is a clause that requires the successor lessee to use the loan provider to fund the new GL. The topic of financeability is complicated and your legal experts will require to learn the different intricacies.
Bear in mind that Assets America can assist fund the building and construction or restoration of commercial residential or commercial property through our network of private financiers and banks.
4. Title Insurance
The lessee needs to organize title insurance for its leasehold. This requires special endorsements to the routine owner's policy.
5. Use Provision
Lenders desire the broadest usage arrangement in the lease. Basically, the provision would allow any legal purpose for the residential or commercial property. In this method, the lending institution can more quickly sell the leasehold in case of default.
The lessor might have the right to permission in any brand-new function for the residential or commercial property. However, the lender will seek to limit this right. If the lessor feels highly about prohibiting particular uses for the residential or commercial property, it ought to specify them in the lease.
6. Casualty and Condemnation
The lending institution manages insurance coverage profits originating from casualty and condemnation. However, this might clash with the standard wording of a ground lease, which gives some control to the lessor.
Unsurprisingly, lenders desire the insurance coverage proceeds to go towards the loan, not residential or commercial property restoration. Lenders likewise require that neither lessors nor lessees can end ground leases due to a casualty without their authorization.
Regarding condemnation, lenders firmly insist upon taking part in the procedures. The lending institution's requirements for using the condemnation proceeds and controlling termination rights mirror those for casualty occasions.
7. Leasehold Mortgages
These are mortgages financing the lessee's enhancements to the ground lease residential or commercial property. Typically, lenders balk at lessor's preserving an unsubordinated position with regard to default.
If there is a preexisting mortgage, the mortgagee must accept an SNDA arrangement. Usually, the GL lending institution desires very first priority relating to subtenant defaults.
Moreover, lending institutions need that the ground lease stays in force if the lessee defaults. If the lessor sends a notification of default to the lessee, the lending institution needs to receive a copy.
Lessees desire the right to get a leasehold mortgage without the loan provider's approval. Lenders desire the GL to act as collateral must 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 desire to limit the type of entity that can hold a leasehold mortgage.
8. Rent Escalation
Lessors want the right to increase leas after defined periods so that it keeps market-level leas. A "cog" increase uses the lessee no security in the face of a financial downturn.
Ground Lease Example
As an example of a ground lease, think about one signed for a Starbucks drive-through shipping container shop in Portland.
Starbucks' concept is to sell decommissioned shipping containers as an eco-friendly alternative to traditional construction. 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 4 5-year alternatives to extend.
This provides the GL an optimal term of 30 years. The rent escalation provision offered a 10% lease increase every 5 years. The lease value was just under $1 million with a cap rate of 5.21%.
The initial lease terms, on a yearly 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 advantages and downsides.
The benefits of a ground lease consist of:
Affordability: Ground rents enable renters to construct on residential or commercial property that they can't manage to buy. Large store like Starbucks and Whole Foods use ground leases to broaden their empires. This allows them to grow without saddling the with too much debt. No Deposit: Lessees do not have to put any money down to take a lease. This stands in plain contrast to residential or commercial property getting, which might require as much as 40% down. The lessee gets to save money it can deploy somewhere else. It likewise improves its return on the leasehold investment. Income: The lessor gets a steady stream of income while maintaining ownership of the land. The lessor keeps the worth of the earnings through the use of an escalation stipulation in the lease. This entitles the lessor to increase leas periodically. Failure to pay rent offers the lessor the right to kick out the tenant.
The disadvantages of a ground lease include:
Foreclosure: In a subordinated ground lease, the owner runs the threat of losing its residential or commercial property if the lessee defaults. Taxes: Had the owner just offered the land, it would have qualified for capital gains treatment. Instead, it will pay ordinary business rates on its lease earnings. Control: Without the required lease language, the owner might lose control over the land's advancement and usage. Borrowing: Typically, ground leases forbid the lessor from borrowing against its equity in the land during the ground lease term.
Ground Lease Calculator
This is a terrific business lease calculator. You get in the location, rental rate, and representative's charge. It does the rest.
How Assets America Can Help
Assets America ® will set up financing for industrial jobs beginning at $20 million, without any upper limitation. We welcome you to contact us for more details about our total monetary services.
We can help finance the purchase, construction, or renovation of business residential or commercial property through our network of personal financiers and banks. For the finest in commercial real estate funding, Assets America ® is the clever option.
- What are the various kinds of leases?
They are gross leases, customized gross leases, single net leases, double net leases and triple net leases. The likewise consist of absolute leases, percentage leases, and the topic of this post, ground leases. All of these leases supply advantages and drawbacks to the lessor and lessee.
- Who pays residential or commercial property taxes on a ground lease?
Typically, ground leases are triple net. That implies that the lessee pays the residential or commercial property taxes during the lease term. Once the lease expires, the lessor becomes responsible for paying the residential or commercial property taxes.
- What happens at the end of a ground lease?
The land always reverts to the lessor. Beyond that, there are 2 possibilities for the end of a ground lease. The very first is that the lessor seizes all enhancements that the lessee made during the lease. The second is that the lessee must demolish the improvements it made.
- For how long do ground leases normally last?
Typically, a ground lease term reaches at lease 5 to ten 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.
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