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When renting a business residential or commercial property, there are a variety of different kinds of business leases one could experience. In many cases occupants may be searching for a residential or commercial property they can construct on and develop improvements that fit their specific requirements. If this is the case, then a ground lease may be the very best choice.

A ground lease is a type of lease contract in which the occupant rents a piece of land and is permitted to establish that residential or commercial property throughout the period of the lease. During the lease term, the occupant owns any structures, developments 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 period 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 typically net leases, they added, in which the tenant is accountable for paying residential or commercial property taxes, insurance and upkeep.

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

There are 2 kinds of ground leases: subordinated and unsubordinated. The distinction in between the 2 relates to what takes place if the tenant is handling financial difficulty during the regard to the lease.

Subordinated Ground Lease

With a subordinated ground lease, the proprietor consents to be a lower priority with concerns to any other funding acquired on the residential or commercial property. If an occupant gets a loan to build 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 circumstances, a tenant who signs a subordinated ground lease might secure a loan for $400,000 to construct a retail residential or commercial property. However, if that renter runs into monetary problem and is not able to make loan payments, the lender can pursue the structure and the land.

"Typically, this is done to facilitate debt funding to construct buildings on the residential or commercial property," Miller and Peden stated. In numerous cases with a subordinated ground lease, the landlord may need higher rent payments due to the fact that they're handling some quantity of risk.

Unsubordinated Ground Lease

With an unsubordinated ground lease, the property owner maintains greater concern than the loan provider. Lenders are unable to foreclose on the land or utilize it as security if a tenant is not able to make their loan payments. Rather, if the renter defaults on the loan, the lender can only pursue their service possessions. Some lenders may hesitate to offer a mortgage to renters who have signed an unsubordinated ground lease. Because of this added difficulty for the tenants, property owners will usually charge lower lease.

Benefits and drawbacks of Ground Leases for Tenants

Like all leases, ground leases come with their benefits and disadvantages, for both occupants and proprietors. For tenants, the pros and cons might vary depending on what you're trying to find in an industrial residential or commercial property.

Location: With a ground lease, occupants can construct a residential or commercial property in an area of their choosing, without being bound to pre-existing structures in an area that may not be perfect for their specific company 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 purchased the land.

No Down Payment: With a land purchase, the renter would be paying a big deposit to purchase the land, after which they would still need to develop on that land. However, with a ground lease, there is no downpayment, and more money can go towards structure on the land rather.

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

Building Customization: When leasing a currently existing space, the renter is unable to personalize the structure to fit their specific needs. However, with a ground lease, renters are only leasing the land and can customize the residential or commercial property as they choose.

Some Higher Costs: Developing a residential or commercial property is expensive, and although renters are able to customize their structure as they please, in some cases the financial expenses might outweigh those advantages.

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

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

Pros and Cons of Ground Leases for Landlords

For landlords, a ground lease could be advantageous for a variety of factors, however obviously it includes both advantages and downsides.

Pros

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

Steady Income: Landlords have the benefit of getting regular monthly rent on the land, thereby granting them a steady earnings stream. In addition, numerous ground leases likewise consist of an escalation stipulation, which guarantees a rent increase and eviction rights in the case of a renter defaulting on payments.

Retains Ownership of Improvements: After the lease period ends, the property owner retains ownership of any improvements made on the land and can therefore offer the residential or commercial property at a revenue.

Cons

Lack of Control: In the situation where a proprietor doesn't include certain stipulations in the lease, they might not have any say in what the tenant finishes with the land.

Higher Income Tax: Although a property manager will not need to pay capital gains taxes, the lease they get from the renter counts as income, and so they will have to pay greater earnings 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 new automobile car dealership. The land was leased to Grubbs Automotive, with plans to transform the existing structures into a new Volvo automobile dealer. In this example, Grubbs Automotive is leasing the land however has the liberty to develop brand-new residential or commercial properties and make improvements on the land and any existing structures as they see fit. 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 landlord.

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

A leasehold estate is extremely comparable 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 celebration, from which the occupant is leasing. The party that is renting the land from the landowner can use the land throughout of the lease. When the lease ends, the building and any enhancements end up being 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 structures that are on it for the period that has actually been accepted. With a leasehold, there is an agreement between the owner of the residential or commercial property and the lessee with typically more limitations on the lessee on what can be finished with the residential or commercial property." Essentially, leasehold contracts feature more constraints than ground leases however are otherwise fairly similar.

Is a Ground Lease Right for You?

While a ground lease comes with its advantages and disadvantages for both the renter and the landlord, it's crucial to know what you're trying to find in a rental agreement before picking a type of lease. Ground leases are useful because of their longevity and guaranteed earnings for landlords. And for occupants, ground leases permit you to develop a residential or commercial property that fits your custom requires. However, there are several lease structures. Before selecting what fits your needs, make certain to do your due diligence and discover the various types of commercial leases around.