Do you own land, perhaps with shabby residential or commercial property on it? One method to extract value from the land is to sign a ground lease. This will permit you to make earnings and potentially capital gains. In this post, we'll explore,
- What is a Ground Lease?
- How to Structure Them
- Examples of Ground Leases
- Benefits and drawbacks
- Commercial Lease Calculator
- How Assets America Can Help
- Frequently Asked Questions
What is a Ground Lease?
In a ground lease (GL), a renter establishes a piece of land during the lease period. Once the lease ends, the occupant turns over the residential or commercial property improvements to the owner, unless there is an exception.
Importantly, the occupant is accountable for paying all residential or commercial property taxes throughout the lease duration. The inherited enhancements permit the owner to offer the residential or commercial property for more money, if so wanted.
Common Features
Typically, a ground lease lasts from 35 to 99 years. Normally, the lessee takes a lease on some raw or ready land and constructs a structure on it. Sometimes, the land has a structure already on it that the lessee should demolish.
The GL defines who owns the land and the enhancements, i.e., residential or commercial property that the lessee constructs. Typically, the lessee controls and diminishes the improvements throughout the lease period. That control goes back to the owner/lessor upon the expiration of the lease.
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Ground Lease Subordination
One essential element of a ground lease is how the lessee will fund enhancements to the land. A crucial arrangement is whether the property manager will accept subordinate his concern on claims if the lessee defaults on its financial obligation.
That's specifically what takes place in a subordinated ground lease. Thus, the residential or commercial property deed ends up being security for the loan provider if the lessee defaults. In return, the property owner asks for greater lease on the residential or commercial property.
Alternatively, an unsubordinated ground lease maintains the property manager's leading priority claims if the leaseholder defaults on his payments. However this may prevent lenders, who would not be able to take ownership in case of default. Accordingly, the landlord will typically charge lower rent on unsubordinated ground leases.
How to Structure a Ground Lease
A ground lease is more complicated than regular commercial leases. Here are some components that go into structuring a ground lease:
1. Term
The lease needs to be sufficiently long to permit the lessee to amortize the cost of the enhancements it makes. In other words, the lessee needs to make sufficient profits throughout the lease to spend for the lease and the improvements. Furthermore, the lessee must make an affordable return on its financial investment after paying all expenses.
The most significant motorist of the lease term is the funding that the lessee sets up. Normally, the lessee will desire a term that is 5 to 10 years longer than the loan amortization schedule.
On a 30-year mortgage, that implies a lease regard to a minimum of 35 to 40 years. However, junk food ground rents with much shorter amortization durations may have a 20-year lease term.
2. Rights and Responsibilities
Beyond the plans for paying rent, a ground lease has numerous special functions.
For example, when the lease expires, what will happen to the enhancements? The lease will specify whether they revert to the lessor or the lessee must eliminate them.
Another function is for the lessor to help the lessee in acquiring essential licenses, authorizations and zoning variations.
3. Financeability
The lending institution must have option to protect its loan if the lessee defaults. This is difficult in an unsubordinated ground lease because the lessor has first top priority when it comes to default. The lender just can claim the leasehold.
However, one solution is a provision that needs the follower lessee to utilize the lending institution to finance the new GL. The subject of financeability is intricate and your legal professionals will require to wade through the various complexities.
Remember that Assets America can assist finance the building or restoration of commercial residential or commercial property through our network of private investors and banks.
4. Title Insurance
The lessee should organize title insurance for its leasehold. This requires unique endorsements to the regular owner's policy.
5. Use Provision
Lenders desire the broadest use provision in the lease. Basically, the provision would permit any legal purpose for the residential or commercial property. In this method, the lending institution can more quickly offer the leasehold in case of default.
The lessor may can authorization in any new purpose for the residential or commercial property. However, the lending institution will look for to limit this right. If the lessor feels strongly about forbiding certain usages for the residential or commercial property, it must specify them in the lease.
6. Casualty and Condemnation
The lending institution controls insurance coverage earnings originating from casualty and condemnation. However, this might contravene the standard phrasing of a ground lease, which provides some control to the lessor.
Unsurprisingly, loan providers want the insurance coverage continues to approach the loan, not residential or commercial property repair. Lenders also require that neither lessors nor lessees can terminate ground leases due to a casualty without their approval.
Regarding condemnation, loan providers insist upon taking part in the procedures. The loan provider's requirements for using the condemnation proceeds and managing termination rights mirror those for casualty occasions.
7. Leasehold Mortgages
These are mortgages financing the lessee's improvements to the ground lease residential or commercial property. Typically, loan providers balk at lessor's keeping an unsubordinated position with respect to default.
If there is a preexisting mortgage, the mortgagee needs to accept an SNDA agreement. Usually, the GL lending institution desires first concern regarding subtenant defaults.
Moreover, lending institutions require that the ground lease remains in force if the lessee defaults. If the lessor sends a notice of default to the lessee, the lender should get a copy.
Lessees want the right to obtain a leasehold mortgage without the loan provider's consent. Lenders want the GL to act as collateral needs to the lessee default.
Upon foreclosure of the residential or commercial property, the lender receives the lessee's leasehold interest in the residential or commercial property. Lessors may wish to restrict the kind of entity that can hold a leasehold mortgage.
8. Rent Escalation
Lessors want the right to increase leas after specified durations so that it preserves market-level leas. A "ratchet" increase offers the lessee no defense in the face of a financial recession.
Ground Lease Example
As an example of a ground lease, think about one signed for a Starbucks drive-through shipping container shop in Portland.
Starbucks' principle is to sell decommissioned shipping containers as an eco-friendly alternative to conventional building. The very first store opened in Seattle, followed by Kansas City, Denver, Chicago, and one in Portland, OR.
It was a rather uncommon ground lease, because it was a 10-year triple-net ground lease with 4 5-year options to extend.
This provides the GL a maximum regard to 30 years. The lease escalation stipulation supplied for a 10% rent increase every five years. The lease value was just under $1 million with a cap rate of 5.21%.
The initial lease terms, on an annual basis, were:
- 09/01/2014 - 08/31/2019 @ $52,000.
- 09/01/2019 - 08/31/2024 @ $57,200.
- 09/01/2024 - 08/31/2029 @ $62,920.
- 09/01/2029 - 08/31/2034 @ $69,212.
- 09/01/2034 - 08/31/2039 @ $76,133.
- 09/01/2039 - 08/31/2044 @ $83,747
Ground Lease Pros & Cons
Ground leases have their advantages and drawbacks.
The benefits of a ground lease consist of:
Affordability: Ground leases allow tenants to construct on residential or commercial property that they can't manage to buy. Large store like Starbucks and Whole Foods utilize ground leases to broaden their empires. This allows them to grow without saddling the companies with excessive financial obligation.
No Down Payment: Lessees do not have to put any cash to take a lease. This stands in plain contrast to residential or commercial property acquiring, which might need as much as 40% down. The lessee gets to save money it can deploy in other places. It also enhances its return on the leasehold investment.
Income: The lessor gets a steady stream of earnings while keeping ownership of the land. The lessor keeps the worth of the income through using an escalation stipulation in the lease. This entitles the lessor to increase leas occasionally. Failure to pay rent provides the lessor the right to force out the renter.
The downsides of a ground lease include:
Foreclosure: In a subordinated ground lease, the owner risks of losing its residential or commercial property if the lessee defaults.
Taxes: Had the owner simply offered the land, it would have qualified for capital gains treatment. Instead, it will pay regular business rates on its lease income.
Control: Without the required lease language, the owner might lose control over the land's development and usage.
Borrowing: Typically, ground leases prohibit the lessor from borrowing against its equity in the land throughout the ground lease term.
Ground Lease Calculator
This is an excellent industrial lease calculator. You get in the area, rental rate, and representative's cost. It does the rest.
How Assets America Can Help
Assets America ® will organize financing for industrial tasks beginning at $20 million, without any upper limitation. We invite you to contact us for more information about our complete financial services.
We can assist fund the purchase, building, or renovation of business residential or commercial property through our network of private financiers and banks. For the very best in commercial genuine estate funding, Assets America ® is the smart option.
- What are the different types of leases?
They are gross leases, customized gross leases, single net leases, double net leases and triple net leases. The also consist of absolute leases, portion leases, and the topic of this article, ground leases. All of these leases offer benefits and disadvantages to the lessor and lessee.
- Who pays residential or commercial property taxes on a ground lease?
Typically, ground leases are triple internet. That implies that the lessee pays the residential or commercial property taxes during the lease term. Once the lease expires, the lessor becomes accountable for paying the residential or commercial property taxes.
- What takes place at the end of a ground lease?
The land constantly reverts to the lessor. Beyond that, there are two possibilities for completion of a ground lease. The very first is that the lessor acquires all enhancements that the lessee made during the lease. The second is that the lessee must destroy the improvements it made.
- The length of time do ground leases usually last?
Typically, a ground lease term extends to at lease 5 to ten years beyond the leasehold mortgage. For instance, if the lessee takes a 30-year mortgage on its enhancements, the lease term will run for a minimum of 35 to 40 years. Some ground leases extend as far as 99 years.
