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Do you own land, possibly with shabby residential or commercial property on it? One method to extract worth from the land is to sign a ground lease. This will allow you to earn income and potentially capital gains. In this post, we'll explore,

- What is a Ground Lease?

How to Structure Them
Examples of Ground Leases
Pros and Cons
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 occupant turns over the residential or commercial property improvements to the owner, unless there is an exception.

Importantly, the tenant is responsible for paying all residential or commercial property taxes during the lease duration. The inherited improvements allow 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 building on it. Sometimes, the land has a structure already on it that the lessee should demolish.

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 aspect of a ground lease is how the lessee will fund improvements to the land. A key plan is whether the property manager will concur to subordinate his priority on claims if the lessee defaults on its financial obligation.

That's precisely what takes place in a subordinated ground lease. Thus, the residential or commercial property deed becomes security for the lending institution if the lessee defaults. In return, the property manager asks for higher rent on the residential or commercial property.

Alternatively, an unsubordinated ground lease maintains the property owner's top priority claims if the leaseholder defaults on his payments. However this may dissuade loan providers, who wouldn't have the ability to occupy in case of default. Accordingly, the property manager will generally charge lower rent on unsubordinated ground leases.

How to Structure a Ground Lease

A ground lease is more complicated than routine business leases. Here are some parts that enter into structuring a ground lease:

1. Term

The lease must be sufficiently long to allow the lessee to amortize the cost of the improvements it makes. Simply put, the lessee needs to make sufficient revenues during the lease to spend for the lease and the enhancements. Furthermore, the lessee should make a sensible return on its investment after paying all expenses.

The most significant driver of the lease term is the financing that the lessee sets up. Normally, the lessee will want a term that is 5 to 10 years longer than the loan amortization schedule.

On a 30-year mortgage, that indicates a lease term of at least 35 to 40 years. However, fast food ground rents with much shorter amortization periods may have a 20-year lease term.

2. Rights and Responsibilities

Beyond the plans for paying lease, a ground lease has a number of special functions.

For example, when the lease ends, what will take place to the enhancements? The lease will define whether they revert to the lessor or the lessee need to remove them.

Another feature is for the lessor to help the lessee in obtaining needed licenses, permits and zoning variations.

3. Financeability

The loan provider must draw on safeguard its loan if the lessee defaults. This is hard in an unsubordinated ground lease due to the fact that the lessor has first priority when it comes to default. The loan provider just has the right to claim the leasehold.

However, one remedy is a clause that requires the follower lessee to utilize the lender to finance the new GL. The topic of financeability is intricate and your legal experts will require to learn the different intricacies.

Remember that Assets America can help finance the building and construction or remodelling of business residential or commercial property through our network of private financiers and banks.

4. Title Insurance

The lessee needs to arrange title insurance coverage for its leasehold. This needs special recommendations to the routine owner's policy.

5. Use Provision

Lenders want the broadest use arrangement in the lease. Basically, the arrangement would permit any legal purpose for the residential or commercial property. In this way, the loan provider can more easily sell the leasehold in case of default.

The lessor might have the right to authorization in any brand-new purpose for the residential or commercial property. However, the lender will seek to limit this right. If the lessor feels highly about forbiding particular usages for the residential or commercial property, it must specify them in the lease.

6. Casualty and Condemnation

The lender controls insurance earnings originating from casualty and condemnation. However, this might contravene the basic phrasing of a ground lease, which provides some control to the lessor.

Unsurprisingly, lending institutions desire the insurance proceeds to approach the loan, not residential or commercial property remediation. Lenders also require that neither lessors nor lessees can end ground leases due to a casualty without their authorization.

Regarding condemnation, lenders insist upon taking part in the procedures. The loan provider's requirements for using the condemnation proceeds and controlling termination rights mirror those for casualty occasions.

7. Leasehold Mortgages

These are mortgages funding the lessee's enhancements to the ground lease residential or commercial property. Typically, lending institutions balk at lessor's keeping an unsubordinated position with respect to default.

If there is a pre-existing mortgage, the mortgagee needs to consent to an SNDA contract. Usually, the GL lender desires very first top priority concerning subtenant defaults.

Moreover, lending institutions 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 loan provider needs to receive a copy.

Lessees desire the right to acquire a leasehold mortgage without the loan provider's authorization. Lenders desire the GL to serve as security needs to the lessee default.

Upon foreclosure of the residential or commercial property, the loan provider receives the lessee's leasehold interest in the residential or commercial property. Lessors may wish to limit the type of entity that can hold a leasehold mortgage.

8. Rent Escalation

Lessors desire the right to increase leas after defined periods so that it maintains market-level rents. A "ratchet" increase uses the lessee no defense in the face of a financial decline.

Ground Lease Example

As an example of a ground lease, consider one signed for a Starbucks drive-through shipping container store in Portland.

Starbucks' principle is to sell decommissioned shipping containers as an eco-friendly option to standard building. The very first shop opened in Seattle, followed by Kansas City, Denver, Chicago, and one in Portland, OR.

It was a rather uncommon ground lease, in that it was a 10-year triple-net ground lease with 4 5-year options to extend.

This offers the GL an optimal term of 30 years. The lease escalation stipulation attended to a 10% lease increase every five years. The lease worth was just under $1 million with a cap rate of 5.21%.

The preliminary 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 disadvantages.

The benefits of a ground lease include:

Affordability: Ground 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 companies with excessive debt. No Down Payment: Lessees do not need to put any cash to take a lease. This stands in plain contrast to residential or commercial property buying, which might require as much as 40% down. The lessee gets to save cash it can deploy somewhere else. It also enhances its return on the leasehold financial investment. Income: The lessor receives a steady stream of earnings while maintaining ownership of the land. The lessor maintains the value of the income through the use of an escalation clause in the lease. This entitles the lessor to increase leas periodically. Failure to pay lease provides 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 risk of losing its residential or commercial property if the lessee defaults. Taxes: Had the owner merely sold the land, it would have qualified for capital gains treatment. Instead, it will pay ordinary corporate rates on its lease income. Control: Without the required lease language, the owner might lose control over the land's development and use. Borrowing: Typically, ground leases forbid the lessor from borrowing against its equity in the land throughout the ground lease term.

Ground Lease Calculator

This is a fantastic commercial lease calculator. You enter the location, rental rate, and representative's fee. It does the rest.

How Assets America Can Help

Assets America ® will arrange funding for commercial jobs starting at $20 million, without any upper limitation. We invite you to contact us for more details about our total financial services.

We can assist fund the purchase, building and construction, or remodelling of business residential or commercial property through our network of personal financiers and banks. For the finest in industrial genuine estate funding, Assets America ® is the clever option.

- What are the different types of leases?

They are gross leases, modified gross leases, single net leases, double net leases and triple net leases. The also include outright leases, portion leases, and the topic of this post, ground leases. All of these leases provide benefits and drawbacks to the lessor and lessee.

- Who pays residential or commercial property taxes on a ground lease?

Typically, ground leases are triple internet. That means that the lessee pays the residential or commercial property taxes during the lease term. Once the lease ends, the lessor ends up being accountable for paying the residential or commercial property taxes.

- What happens at the end of a ground lease?

The land constantly goes back to the lessor. Beyond that, there are two possibilities for the end of a ground lease. The first is that the lessor acquires all improvements that the lessee made throughout the lease. The 2nd is that the lessee must demolish the enhancements it made.

- How long do ground leases normally last?

Typically, a ground lease term extends to at lease 5 to 10 years beyond the leasehold mortgage. For example, 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.