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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 worth from the land is to sign a ground lease. This will enable you to make income and possibly capital gains. In this post, we'll check out,
- What is a Ground Lease?
- How to Structure Them
- Examples of Ground Leases
- Advantages and disadvantages - Commercial Lease Calculator
- How Assets America Can Help
- Frequently Asked Questions
What is a Ground Lease?
In a ground lease (GL), a renter develops a piece of land during the lease duration. Once the lease ends, the occupant turns over the residential or commercial property improvements to the owner, unless there is an exception.
Importantly, the renter is accountable for paying all residential or commercial property taxes throughout the lease duration. The acquired improvements permit the owner to sell the residential or commercial property for more money, if so desired.
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 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 improvements during the lease duration. That control goes back 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 fund enhancements to the land. A crucial plan is whether the property manager will agree to subordinate his priority on claims if the lessee defaults on its financial obligation.
That's exactly what happens in a subordinated ground lease. Thus, the residential or commercial property deed becomes security for the loan provider if the lessee defaults. In return, the landlord requests for higher rent on the residential or commercial property.
Alternatively, an unsubordinated ground lease keeps the proprietor's top concern claims if the leaseholder defaults on his payments. However this may prevent lenders, who wouldn't have the ability to occupy in case of default. Accordingly, the landlord will typically charge lower lease on unsubordinated ground leases.
How to Structure a Ground Lease
A ground lease is more complex than regular industrial leases. Here are some components that go into structuring a ground lease:
1. Term
The lease should be adequately long to allow the lessee to amortize the expense of the enhancements it makes. Simply put, the lessee needs to make adequate earnings throughout the lease to pay for the lease and the improvements. Furthermore, the lessee needs to make a reasonable return on its financial investment after paying all expenses.
The biggest motorist of the lease term is the financing that the lessee arranges. Normally, the lessee will want a term that is 5 to ten years longer than the loan amortization schedule.
On a 30-year mortgage, that implies a lease term of a minimum of 35 to 40 years. However, quick food ground rents with much shorter amortization periods might have a 20-year lease term.
2. Rights and Responsibilities
Beyond the plans for paying lease, a ground lease has several special functions.
For instance, when the lease expires, what will occur to the ? The lease will define whether they revert to the lessor or the lessee should remove them.
Another feature is for the lessor to help the lessee in getting necessary licenses, authorizations and zoning variances.
3. Financeability
The loan provider must have option to safeguard its loan if the lessee defaults. This is challenging in an unsubordinated ground lease due to the fact that the lessor has initially priority in the case of default. The lender just has the right to declare the leasehold.
However, one solution is a stipulation that needs the successor lessee to use the lender to finance the new GL. The subject of financeability is complicated and your legal experts will need to learn the different complexities.
Keep in mind that Assets America can help finance the building or restoration of commercial residential or commercial property through our network of private financiers and banks.
4. Title Insurance
The lessee should arrange title insurance coverage for its leasehold. This requires special endorsements to the regular owner's policy.
5. Use Provision
Lenders want the broadest usage provision in the lease. Basically, the arrangement would allow any legal purpose for the residential or commercial property. In this way, the loan provider can more quickly offer the leasehold in case of default.
The lessor may deserve to consent in any new function for the residential or commercial property. However, the lending institution will look for to limit this right. If the lessor feels highly about restricting particular uses for the residential or commercial property, it must specify them in the lease.
6. Casualty and Condemnation
The loan provider manages insurance profits coming from casualty and condemnation. However, this might conflict with the basic phrasing of a ground lease, which offers some control to the lessor.
Unsurprisingly, loan providers desire the insurance coverage continues to approach the loan, not residential or commercial property restoration. 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 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 improvements 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 needs to concur to an SNDA contract. Usually, the GL lending institution desires first concern relating to subtenant defaults.
Moreover, loan providers need that the ground lease remains in force if the lessee defaults. If the lessor sends out a notice of default to the lessee, the lender should get a copy.
Lessees want the right to acquire a leasehold mortgage without the loan provider's consent. Lenders want the GL to act as security needs 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 may wish to limit the kind of entity that can hold a leasehold mortgage.
8. Rent Escalation
Lessors desire the right to increase leas after specified periods so that it keeps market-level rents. A "cog" boost uses the lessee no defense in the face of an economic downturn.
Ground Lease Example
As an example of a ground lease, consider one signed for a Starbucks drive-through shipping container store in Portland.
Starbucks' idea is to offer decommissioned shipping containers as an eco-friendly alternative to conventional building. The first shop opened in Seattle, followed by Kansas City, Denver, Chicago, and one in Portland, OR.
It was a rather uncommon ground lease, because it was a 10-year triple-net ground lease with four 5-year choices to extend.
This offers the GL a maximum term of 30 years. The lease escalation provision offered a 10% rent boost every 5 years. The lease value was simply 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 benefits and downsides.
The benefits of a ground lease include:
Affordability: Ground rents permit tenants to develop on residential or commercial property that they can't afford to buy. Large store like Starbucks and Whole Foods use ground leases to expand their empires. This permits them to grow without saddling the business with too much debt. No Deposit: Lessees do not have to put any cash down to take a lease. This stands in stark contrast to residential or commercial property acquiring, which may require as much as 40% down. The lessee gets to save money it can release somewhere else. It also enhances its return on the leasehold investment. Income: The lessor gets a steady stream of income while retaining ownership of the land. The lessor maintains the value of the income through using an escalation clause in the lease. This entitles the lessor to increase leas regularly. Failure to pay lease gives the lessor the right to evict the occupant.
The disadvantages of a ground lease consist of:
Foreclosure: In a subordinated ground lease, the owner runs the danger of losing its residential or commercial property if the lessee defaults. Taxes: Had the owner merely sold the land, it would have received capital gains treatment. Instead, it will pay regular corporate rates on its lease earnings. Control: Without the required lease language, the owner may lose control over the land's advancement and usage. Borrowing: Typically, ground leases prohibit the lessor from borrowing against its equity in the land throughout the ground lease term.
Ground Lease Calculator
This is a great business lease calculator. You get in the location, rental rate, and agent's fee. It does the rest.
How Assets America Can Help
Assets America ® will set up funding for commercial tasks beginning at $20 million, with no upper limit. We welcome you to call us to find out more about our complete monetary services.
We can help fund the purchase, building, or renovation of industrial residential or commercial property through our network of personal financiers and banks. For the best in commercial genuine estate financing, Assets America ® is the wise option.
- What are the various types of leases?
They are gross leases, modified gross leases, single net leases, double net leases and triple net leases. The likewise consist of absolute leases, percentage leases, and the subject of this article, ground leases. All of these leases offer advantages and downsides to the lessor and lessee.
- Who pays residential or commercial property taxes on a ground lease?
Typically, ground leases are triple internet. That indicates that the lessee pays the residential or commercial property taxes throughout the lease term. Once the lease ends, the lessor becomes accountable for paying the residential or commercial property taxes.
- What takes place at the end of a ground lease?
The land constantly goes back to the lessor. Beyond that, there are 2 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 must demolish the enhancements it made.
- The length of time do ground leases usually last?
Typically, a ground lease term encompasses at lease 5 to 10 years beyond the leasehold mortgage. For instance, if the lessee takes a 30-year mortgage on its improvements, the lease term will run for a minimum of 35 to 40 years. Some ground leases extend as far as 99 years.
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