When renting a business residential or commercial property, there are a number of various kinds of business leases one could come across. Sometimes tenants might be searching for a residential or commercial property they can build on and develop improvements that fit their specific needs. If this holds true, then a ground lease may be the very best alternative.
A ground lease is a type of lease arrangement in which the tenant leases a piece of land and is permitted to establish that residential or commercial property during the duration of the lease. During the lease term, the occupant owns any structures, advancements or enhancements made on the land. Once the lease ends, the land and any construction or enhancements on that land end up being the residential or commercial property owner's. Usually, ground leases are long-lasting, with a lease period 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 renter is responsible for paying residential or commercial property taxes, insurance coverage and maintenance.
What's the Difference Between a Subordinated vs Unsubordinated Ground Lease?
There are 2 kinds of ground leases: subordinated and unsubordinated. The distinction between the two has to do with what takes place if the occupant is handling financial difficulty during the term of the lease.
Subordinated Ground Lease
With a subordinated ground lease, the property owner accepts be a lower priority with concerns to any other funding obtained on the residential or commercial property. If an occupant secures a loan to construct on the land and then defaults on the loan, the lender can pursue the residential or commercial property, consisting of the land, as collateral. For instance, an occupant who signs a subordinated ground lease might get a loan for $400,000 to develop a retail residential or commercial property. However, if that tenant encounters monetary and is not able to make loan payments, the loan provider can pursue the structure and the land.
"Typically, this is done to facilitate financial obligation funding to construct structures on the residential or commercial property," Miller and Peden said. In lots of cases with a subordinated ground lease, the property owner may need higher lease payments because they're handling some amount of threat.
Unsubordinated Ground Lease
With an unsubordinated ground lease, the landlord maintains greater priority than the lending institution. Lenders are not able to foreclose on the land or use it as collateral if a tenant is unable to make their loan payments. Rather, if the renter defaults on the loan, the lending institution can just go after their service assets. Some loan providers might hesitate to offer a mortgage to occupants who have actually signed an unsubordinated ground lease. Because of this added problem for the occupants, property managers will normally charge lower rent.
Pros and Cons of Ground Leases for Tenants
Like all leases, ground leases feature their advantages and downsides, for both tenants and proprietors. For tenants, the advantages and disadvantages may vary depending upon what you're trying to find in a business residential or commercial property.
Location: With a ground lease, tenants can build a residential or commercial property in a location of their choosing, without being bound to pre-existing buildings in a place that might not be perfect for their particular service requirements.
Lower Taxes: For both federal and state taxes, the lease paid on a ground lease is tax deductible. The occupant is paying less taxes than they would be if they just acquired the land.
No Down Payment: With a land purchase, the occupant 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 cash can approach building on the land rather.
Reduced Lease Payments: If the tenant were leasing both the land and the building, then lease payments would be much greater. With a ground lease, the renter is making lower regular monthly payments.
Building Customization: When renting a currently existing area, the occupant is not able to tailor the building to fit their specific requirements. However, with a ground lease, renters are only renting the land and can tailor the residential or commercial property as they see fit.
Some Higher Costs: Developing a residential or commercial property is expensive, and although tenants have the ability to customize their building as they please, in some cases the financial costs may surpass those benefits.
Doesn't Retain Ownership After the Lease Expires: After putting cash and time into developing a residential or commercial property and making improvements, the tenant will have to offer up ownership of the residential or commercial property once the lease ends, if they select not to renew the lease. At that point, the landowner stands to benefit from the enhancements the tenant made.
Responsible for Fees: The tenant needs to pay residential or commercial property taxes, insurance coverage and maintenance expenses on the residential or commercial property for the term of the lease.
Benefits and drawbacks of Ground Leases for Landlords
For proprietors, a ground lease might be helpful for a variety of reasons, however naturally it includes both benefits and downsides.
Lower Taxes: With a ground lease, proprietors do not need to report any capital gains as they would with a land sale. On top of that, the tenant is accountable for residential or commercial property taxes.
Steady Income: Landlords have the advantage of getting monthly lease on the land, consequently giving them a steady income stream. In addition, numerous ground leases also include an escalation stipulation, which guarantees a rent boost and eviction rights when it comes to a tenant defaulting on payments.
Retains Ownership of Improvements: After the lease duration ends, the property manager maintains ownership of any improvements made on the land and can therefore sell the residential or commercial property at a profit.
Lack of Control: In the circumstance where a landlord does not consist of specific provisions in the lease, they might not have any say in what the tenant finishes with the land.
Higher Income Tax: Although a proprietor will not need to pay capital gains taxes, the rent they receive from the occupant counts as earnings, therefore they will need to pay greater income taxes.
In Houston last June, Peden and Miller negotiated a 20-year, 2.64-acre ground lease for a brand-new automotive dealership. The land was leased to Grubbs Automotive, with strategies to convert the existing structures into a brand-new Volvo automotive dealership. In this example, Grubbs Automotive is renting the land but has the freedom to construct brand-new residential or commercial properties and make improvements on the land and any existing buildings 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 property owner.
What's the Difference Between a Ground Lease vs Leasehold?
A leasehold estate is really comparable to a ground lease, because with a leasehold estate, the physical structures are owned by the tenant, and the land is owned by another celebration, from which the tenant is renting. The celebration that is leasing the land from the landowner deserves to utilize the land for the duration of the lease. When the lease ends, the building and any improvements become residential or commercial property of the landowner, comparable to a ground lease. See also appurtenance.
However, according to Miller and Peden, "With a ground lease, you basically have the rights as an owner of the land and the residential or commercial property or buildings that are on it for the period that has been accepted. With a leasehold, there is an arrangement between the owner of the residential or commercial property and the lessee with typically more restrictions on the lessee on what can be done with the residential or commercial property." Essentially, leasehold arrangements feature more constraints than ground leases but are otherwise fairly comparable.
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Is a Ground Lease Right for You?
While a ground lease comes with its advantages and downsides for both the renter and the property manager, it is essential to understand what you're trying to find in a rental agreement before choosing a type of lease. Ground leases are advantageous since of their longevity and guaranteed income for proprietors. And for renters, ground leases enable you to construct a residential or commercial property that fits your custom-made needs. However, there are several lease structures. Before deciding on what fits your requirements, make sure to do your due diligence and find out about the various types of commercial leases around.
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Does a Ground Lease Fit Your Commercial Residential Or Commercial Property Needs?
Vallie Diederich edited this page 2 weeks ago