When renting a business residential or commercial property, there are a variety of various types of industrial leases one could come across. Sometimes occupants might be searching for a residential or commercial property they can build on and produce improvements that fit their specific requirements. If this is the case, then a ground lease might be the very best option.

A ground lease is a type of lease arrangement in which the occupant leases a piece of land and is allowed to develop that residential or commercial property throughout the duration of the lease. During the lease term, the renter owns any buildings, advancements or improvements made on the land. Once the lease ends, the land and any building or enhancements on that land end up being the residential or commercial property owner's. Usually, ground leases are long-lasting, with a lease duration in 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 normally net leases, they added, in which the tenant is accountable for paying residential or commercial property taxes, insurance and maintenance.

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

There are 2 types of ground leases: subordinated and unsubordinated. The distinction between the two involves what happens if the occupant is dealing with financial difficulty during the regard to the lease.

Subordinated Ground Lease

With a subordinated ground lease, the landlord consents to be a lower priority with regards to any other financing obtained on the residential or commercial property. If an occupant takes out a loan to develop on the land and then defaults on the loan, the lender can pursue the residential or commercial property, including the land, as security. For circumstances, a renter who signs a subordinated ground lease might take out a loan for $400,000 to construct a retail residential or commercial property. However, if that tenant runs into monetary trouble and is unable to make loan payments, the loan provider can go after the building and the land.

"Typically, this is done to assist in debt financing to build buildings on the residential or commercial property," Miller and Peden stated. In lots of cases with a subordinated ground lease, the proprietor might need higher rent payments since they're handling some quantity of threat.

Unsubordinated Ground Lease

With an unsubordinated ground lease, the property owner keeps higher priority than the lending institution. Lenders are unable to foreclose on the land or use it as security if an occupant is unable to make their loan payments. Rather, if the renter defaults on the loan, the loan provider can only go after their organization properties. Some loan providers might hesitate to offer a mortgage to tenants who have actually signed an unsubordinated ground lease. Because of this added difficulty for the renters, landlords will usually charge lower rent.

Pros and Cons of Ground Leases for Tenants

Like all leases, ground leases come with their advantages and downsides, for both occupants and landlords. For occupants, the advantages and disadvantages might vary depending upon what you're searching for in an industrial residential or commercial property.

Location: With a ground lease, tenants can develop a residential or commercial property in a location of their choosing, without being bound to pre-existing buildings in an area that may not be ideal for their specific organization requirements.

Lower Taxes: For both federal and state taxes, the rent paid on a ground lease is tax deductible. The tenant is paying less taxes than they would be if they merely acquired the land.

No Down Payment: With a land purchase, the tenant would be paying a large down payment to buy the land, after which they would still require to construct on that land. However, with a ground lease, there is no downpayment, and more money can approach structure on the land rather.

Reduced Lease Payments: If the tenant were renting both the land and the building, then lease payments would be much greater. With a ground lease, the occupant is making lower monthly payments.

Building Customization: When renting an already existing space, the tenant is not able to customize the building to fit their specific needs. However, with a ground lease, renters are only leasing the land and can tailor the residential or commercial property as they please.

Some Higher Costs: Developing a residential or commercial property is costly, and although occupants are able to tailor their building as they see fit, often the financial costs might exceed those advantages.

Doesn't Retain Ownership After the Lease Expires: After putting cash and time into building a residential or commercial property and making enhancements, the occupant will need to provide up ownership of the residential or commercial property once the lease expires, if they choose not to restore the lease. At that point, the landowner stands to benefit from the enhancements the occupant made.

Responsible for Fees: The tenant needs to pay residential or commercial property taxes, insurance and upkeep expenditures on the residential or commercial property for the term of the lease.

Advantages and disadvantages of Ground Leases for Landlords

For property managers, a ground lease could be useful for a number of factors, but of course it comes with both advantages and disadvantages.

Pros

Lower Taxes: With a ground lease, property managers do not have to report any capital gains as they would with a land sale. On top of that, the renter is accountable for residential or commercial property taxes.

Steady Income: Landlords have the benefit of getting monthly lease on the land, consequently granting them a stable earnings stream. In addition, numerous ground leases likewise include an escalation stipulation, which ensures a rent boost and eviction rights when it comes to an occupant defaulting on payments.

Retains Ownership of Improvements: After the lease duration ends, the landlord keeps ownership of any improvements made on the land and can therefore offer the residential or commercial property at an earnings.

Cons

Lack of Control: In the scenario where a property manager does not include specific clauses in the lease, they may not have any say in what the renter does with the land.

Higher Income Tax: Although a property manager will not have to pay capital gains taxes, the rent they receive from the renter counts as earnings, and so they will need to pay higher income taxes.

Example of a Ground Lease

In Houston last June, Peden and Miller worked out a 20-year, 2.64-acre ground lease for a brand-new automotive dealership. The land was rented to Grubbs Automotive, with plans to transform the existing structures into a brand-new Volvo vehicle dealer. In this example, Grubbs Automotive is leasing the land but has the freedom to develop new residential or commercial properties and make enhancements on the land and any existing structures as they please. Once the lease term ends, if they do not renew, then all of those improvements 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 really similar to a ground lease, in that with a leasehold estate, the physical structures are owned by the renter, and the land is owned by another party, from which the occupant is renting. The celebration that is leasing the land from the landowner can utilize the land for the period of the lease. When the lease ends, the building and any enhancements end up being residential or commercial property of the landowner, similar 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 structures that are on it for the duration that has actually been agreed to. With a leasehold, there is an agreement between the owner of the residential or commercial property and the lessee with normally more limitations on the lessee on what can be made with the residential or commercial property." Essentially, leasehold arrangements come with more limitations than ground leases however are otherwise fairly comparable.

Is a Ground Lease Right for You?

While a ground lease includes its benefits and downsides for both the tenant and the landlord, it is essential to know what you're looking for in a rental arrangement before selecting a type of lease. Ground leases are beneficial since of their longevity and guaranteed income for property owners. And for renters, ground leases allow you to build a residential or commercial property that fits your customized needs. However, there are numerous various lease structures. Before picking what fits your needs, make certain to do your due diligence and find out about the different kinds of industrial leases around.