What is a Ground Lease?

In the simplest form, a ground lease is a long-term net lease (usually 49 years or 99 years) of land including any improvements on the said land. Assets that can be subject to a ground lease include but are not limited to, vacant land, office buildings, and large residential buildings.

Are most owners familiar with ground leases? How do they respond when you explain how they work?

The way ground leases are structured opens opportunities for owners who don’t want to sell but are still open to doing a deal. Ultimately, owners should understand that a ground lease is just like any other type of real estate transaction in that both sides of the table need to feel like they’re making a deal that works for them economically.

Who should consider a ground lease?

Ground leases make the most sense for long-term property owners who aren’t prepared to make the necessary capital improvements required to maximize their property’s upside potential. Someone who owns a plot of land, a property with significant air rights, doesn’t want or need to build, or someone who wants to ensure that their property remains in the family to produce generational income would also benefit from considering a ground lease.

How do owners benefit from ground leases?

The property title never transfers to the tenant; therefore, the owner stays the owner of the property while generating income on the property. The owner is not responsible for capital gains tax, unless there is an upfront payment, and in some cases the owner is eligible to avoid transfer tax payments. The property also remains in the family, which means the asset will generate a hassle-free income stream for generations to come.

How do tenants benefit from a ground lease?

Many developers and commercial tenants have long been faced with property owners who ask for a price that isn’t supported by comparable deals. The owners are emotionally attached to the asset, and they’d rather sit on it than do a deal that makes sense for both parties. The tenant’s basis is significantly reduced because they don’t need to invest upfront capital for a purchase. If an owner is unwilling to sell, a ground lease can still get a deal done that will give them long-term access to prime locations.

Are ground leases complicated?

The more knowledge each party brings to the transaction, the smoother it will go. To that end, our real edge at Skyline is our personal relationships with the most active real estate players in today’s market. For owners, this translates into not wasting time and getting a deal done correctly. Ground leases are considered sophisticated and complex transactions. If structured correctly, ground leases can be tax efficient and protect both the ground lessee and lessor.

What asset classes can be ground leased?

Technically, you can ground lease any asset class, but most commonly vacant land, industrial properties, office buildings, residential buildings, and hotels are ground leased.

Is the owner stuck once the ground lease is in place?

Since the title to the property never transfers to the tenant, the owner retains the right to mortgage the leased property or sell it. In fact, the owner can borrow more money from the bank once the ground lease is in place because often their net income has increased substantially.

Once the tenant has committed to a ground lease, are they trapped?

The ground lease tenant retains the option to mortgage their lease or assign the lease to a new tenant. It’s also worth mentioning that since the tenant is not on the title, the owner is not responsible for any debt they incur, so if the tenant default on the debt, the landlord isn’t held accountable.

What makes an appropriate ground lease tenant?

Ground leases can be thought of as long-term partnerships. Therefore, it’s vital that landlords have partners who are knowledgeable about ground leases to provide the owner with tax efficient structures. The tenant also needs the financial ability to perform the renovations or development in the timeframe outlined in the lease. When picking a ground tenant, owners should look for tenants who are willing to provide personal guarantees for the work they are saying they are going to do, and they should obtain a comprehensive understanding of the tenant’s financial history including defaults.

Where can I learn more about ground leases?

Most owners either don’t know anything about ground leasing or they’ve only heard part of the story, so we created an informational website (groundlease.nyc) to help educate them.

What is a Ground Lease?

A ground lease is a legal agreement where a tenant is granted the right to use a piece of land for a long duration, typically 49 or 99 years. The tenant may make improvements on the land, such as building structures or other developments, but the ownership of the land itself remains with the landlord. Ground leases are most often used in situations where the land is valuable, and both the landlord and tenant can benefit from the arrangement without the tenant needing to purchase the property outright. Ground leases can apply to various property types, including vacant land, office buildings, large residential buildings, and even industrial complexes. The tenant is responsible for maintaining the improvements during the lease term, which can include buildings, roads, and other infrastructure. At the end of the lease, the land, along with any improvements made, reverts to the landlord, unless otherwise stipulated in the lease.

Who should consider a ground lease?

Ground leases are particularly beneficial for long-term property owners who want to retain ownership of their land while still generating income from it. This type of lease is ideal for those who may not have the capital to make improvements or wish to avoid the risks associated with property development. Property owners with significant air rights or those looking to secure a source of generational income should also consider entering into ground leases. Additionally, ground leases can be a strategic choice for owners seeking to avoid a sale of the property but who still want to benefit from its economic potential without taking on the financial burden of developing the land themselves. It allows owners to transfer the responsibility of improving the property to the tenant while maintaining ownership of the land.

How do owners benefit from ground leases?

Property owners can reap several benefits from ground leases. First and foremost, they retain the title to the land, which is important for maintaining long-term ownership and control. They also generate a steady income stream without having to sell the property outright or invest heavily in its development. Furthermore, because the lease is typically structured as a net lease, the tenant is responsible for most of the expenses, including taxes, insurance, and maintenance, resulting in minimal ongoing costs for the owner. Ground leases can also provide tax advantages, such as the potential deferral of capital gains taxes if the property is not sold. Additionally, property owners can use the steady income from a ground lease to finance other investments, making it a strategic tool for long-term financial planning. For many owners, ground leases offer a hassle-free way to monetize their land while maintaining control and maximizing their return on investment.

How do tenants benefit from a ground lease?

Tenants benefit from ground leases primarily by gaining long-term access to desirable land without the need for a significant upfront capital outlay to purchase the property. This is particularly valuable in areas where the land itself is very expensive, but the tenant wants to develop a business or residential property. With a ground lease, the tenant can use their capital to develop the property and generate revenue rather than being tied up in the land acquisition. This arrangement also provides tenants with access to prime locations that might otherwise be unattainable. Tenants can negotiate terms that allow for flexibility in the development and use of the land, enabling them to make the most of the property for their specific needs, whether that’s for retail, residential, office, or industrial purposes. Over the term of the lease, tenants can build equity in the improvements made to the land, further increasing the long-term value of the investment.

Are ground leases complicated?

Ground leases are indeed complex agreements that require careful negotiation and expert advice. The intricacies of the lease terms, including rent escalations, reversion clauses, and the allocation of responsibilities between the landlord and tenant, need to be clearly outlined and understood by both parties. Ground leases also often involve significant legal and tax implications that can vary depending on how the lease is structured. For example, ground leases that are correctly structured can be highly tax-efficient, benefiting both the landlord and the tenant. However, due to the complexity of these transactions, both parties should work with legal and real estate professionals who are experienced in ground leases to ensure that the agreement is beneficial and that any potential risks are mitigated. A well-structured ground lease can provide long-term stability and income, but a poorly designed one can lead to financial difficulties or disputes.

What asset classes can be ground leased?

A wide variety of asset classes can be ground leased, making this type of agreement very versatile. Ground leases are most commonly associated with vacant land, as it allows the tenant to build or develop on it. However, other asset classes are also commonly involved in ground leases, such as office buildings, industrial properties, residential buildings, and hotels. Some ground leases are also used for retail centers, airports, and even agricultural land. The flexibility of ground leases makes them suitable for a wide range of real estate projects, from small-scale residential developments to large commercial and industrial complexes. The asset class involved often determines the specific terms and structure of the lease, as well as the financial and legal considerations that need to be addressed.

Is the owner stuck once the ground lease is in place?

No, property owners are not 'stuck' once a ground lease is in place. One of the key advantages of ground leases for property owners is the flexibility it offers. Owners can still mortgage or sell their property even after entering into a ground lease agreement. In many cases, the value of the property may increase due to the tenant's improvements, which can allow the owner to borrow more against the property. Additionally, the ground lease agreement typically includes provisions that allow the owner to retain control over key decisions, such as approving modifications or changes to the property, ensuring that the owner's interests are protected throughout the term of the lease.

What flexibility does the tenant have in a ground lease?

Tenants under ground leases often have a significant degree of flexibility. For example, they can mortgage their lease or assign it to a new tenant, providing opportunities for financing and liquidity. Tenants are typically responsible for their own debts under the lease, protecting the landlord from liability. Additionally, the lease terms can often be structured to allow tenants to make decisions about the development and use of the property in ways that best suit their business or investment goals. However, the tenant's flexibility is typically subject to the terms of the lease and the landlord's approval for certain actions, such as significant alterations or subleasing.

What makes an appropriate ground lease tenant?

An appropriate ground lease tenant is typically a party that is financially stable, has a good understanding of the real estate market, and has the capacity to develop and improve the property. Such tenants often provide personal guarantees or show evidence of strong financial backing, ensuring that they can meet the obligations of the lease, such as rent payments and property maintenance. Tenants who are experienced in managing or developing real estate are particularly desirable, as they are more likely to succeed in maximizing the property's value. Furthermore, landlords often look for tenants who are committed to a long-term partnership and have a clear vision for the development and use of the land.

Where can I learn more about ground leases?

For those interested in learning more about ground leases, there are a variety of resources available. One comprehensive resource is groundlease.nyc, a website dedicated to providing information about ground leases, their benefits, and how they are used in real estate transactions. In addition, real estate professionals, such as brokers and lawyers who specialize in ground leases, can offer personalized advice and guidance on the intricacies of these agreements. Engaging with experienced professionals can be particularly valuable for both landlords and tenants who are considering entering into a ground lease arrangement.

What is a Subordinated Ground Lease?

A subordinated ground lease is a type of ground lease where the tenant agrees that the landlord's interest in the land is subordinate to the interests of any lenders. In a subordinated ground lease, if the tenant takes out a loan to develop the property and then defaults on the loan, the lender may have the right to foreclose on the land and improvements. This arrangement can be riskier for the landlord, as they may lose control of the land if the tenant defaults. However, landlords may agree to a subordinated ground lease in exchange for higher rent or other favorable terms. These leases are more common in situations where the tenant needs financing to develop the property, as lenders are more likely to provide financing if they have recourse to the land.

What is an Unsubordinated Ground Lease?

An unsubordinated ground lease is the opposite of a subordinated lease. In this type of agreement, the landlord's interest in the land remains superior to any claims by the tenant's lenders. In other words, if the tenant defaults on a loan used to develop the property, the lender cannot foreclose on the land itself, though they may be able to take control of the improvements or pursue other remedies. This arrangement is generally less risky for the landlord, as they maintain full control over the land in the event of a default. As a result, unsubordinated ground leases typically result in lower rents, as tenants may have a harder time obtaining financing. However, many landlords prefer unsubordinated leases because they offer greater security and protect the property from being lost in a foreclosure.

What is the difference between a Subordinated and an Unsubordinated Ground Lease?

The primary difference between subordinated and unsubordinated ground leases lies in the risk to the landlord and the tenant's ability to obtain financing. In a subordinated ground lease, the landlord agrees to allow the tenant's lenders to have a claim on the land in the event of a default, which increases the risk to the landlord but can make it easier for the tenant to secure financing. In contrast, an unsubordinated ground lease keeps the landlord's interest in the land superior to any claims by the tenant's lenders, offering more protection to the landlord but potentially making financing more difficult for the tenant. In practice, landlords may prefer unsubordinated ground leases to minimize their risk, though they may need to offer lower rent to attract tenants willing to accept these terms. Subordinated ground leases, on the other hand, often involve higher rent but greater risk for the landlord.

Skyline Properties, Daniel Shirazi, NYREJ

IS THE GROUND LEASE A COVID-19 SAVIOR?

The declining retail market coupled with the COVID-19 pandemic has left many real estate investors in limbo. Buyers are uncertain what the future may bring and are thus not inclined to buy in this market. This leaves cash strapped owners no other option but to continue to let their property “bleed” or alternatively for owners who want to sell to keep their properties since they cannot find a replacement property via a 1031 transaction. Ground leases may prove to be a valuable alternative to a sale of the property. Simply put, a ground lease is a long-term net lease (usually 49 years or 99 years) of land including any improvements on the said land.

In recent years, ground leases have provided life support to cash strapped owners as once the ground lease is executed, the ground tenant would be responsible for all of the expenses and maintenance of the property. The owner would then receive an influx in cash via the lease. The ground lease would also eliminate the need to find a 1031 since the owner retains ownership of the property and therefore not subject to capital gains tax (although there are instances where capital gains tax might be incurred).

The ground lease provides a generational hassle-free income stream that can be sold or mortgaged at any time by the owner. The ground lessee will maximize the potential and improve the property by making capital improvements to the existing structure; or in the case of a development site, they will be constructing a new building that would revert back to the owner at the end of the lease.

Ground leases enable reluctant buyers to participate in the market since they would not need to provide the upfront capital that is needed to purchase the property therefore widening the potential pool of buyers for an owner. Many developers and commercial tenants have long been faced with property owners who ask for a price that isn’t supported by comparable sales. The owners are emotionally attached to the asset, and they’d rather sit on it than do a deal that makes sense for both parties. If an owner is unwilling to sell, a ground lease can still get a deal done that will give them long-term access to prime locations.

Although ground leases can be complex, they provide a tax efficient and a cost-effective alternative to a sale needed to navigate through the uncertainties in the current real estate market.

Written By Daniel Shirazi, Esq
November 3, 2020