Does A Ground Lease Fit Your Commercial Residential Or Commercial Property Needs
When renting an or commercial property, there are a variety of various types of commercial leases one could experience. In many cases renters may be trying to find a residential or commercial property they can construct on and create improvements that fit their specific requirements. If this holds true, then a ground lease might be the very best option.
A ground lease is a kind of lease agreement in which the occupant leases a piece of land and is allowed to develop that residential or commercial property during the period of the lease. During the lease term, the renter owns any buildings, developments or improvements 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 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 generally 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 types of ground leases: subordinated and unsubordinated. The distinction in between the two involves what occurs if the occupant is handling financial trouble throughout the term of the lease.
Subordinated Ground Lease
With a subordinated ground lease, the landlord consents to be a lower top priority with concerns to any other financing acquired on the residential or commercial property. If a renter takes out a loan to construct on the land and then defaults on the loan, the loan provider can go after the residential or commercial property, consisting of the land, as security. For example, an occupant who signs a subordinated ground lease might get a loan for $400,000 to build a retail residential or commercial property. However, if that renter runs into monetary problem and is unable to make loan payments, the loan provider can pursue the structure and the land.
"Typically, this is done to help with financial obligation financing to construct structures on the residential or commercial property," Miller and Peden stated. In most cases with a subordinated ground lease, the property manager may require higher lease payments since they're handling some amount of threat.
Unsubordinated Ground Lease
With an unsubordinated ground lease, the proprietor maintains higher priority than the lending institution. Lenders are unable to foreclose on the land or use it as security if a tenant is unable to make their loan payments. Rather, if the occupant defaults on the loan, the lender can only pursue their service properties. Some lending institutions may be unwilling to provide a mortgage to occupants who have signed an unsubordinated ground lease. Because of this added trouble for the occupants, property managers will usually charge lower lease.
Advantages and disadvantages of Ground Leases for Tenants
Like all leases, ground leases include their benefits and disadvantages, for both tenants and property owners. For tenants, the pros and cons may differ depending on what you're searching for in a commercial residential or commercial property.
Location: With a ground lease, tenants can build a residential or commercial property in a place of their choosing, without being bound to pre-existing buildings in a place that may not be ideal for their specific organization needs.
Lower Taxes: For both federal and state taxes, the rent paid on a ground lease is tax deductible. The renter is paying less taxes than they would be if they simply purchased the land.
No Down Payment: With a land purchase, the occupant would be paying a large down payment to buy the land, after which they would still require to develop on that land. However, with a ground lease, there is no downpayment, and more money can approach building on the land rather.
Reduced Lease Payments: If the renter were renting both the land and the structure, then lease payments would be much higher. With a ground lease, the occupant is making lower monthly payments.
Building Customization: When leasing an already existing space, the tenant is not able to tailor the building to fit their particular requirements. However, with a ground lease, occupants 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 costly, and although renters have the ability to tailor their structure as they see fit, often the financial expenses might exceed those benefits.
Doesn't Retain Ownership After the Lease Expires: After putting money and time into constructing a residential or commercial property and making improvements, the occupant will have to quit 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 make money from the improvements the renter made.
Responsible for Fees: The occupant needs to pay residential or commercial property taxes, insurance and upkeep expenses on the residential or commercial property for the regard to the lease.
Advantages and disadvantages of Ground Leases for Landlords
For property owners, a ground lease might be advantageous for a number of reasons, however naturally it comes with both advantages and disadvantages.
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 renter is accountable for residential or commercial property taxes.
Steady Income: Landlords have the advantage of getting monthly rent on the land, thereby giving them a constant income stream. In addition, many ground leases likewise consist of an escalation provision, which guarantees a lease boost and expulsion rights in the case of an occupant defaulting on payments.
Retains Ownership of Improvements: After the lease duration ends, the property owner maintains ownership of any improvements made on the land and can for that reason sell the residential or commercial property at a profit.
Lack of Control: In the circumstance where a property owner doesn't consist of specific stipulations in the lease, they might not have any say in what the tenant makes with the land.
Higher Income Tax: Although a landlord won't need to pay capital gains taxes, the lease they receive from the tenant counts as income, therefore they will need to pay greater earnings taxes.
In Houston last June, Peden and Miller worked out a 20-year, 2.64-acre ground lease for a new vehicle dealership. The land was leased to Grubbs Automotive, with plans to convert the existing structures into a brand-new Volvo automobile dealer. In this example, Grubbs Automotive is leasing the land but has the flexibility to develop new residential or commercial properties and make enhancements on the land and any existing buildings as they see fit. Once the lease term ends, if they do not renew, then all of those improvements become the residential or commercial property of the landlord.
What's the Difference Between a Ground Lease vs Leasehold?
A leasehold estate is extremely similar to a ground lease, because with a leasehold estate, the physical structures are owned by the occupant, and the land is owned by another party, from which the renter is leasing. The party that is renting the land from the landowner can use the land for the duration 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 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 structures that are on it for the period that has actually been concurred to. With a leasehold, there is an arrangement in 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 include more restrictions than ground leases but are otherwise relatively comparable.
Is a Ground Lease Right for You?
While a ground lease includes its advantages and downsides for both the occupant and the landlord, it is very important to know what you're looking for in a rental arrangement before picking a type of lease. Ground leases are helpful since of their longevity and surefire earnings for proprietors. And for tenants, ground leases allow you to construct a residential or commercial property that fits your custom needs. However, there are several lease structures. Before picking what fits your requirements, make sure to do your due diligence and discover the various types of commercial leases in presence.