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Subordinated vs. Unsubordinated
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What Is a Ground Lease? How It Works, Advantages, and Example
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Investopedia/ Tara Anand

A ground lease is an agreement in which an occupant is permitted to establish a piece of residential or commercial property throughout the lease duration, after which the land and all enhancements are committed the residential or commercial property owner.

- A ground lease is a contract in which a tenant can establish residential or commercial property during the lease duration, after which it is turned over to the residential or commercial property owner.
- Ground leases are commonly made by business property managers, who generally rent land for 50 to 99 years to renters who build buildings on the residential or commercial property.
- Tenants who otherwise can't manage to purchase land can construct residential or commercial with a ground lease, while landlords get a constant earnings and retain control over the use and development of their residential or commercial property.
How a Ground Lease Works

A ground lease indicates that enhancements will be owned by the residential or commercial property owner unless an exception is developed and states that all relevant taxes incurred throughout the lease duration will be paid by the renter. Because a ground lease enables the proprietor to assume all enhancements once the lease term expires, the property owner might offer the residential or commercial property at a higher rate. Ground leases are also typically called land leases, as landlords rent out the land only.

Although they are used primarily in commercial space, ground leases differ significantly from other kinds of business leases, like those discovered in shopping center and workplace structures. These other leases usually don't designate the lessee to handle obligation for the unit. Instead, these tenants are charged rent in order to operate their companies. A ground lease involves renting land for a long-lasting period-typically for 50 to 99 years-to a tenant who constructs a structure on the residential or commercial property.

Tenants usually presume duty for all financial elements of a ground lease, consisting of lease, taxes, construction, insurance coverage, and financing.

A 99-year lease is usually the longest possible lease term for a piece of property residential or commercial property. Historically, it was the longest possible under common law. Nowadays, it depends upon the jurisdiction whether leases longer than 99 years are permitted. Most U.S. states still have a 99-year maximum.

The ground lease specifies who owns the land and who owns the building and improvements on the residential or commercial property. Many landlords utilize ground leases as a method to retain ownership of their residential or commercial property for preparing factors, to avoid any capital gains, and to generate income and earnings. Tenants usually assume obligation for any and all expenditures. This includes construction, repairs, renovations, improvements, taxes, insurance, and any funding expenses associated with the residential or commercial property.

Example of a Ground Lease

Ground leases are often utilized by franchises and huge box stores, along with other commercial entities. The corporate head office will generally acquire the land, and enable the tenant/developer to construct and utilize the facility. There's a great opportunity that a McDonald's, Starbucks, or Dunkin Donuts near you are bound by a ground lease

A lot of Macy's shops are ground leased. Macy's owns the buildings but still pays lease on the ground the building is on. Since February 3, 2024, Macy's reported long-term lease liabilities of just under $3 billion. This rented realty consists of small-format stores, warehouse, workplace, and full-line shops.

A few of the basics of any ground lease must include:

- Regards to the lease.
- Rights of both the property owner and tenant
- Conditions on funding
- Use arrangements
- Fees
- Title insurance
- Default

Subordinated vs. Unsubordinated Ground Leases

Ground lease occupants often finance enhancements by handling financial obligation. In a subordinated ground lease, the proprietor agrees to a lower priority of claims on the residential or commercial property in case the tenant defaults on the loan for enhancements. Simply put, a subordinated ground lease-landlord essentially permits the residential or commercial property deed to function as collateral in the case of renter default on any improvement-related loan.

For this kind of ground lease, the landlord may work out higher rent payments in return for the threat taken on in case of occupant default. This might also benefit the landlord because constructing a building on their land increases the value of their residential or commercial property.

On the other hand, an unsubordinated ground lease lets the landlord keep the leading priority of claims on the residential or commercial property in case the tenant defaults on the loan for enhancements. Because the lending institution might not take ownership of the land if the loan goes unpaid, loan professionals might be hesitant to extend a mortgage for enhancements. Although the property manager keeps ownership of the residential or commercial property, they generally need to charge the renter a lower amount of rent.

Advantages and Disadvantages of a Ground Lease

A ground lease can benefit both the occupant and the proprietor.

Tenant Benefits

The ground lease lets a tenant build on residential or commercial property in a prime area they might not themselves purchase. For this reason, large chain shops such as Whole Foods and Starbucks frequently use ground leases in their corporate growth plans.

A ground lease also does not need the occupant to have a down payment for protecting the land, as acquiring the residential or commercial property would require. Therefore, less equity is included in acquiring a ground lease, which maximizes money for other functions and enhances the yield on making use of the land.

Any lease paid on a ground lease might be deductible for state and federal income taxes, suggesting a decrease in the occupant's overall tax burden.

Landlord Benefits

The landowner acquires a consistent stream of income from the occupant while maintaining ownership of the residential or commercial property. A ground lease normally contains an escalation clause that guarantees boosts in rent and eviction rights that provide protection in case of default on lease or other expenditures.

There are likewise tax cost savings for a proprietor who utilizes ground leases. If they sell a residential or commercial property to a tenant outright, they will understand a gain on the sale. By executing this kind of lease, they prevent needing to report any gains. But there may be some tax implications on the rent they receive.

Depending on the arrangements put into the ground lease, a landlord might likewise be able to maintain some control over the residential or commercial property including its use and how it is established. This suggests the proprietor can approve or reject any modifications to the land.

Tenant Disadvantages

Because proprietors may require approval before any modifications are made, the occupant may encounter obstructions in the use or advancement of the residential or commercial property. As a result, there might be more constraints and less flexibility for the tenant.

Costs related to the ground lease procedure may be greater than if the tenant were to buy a residential or commercial property outright. Rents, taxes, enhancements, allowing, along with any wait times for proprietor approval, can all be expensive.

Landlord Disadvantages

Landlords who don't put in the proper arrangements and stipulations in their leases stand to lose control of occupants whose residential or commercial properties go through development. This is why it's always important for both parties to have their leases evaluated before signing.

Depending on where the residential or commercial property lies, utilizing a ground lease may have greater tax implications for a landlord. Although they might not realize a gain from a sale, rent is considered earnings. So lease is taxed at the regular rate, which might increase the tax burden.

What Are the Disadvantages of a Ground Lease?

Some of the disadvantages of ground leases consist of the possibility of residential or commercial property loss, loss of higher earnings due to market changes if lease increases aren't constructed into the contract, and tax drawbacks, such as depreciation and other expenses that can't balance out earnings.

Is a Ground Lease a Good Investment?

It can be. A ground lease lets a renter build on residential or commercial property in a prime area they could not themselves purchase. They can invest their money in improving the residential or commercial property. On the other hand, an occupant may deal with limitations on what they can do with the residential or commercial property.

What Happens When a Ground Lease Expires?

Ground leases normally last years so it will not end anytime soon. When it does, you'll need to leave the residential or commercial property, and all buildings and enhancements go back to the landlord. However, a lease can be extended. Prior to the expiration date, unless you or your proprietor take particular steps to end the agreement, it will just continue precisely the same terms up until its end. You do not need to do anything unless you receive a notice from your landlord.

A ground lease is an arrangement in which a renter can establish residential or commercial property during the lease period, after which it is committed the residential or commercial property owner. Ground leases are typically made by industrial property owners, who usually lease land for 50 years to 99 years to tenants who construct structures on the residential or commercial property.

Tenants who can't afford to purchase land can develop on the residential or commercial property and use the land, while proprietors get a steady income and retain control of their residential or commercial property.

Schorr Law. "Lease Over 99 Years Is Void, Not Voidable."

Macy's. "Macy's, Inc.
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