A ground lease is when a property owner allows renters to make improvements to the property during the lease period. However, the property owner will continue to own the land, including the improvements, after the lease is up.
First-time renters are often shocked to learn how many different types of leases are available. Regular apartment leases can be perplexing enough, but what does a ground lease mean for renters? Moreover, what happens when you enter a ground lease?
Ground leases, also known as land lease agreements, allow real estate renters to make permanent alterations and upgrades to the property they are renting. However, the property owner will own all the upgrades and property after the lease is done.
This type of lease is relatively rare, and therefore you’re unlikely to encounter one in your search for a residential property to rent. However, it’s still worth knowing what a ground lease is and how it can affect you.
What is a ground lease?
A ground lease is a special type of rental agreement in which the renter technically rents the land, not the building. This means that you have the right to build on the land, improve buildings that are already there, and potentially sublease buildings on the land.
However, once the ground lease has expired, the land and all the property upgrades revert to the property owner. Because you are leasing the land, your chances of retaining ownership of any property and improvements you’ve invested in are zero.
Even though a tenant won’t end up owning the property, they are still liable for all the expenses related to the property and its improvements. These can include repairs, upgrades, property taxes, solar panels, and maintenance. Once the lease is over and the property transfers back to the owner, they assume responsibility for those expenses.
How long does a ground lease last?
Ground leases are generally long-term lease agreements, with many land leases being decades long. In many major cities, ground lease periods can last as long as 50 to 99 years. This creates the impression that, over the long term, the land renter owns the property.
Why would a renter go into a ground lease?
Commercial real estate investors often use ground leases to sublease a commercial property. This is a particularly common practice for big box stores like Sears or McDonald’s. The corporation will buy the land, then allow franchisees to build and manage the store through a ground lease.
If the franchisee fails to turn a profit, the company can terminate the ground lease agreement. They may re-rent the property to another franchisee or sell it to other real estate investors for a different commercial venture.
Subordinated ground leases vs unsubordinated ground leases
There are two types of ground leases you may encounter when seeking property to rent: subordinated and unsubordinated. The difference between these types of ground leases relates to how lenders treat properties on the land. Let’s look into how each one works and what it means for renters.
Subordinated ground lease
In a subordinated ground lease, if a renter obtains a loan to make improvements on the property, the landlord allows for the property deed to be used as collateral. Essentially, the landlord has a lower priority of claims on that property.
This means that if the tenant defaults on the loan or fails to make their loan payments on time, the property owner could lose the leased land to the lender. Therefore, to mitigate the risk of a subordinated ground lease, property owners will usually negotiate higher rent payments from their tenants.
Unsubordinated ground lease
Conversely, an unsubordinated ground lease gives the landlord a higher priority of claims on the property, allowing them to maintain ownership of the land even if the renter defaults on a loan. Since the lender cannot use the property as collateral, a tenant in an unsubordinated ground lease may find it harder to get approved for a loan to make improvements.
Because they come with significantly lower risk to both parties, unsubordinated ground leases tend to be more popular among landlords and tenants alike. Property owners can retain control of their land, while renters get to enjoy lower rent payments every month.
Why renting with a ground lease may be right for you
A ground lease isn’t the best choice for every renter, but depending on your circumstances, it could be worth looking into. Here are some reasons you may want to consider renting a property with a ground lease:
- Homeownership is out of your reach. Real estate can be incredibly expensive to own, especially in areas like San Francisco or New York City. Leasing is one way to avoid high mortgage payments and save more money in the long run. Rent payments for a ground lease generally cost less than a down payment on a massive plot of land.
- You’re not entirely sure you want to stay in an area permanently. A ten-year ground lease on a business may be enough to help you build up a financial cushion. When you’re ready, you can simply end the lease term and search for a bigger property elsewhere.
- You plan to start a business in a major urban area. Most big-city properties in high-traffic areas can only be leased via land leases.
- You want to own a franchise. Whether you want to open a McDonald’s, a Starbucks, or a Dunkin’ Donuts, franchise companies tend to require franchisees to open their businesses under a commercial land lease.
What are the benefits of a ground lease?
Depending on the circumstances, a ground lease can come with multiple benefits for both the landlord and the renter. Property owners can receive a steady income stream from the land while also enjoying a lower tax burden by avoiding capital gains and federal income taxes on the property.
As for renters, a ground lease can offer an ideal arrangement for corporate expansion plans that may or may not be permanent. Additionally, if it’s a temporary arrangement, the company can walk away from the property once the lease expires. On top of that, land lease agreements are often the best way for renters to gain affordable access to a prime location — such as a corner of 42nd street in New York City.
Who owns the building in a ground lease?
The building is always the property of the landowner, even in subordinated leases. Since a renter is only leasing the ground that the building is on, the owner of the land will retain ownership of the building throughout the lease.
What happens at the end of a ground lease?
In most cases, the end of a ground lease means that the tenant will either choose to renew the lease (if the landlord offers this option) or have to leave the premises. If the lease ends and the current tenant does not renew it, the landowner will usually offer a new land lease agreement to another real estate investor.
However, in some cases, the end of a ground lease may also mean that the landowner doesn’t want to rent out the land anymore. In this case, the landlord may put the property on the market and even offer the tenant a chance to buy the property outright.
Is a ground lease considered an operating expense for a business?
Yes, a ground lease is typically viewed as an operating expense. You can maximize your tax savings on your business by writing off lease payments as part of your cost of operation.
However, it’s always worth knowing if your tax burden may be different than the norm. When in doubt, it’s best to discuss the tax implications of ground leases with a CPA.
- A ground lease is a special type of rent in which the tenant has the right to develop and make improvements on property situated on the property owner’s land.
- In a ground lease, tenants pay for upgrades, development costs, taxes, repairs, and maintenance on the land and any properties it includes, while the land owner retains ownership of the grounds and those properties.
- Landlords use ground leases as a way to gain a steady income flow while avoiding higher tax implications.
- Tenants may use land leases to acquire prime real estate or as part of the conditions to operate a franchise from a large company.
- You should always read the terms of a ground lease agreement thoroughly before you sign so you know exactly what your rights and obligations are as a tenant.
Unless you’re in commercial real estate, you may never encounter a ground lease, let alone enter into one. However, the principles behind ground leases largely apply to other types of leases that are more common, such as leasing a car or a truck.
If you have the option to enter into any kind of lease agreement but are debating whether it’s a good choice for you, it’s worth doing your research so you know all the details going in. Start by reading some of our expert guides on leases, such as the best time to lease a car, how to buy out a leased car, and the details of the buyout process.