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OneTen REI Eplains some Unique Benefits of a Ground Lease
What is a Ground Lease?
As the name implies, a ground lease only involves leasing the ground — not any buildings. A ground lease involves undeveloped commercial land that is leased to tenants, who then have the rights to develop and use the property for the duration of the lease. Matthew Frankel, CFP.
This agreement between a land owner and tenant is common in high profile locations. Ground lease, sometimes referred to as a land lease, rents are typically lower than build-to-suit rents as the cost to develop the property is absorbed by the Tenant. Ground leases are more common when dealing with a credit rated or high net worth tenant group. The benefit to the tenant is that it maintains ownership of all the improvements on the property providing more tax benefits due to depreciation. On the flip side, since land is not a depreciable asset, the landowner is unable to achieve the typical tax benefits associated with owning real estate. The benefit, however, to the landowner is that the property is being improved at the cost of the tenant and the title to those improvements will revert to the landowner in the future once the Tenant ceases to operate or at the expiration of the lease term. These agreements can range in term from 20 to 99 years. Upon the end of the lease, unless otherwise stipulated, the land owner retains the land and all improvements made to the land, allowing the land owner to increase rent significantly.
Ground leases are absolute triple net (NNN) leases which obligate the tenant to cover the costs of property taxes, insurance, and maintenance throughout the term of the lease. Because all rights to the property reside with the landlord, it is important to note that the land can still be sold or transferred.
Let’s take a closer look:
Some of the considerations of any ground lease might include:
- Lease Term: length of term can range anywhere from 20 to 99 years, typically.
- Rights & Responsibilities: rights of both the landlord and tenant should be outlined so that both parties understand the other’s financial responsibilities throughout the term of the lease. Ground leases are typically structured as absolute NNN leases.
- Conditions on financing: a determination about whether the lease will be a subordinated or unsubordinated lease must be outlined and will have impacts on the ability to obtain financing and should be discussed with your lender in advance of executing the lease.
- Use provisions: stipulations on the use and type operations that the tenant is allowed on property must be negotiated and clearly outlined in the land lease agreement.
- Fees: the fees associated with maintenance of the building and property should be clearly outlined in the lease as well as whether the fees are paid directly by the tenant or if the tenant is reimbursing the landlord for certain expenses i.e. property taxes, common area maintenance (CAM), insurance, etc.
- Insurance: an insurance expert should be consulted to ensure proper coverage for both the landlord and tenant and these requirements should be outlined in the lease.
- Rent Escalation Clause: The rent escalation clause should be outlined thoroughly to account for inflation.
Subordination or Not?
Are you in need of collateral for your construction costs? Let’s break down the options for subordinated and unsubordinated ground leases.
A subordinated ground lease allows for the tenant to use the land as collateral in some cases when agreed upon by both tenant and landowner. In such cases, the landowner may require a higher rent. Since the landowner is taking responsibility for the loan, the risk is greater to the landowner and therefore that risk may be reflected in the rent.
In contrast, an unsubordinated ground lease allows the landowner to retain claims on the property in the event the tenant defaults on the loan for improvements. This can be risky for the tenant’s lender as they may not take ownership of the land in the case of default, but protects the landowner. This option may result in more difficulty in obtaining a construction loan, however the rent may be lower as you factor in start up costs and overall return on the investment.
Ground Lease Valuation Model
A Ground Lease Valuation Model can be used to determine if the ground lease is right for the tenant and land owner. For more information on ground leases and the ground lease valuation model consider this Assets America article and calculator feature.
Conclusion:
A ground lease can have benefits for both the land owner and the tenant. Landlords can benefit from a tenant improving their property at the cost of the tenant and receiving passive rental income on a long-term basis with no maintenance obligations. These assets are highly sought after in the investment market and can be sold for a premium to investors at significantly higher values. Tenants can benefit greatly from accelerating depreciation of the improvements and signing lower rents for high profile locations that can provide increased customer activity, subsequently translating into higher store sales.
OneTen REI has been providing clients with unparalleled personalized experiences since 2017. Let us do the heavy lifting on your next ground lease project.
Take 5 Oil, located at 1210 W. Guadalupe Rd. in Mesa, AZ, a .43 acre single-tenant property is an example of a successful ground lease project in our portfolio.