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When renting a commercial residential or commercial property, there are a variety of different kinds of industrial leases one might encounter. In many cases renters may be trying to find a residential or commercial property they can construct on and produce enhancements that fit their specific requirements. If this is the case, then a ground lease might be the very best alternative.

A ground lease is a type of lease agreement in which the renter rents a piece of land and is permitted to develop that residential or commercial property during 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 become the residential or commercial property owner's. Usually, ground leases are long-lasting, with a lease duration 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 tenant is responsible for paying residential or commercial property taxes, insurance coverage and upkeep.

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

There are two kinds of ground leases: subordinated and unsubordinated. The difference between the two involves what occurs if the occupant is dealing with financial trouble throughout the term of the lease.

Subordinated Ground Lease

With a subordinated ground lease, the landlord consents to be a lower top priority with concerns to any other funding acquired on the residential or commercial property. If a tenant secures a loan to construct on the land and after that defaults on the loan, the lender can pursue the residential or commercial property, including the land, as collateral. For example, a renter who signs a subordinated ground lease might secure a loan for $400,000 to construct a retail residential or commercial property. However, if that tenant faces monetary trouble and is not able to make loan payments, the lending institution can go after the structure and the land.

"Typically, this is done to help with financial obligation financing to construct buildings on the residential or commercial property," Miller and Peden stated. In most cases with a subordinated ground lease, the property owner might need higher rent payments due to the fact that they're taking on some amount of danger.

Unsubordinated Ground Lease

With an unsubordinated ground lease, the property owner retains higher concern than the lending institution. Lenders are not able to foreclose on the land or use it as security if a renter is unable to make their loan payments. Rather, if the occupant defaults on the loan, the loan provider can only pursue their organization possessions. Some lenders may hesitate to provide a mortgage to tenants who have signed an unsubordinated ground lease. Because of this included problem for the tenants, proprietors will generally charge lower rent.

Pros and Cons of Ground Leases for Tenants

Like all leases, ground leases come with their advantages and drawbacks, for both occupants and landlords. For tenants, the advantages and disadvantages may differ depending on what you're trying to find in an industrial residential or commercial property.

Location: With a ground lease, occupants can build a residential or commercial property in a place of their choosing, without being bound to pre-existing structures in a location that may not be ideal for their specific organization requirements.
Lower Taxes: For both federal and state taxes, the lease paid on a ground lease is tax deductible. The tenant is paying less taxes than they would be if they merely bought the land.
No Deposit: With a land purchase, the renter would be paying a large down payment to buy the land, after which they would still require to develop on that land. However, with a ground lease, there is no downpayment, and more money can approach building on the land rather.
Reduced Lease Payments: If the renter were leasing both the land and the structure, then lease payments would be much greater. With a ground lease, the tenant is making lower regular monthly payments.
Building Customization: When renting a currently existing space, the occupant is unable to customize 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 see fit.

Some Higher Costs: Developing a residential or commercial property is expensive, and although tenants are able to personalize their structure as they choose, often the financial expenses may outweigh those advantages.
Doesn't Retain Ownership After the Lease Expires: After putting money and time into constructing a residential or commercial property and making improvements, the occupant will need to quit ownership of the residential or commercial property once the lease ends, if they pick not to renew the lease. At that point, the landowner stands to benefit from the enhancements the renter made.
Responsible for Fees: The renter needs to pay residential or commercial property taxes, and maintenance expenditures on the residential or commercial property for the term of the lease.

Benefits and drawbacks of Ground Leases for Landlords

For landlords, a ground lease could be useful for a number of reasons, but obviously it comes with both benefits and disadvantages.

Lower Taxes: With a ground lease, property owners do not need to report any capital gains as they would with a land sale. On top of that, the tenant is responsible for residential or commercial property taxes.
Steady Income: Landlords have the benefit of receiving month-to-month lease on the land, consequently approving them a constant earnings stream. In addition, many ground leases also consist of an escalation clause, which guarantees a rent boost 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 enhancements made on the land and can therefore offer the residential or commercial property at a revenue.

Lack of Control: In the circumstance where a proprietor does not consist of certain clauses in the lease, they might not have any say in what the occupant finishes with the land.
Higher Income Tax: Although a property manager won't have to pay capital gains taxes, the rent they get from the tenant counts as earnings, and so they will have to pay greater earnings taxes.

In Houston last June, Peden and Miller worked out a 20-year, 2.64-acre ground lease for a brand-new automotive dealer. The land was leased to Grubbs Automotive, with plans to convert the existing structures into a new Volvo vehicle dealership. In this example, Grubbs Automotive is renting the land but has the flexibility to build brand-new residential or commercial properties and make improvements on the land and any existing structures as they please. Once the lease term ends, if they do not restore, then all of those enhancements end up being the residential or commercial property of the proprietor.

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

A leasehold estate is very 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 can utilize the land for the period of the lease. When the lease ends, the structure and any improvements become 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 duration that has been consented to. With a leasehold, there is an agreement between the owner of the residential or commercial property and the lessee with usually more constraints on the lessee on what can be finished with the residential or commercial property." Essentially, leasehold agreements include more limitations than ground leases however are otherwise fairly similar.

Is a Ground Lease Right for You?

While a ground lease features its benefits and drawbacks for both the renter and the property manager, it is very important to understand what you're looking for in a rental agreement before deciding on a kind of lease. Ground leases are beneficial because of their durability and surefire earnings for landlords. And for occupants, ground leases permit you to build a residential or commercial property that fits your customized requires. However, there are various lease structures. Before picking what fits your requirements, make sure to do your due diligence and find out about the various types of commercial leases out there.