What is a ‘Ground Lease’
A ground lease is an agreement in which a tenant is permitted to develop a piece of property during the lease period, after which the land and all improvements are turned over to the property owner. A ground lease indicates that the improvements will be owned by the property owner unless an exception is created and stipulates that all relevant taxes incurred during the lease period will be paid by the tenant. Because a ground lease allows the landlord to assume all improvements once the lease term expires, the landlord may sell the property at a higher rate.
BREAKING DOWN ‘Ground Lease’
A ground lease involves leasing land, typically for 50 to 99 years, to a tenant who constructs a building on the property. The ground lease defines who owns the land and who owns the building and improvements on the property.
Subordinated and Unsubordinated Ground Leases
Ground lease tenants often finance improvements by taking on debt. In a subordinated ground lease, the landlord agrees to a lower priority of claims on the property in case the tenant defaults on the loan for improvements. In other words, the landlord in a subordinated ground lease essentially allows for the property deed to act as collateral in the case of tenant default on any improvement-related loan. For this type of ground lease, the landlord may negotiate higher rent payments in return for the risk taken on in case of tenant default. This may also benefit the landlord because constructing a building on his land increases the value of his property.
In contrast, an unsubordinated ground lease lets the landlord retain top priority of claims on the property in case the tenant defaults on the loan for improvements. Because the lender may not take ownership of the land if the loan goes unpaid, loan professionals may be hesitant to extend a mortgage for improvements. Although the landlord retains ownership of the property, he typically has to charge the tenant a lower amount of rent.
Benefits of a Ground Lease
A ground lease lets a tenant build on property in a prime location that he could not purchase. For this reason, large chain stores such as Whole Foods and Starbucks often utilize ground leases in their corporate expansion plans.
A ground lease also does not require the tenant to have a down payment for securing the land, as purchasing the property would require. Therefore, less equity is involved in acquiring a ground lease, which frees up cash for other purposes and improves the yield on utilizing the land.
In addition, the landowner gains a steady stream of income from the tenant while retaining ownership of the property. A ground lease typically contains an escalation clause that guarantees increases in rent and eviction rights that provide protection in case of default on rent or other expenses.
Example of a Ground Lease
In July 2016, AllianceBernstein, an investment firm based in New York, purchased a 99-year ground lease from BLDG Management for New York City’s George Washington Hotel in a deal worth $100.4 million. BLDG originally purchased the hotel when it was in foreclosure in 1994. Although the building was most recently used by the Manhattan-based School of Visual Arts as a student dormitory, BLDG filed plans in April 2016 to restore the property to a hotel with a restaurant, bar and ground-level stores.